What Makes an Excellent Tax Return Reviewer

BONUSES: A 10-question test (and answer key), plus 18 other issues you might want to test.

By Ed Mendlowitz
How to Review Tax Returns: The Field-Tested Update

Firms have to decide who will do the tax return review, and how qualifed they are for this. Ideally, trained tax department personnel are the primary reviewers. However, the bunching and compression of work often shifts some of the review to higher level, non-tax personnel such as audit managers and partners who might not have the comprehensive training, background, knowledge and experience to handle everything that comes up during the tax preparation process.

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Additionally, in many firms, almost everyone on the staff will prepare some returns to ease the almost insurmountable burden on the tax department. That lack of trained preparers, though, places an added burden on the reviewers, making it important for them to be more aware and alert when they perform the review.

Reviewing returns is usually done by preparers with an above average knowledge of taxes who express interest in advancing in the tax specialty. They take added tax CPE, actually read the tax articles in the journals they subscribe to, think about unusual tax rulings and decisions, talk taxes with their buddies and associates at other firms, seek graduate degrees in taxes and develop an ability in article writing and speech presenting. It is important for the staff person to express the interest in stepping up to become a reviewer although it is part of good management for an owner or partner to spot the potential and conscript the preparer to become a reviewer.

I know many non-tax specialist managers and partners who feel they could review returns. But in my opinion, they lack the broad range of knowledge and experience to do a reasonable job. They spend their time ticking and tying and consider that an adequate review. But it isn’t, because they don’t have the ability to identify or uncover issues or flush out opportunities for either the current return they are reviewing or planning for the next tax year.

Reviewers also need to be familiar with the processes and procedures and have patience and ability to train and insist that procedures be followed and have a consistent record of adherence to the system. Shortcutters will never make good reviewers.

I suggest giving any person who might be reviewing returns a short test to determine whether they have the basic knowledge a reviewer will need for situations they might encounter. These questions are suggestions. They should be tailored to the type of practice you have, and the issues your reviewers might come across.

10-Question Reviewer Qualification Test

Following are 10 questions reviewers should be able to answer to qualify for their role. Note: Whether or not you agree with the questions below, you have to consider a method for making sure reviewers are qualified. Doing so should also include reviewer-appropriate CPE and in-house training.

1. What is the latest date a simplified employee pension (SEP) plan can be opened for the previous tax year for a sole proprietor? Planning question: What advice would you give to that client for the current year?
2. What date is used as the “date purchased” to report a stock transaction that includes an unallowed loss because there was a previous wash sale?
3. Are extra payments made to an ex-spouse to cover unanticipated increases in tuition in her nursing school deductible as alimony? The divorce occurred before 2019.
4. What is the maximum federal capital gains tax rate from any portion of the gain on commercial real estate that an individual tax client sells?
5. When would you use the annualization exception for the 2210 penalty?
6. How are individuals taxed on section 1256 gains?
7. How would you advise a client who makes large amounts of annual charitable contributions and typically reports large long-term capital gains?
8. What cost basis is used when a client sells immediately upon vesting employer-issued restricted stock shares that had no cost and the stockbroker has provided a 1099-B showing proceeds of $8,100? Use an approximate amount for the cost basis for your answer.
9. What is the equivalent taxable interest amount for a client with 4 percent municipal bond interest if his or her marginal federal tax rate is 25 percent (assume no state tax)?
10. What is the taxable income for a client who sells legal marijuana with sales of $5,000,000, cost of sales of $2,500,000, selling costs of $1,000,000 and general and administrative expenses of $500,000?

The Answers (No peeking)

1. A SEP can be opened through the latest due date, including extensions, of the tax return for the previous year. This cannot be done for a taxpayer over 70½ and catch-up contributions do not apply to SEPs. The planning should be for the client to consider a solo 401(k) for the current year and going forward. Note: Contributions cannot be made to a SEP for an owner over age 70½ but can be made to a solo 401(k) including catch-up contributions.
2. The date the first or original lot of stocks was purchased.
3. Voluntary payments, which the tuition would be, to an ex-spouse are not deductible as alimony.
4. Pre-1987 recaptured depreciation on real estate is taxed at ordinary income rates; 1987 or later recaptured depreciation on real estate is taxed at a top capital gains rate of 25 percent and might be subject to an additional 3.8 percent for net investment income tax.
5. When the income or deductions are earned erratically, bunched or not received or paid equally during the year, and it results in a lower or no 2210 penalty.
6. The gains are taxed as 60 percent long-term capital gains and 40 percent short-term capital gains regardless of holding period.
7. The client should consider donating appreciated long-term owned securities. The client would get a charitable deduction for the fair market value of the securities and not have to report the capital gain income.
8. The employer is required to report the entire gain as wages on the employee’s Form W-2. I would use $8,100. However, the technically correct answer is that the cost should be the fair market value on the date vested, before deduction for the broker’s commission. A practical solution on small transactions is to use the net proceeds.
9. Thirty-three percent. Divide 4 percent by 75 percent (1 – 25 percent).
10. The taxable income is $2,500,000. Marijuana is an illegal substance for federal purposes so only the cost of sales is deductible.

18 more issues that you can test, depending on the nature of your practice:

• Section 1231 losses
• Section 1245 and 1250 recapture
• 1244 losses
• 754 step-up
• Capital gains on sale of collectibles
• Contributions of art that has appreciated in value that is immediately resold by the charity
• Disclosure thresholds for non-cash charity
• How charity expense on a Schedule C business is reported
• Basis of a Roth IRA account that is terminated early
• Section 83(b) elections
• How legal fees are deducted when a client wins a settlement in a litigated matter and the attorney received a 33 percentage of the award as a fee
• How are capital gain transactions taxed for a client’s irrevocable life insurance trust
• How are interest and dividends taxed that a client’s revocable living trust has
• Office at home maintained as a condition of employment for a salesperson, or a self-employed individual
• What type of retirement plan a one-owner business that employs many people can establish so the owner gets a giant share of the plan’s contribution
• How real estate taxes and mortgage interest are treated on a piece of land a client purchased for investment purposes
• How a client can use their IRA funds to invest in real estate
• The taxability to an IRA or Roth IRA of gains resulting from investments in shares of a publicly traded partnership

Posted on March 1, 2023