Need Guidance Please

[Terry D EA]

I need some guidance and other opinions regarding this situation. A long time individual tax client joined in with his step father and formed a used car dealership as a single member LLC with the Step Dad making all the investment for startup in June of 09. Because of my previous relationship, with the step son, I was retained as the company accountant. An engagement of services was signed. Step Dad couuld not understand how to compensate his step son. I advised him his step son was an employee... October 09, Step dad wanted to gift step son a percentage of the LLC making it a partnership. I told him what needed to be done and to the best of knowledge it was and I was advised to include the step son as a 50% partner. As of yesterday, this guy calls and does not want the step son as a partner and wants the money the step son received listed on a 1099-MISC. Step dad did not mail any of the 1099's that I gave him for other vendors so he feels this should be an easy change. The 1065 is completed and the step dad now claims I have overstated the income for the year. If I had, this places the company in a loss instead of a profit. Changing the step son to a sub contractor places the company at a greater loss. Also, this places the step son in a position to have to pay income and self-employmen taxes and step daddy gets all the glory. I smell a huge rotting rat here.

Here are my questions:

1. The step son is my original client and dear friend and he is getting the screws from his step dad. How do I advise him to avoid breaking any client confidentiality?

2. Am I required to change the financial statements to reflect what this guy says they should be. All of the bank statements and other income and expense accounts reconciled at the date and hour I completed them.

3. Would you remove yourself from this engagement? Good revenue will be lost and I realize that no amount is worth getting involved with questionable acts.

Thanks,

[Lion EA]

Wow! Lots of ways to look at this, and the only way that matters is your way. I think that with the son your original client and the son not an owner or an officer in this new company the way the stepdad NOW describes it, I would handle this a lot like a divorce. If you had a long-time client that married and then not long after was in the midst of a divorce, what would you do? Keep your first client and decline the MFS return of his spouse? You could hand back stepdad's source documents and any work for which you were paid, explaining that you have a conflict of interest with no further explanation. You could also use a technique many mention: quote stepdad such a huge price for the "do-over" that he'll leave of his own accord. You know stepdad well enough by now to know if the latter will create more hard feelings than the former. In this situation, you want to take the calmest route. Looking forward to reading everyone's suggestions. Good luck.

[kcjenkins]

I think you will end up having to fire this guy. But while you may have to discuss this with an attorney or insurance carrier, I think the son was, you were informed, a partner, so I'd discuss this with him.

[Lion EA]

Good point, KC. With all the changes stepdad made and proposed, keep a really good time line.

[jainen]

>>How do I advise him to avoid breaking any client confidentiality?<<

In my opinion, really more of a guess, you still only have a POTENTIAL conflict of interest, no more or less than you've always had. Review your engagement letter and other records carefully to see who exactly is your client, either or both of the individuals or the LLC and/or partnership. Your friend can help by giving you the partnership agreement, memos, paystubs, insurance endorsements, or other documents that show a valid partnership was formed (assuming of course that he WANTS to show that, an assumption I can make but you can not!) Being discreet with the old man's information is no problem because your friend undoubtedly already knows all about it.

What would really be fun is if the engagement letter was signed by your friend or indicated he was the tax matters partner, so you give him the 1065 to file! (Okay, it might not be so much fun, depending on what relationship is involved in the word "step.")

[kcjenkins]

It means that they all have a right to be informed of tax issues, always been my policy that I would discuss any tax matter involving a partnership with any partner. Not only the 'tax matters' partner. That is part of the nature of a partnership, the 'joint and several liability' means they each have a right to be informed of all tax issues. And since a partnership is legal without any written partnership, the simple act of the Dad informing you that he was making it a partnership did 'create' a partnership. He can not just 'change his mind, and retroactively make that fact go away.

[Terry D EA]

Thanks for all the replies. I agree, this is an interesting one to say the least. I have now found that a formal partnership was never established. No agreement and the LLC is still listed as a single member LLC with the Secretary of State. Yes, the NC Secretary of State is real promt with it's filings. With that said, this becomes a little less complicated. I did advise the step dad that additional billings would occur due to his requests and ignorance.

I am glad that I have not filed the form 1065 yet even though I waisted my time preparing it. Don't have to worry about that can of worms now.

Still the question remains, should I change the financial statements to reflect step dad's desired figures? I say desired because I took every precaution possible to ensure my adjustements, closings' etc were accurate. My only guess is some transactions were entered in 2009 after I prepared the financials. I let this guy know that by my review and reference to the date and time stamp on the reports, they were accurate as of that time. My concern is not being able to verify the changes. If I am going to sign off on this, then it had better be right.

Jainen, I always like your responses as they usually cause me to look at the situation from a different perspective. A hugh thanks for that.

I agree with KC, that I may need to fire this guy. Any further suggestions are appreciated.

[jainen]

>>a formal partnership was never established<<

Why did you tell us you were "advised to include the step son as a 50% partner"?

At least for tax purposes I see no reason not to accept corrected or updated numbers from the client, assuming they are still consistent with everything else you know. You might ask for more documentation to support the accounting changes.

[Terry D EA]

>>a formal partnership was never established<<

Why did you tell us you were "advised to include the step son as a 50% partner"?

This is clearly my fault. I assumed there was a partnership based on the verbal information I received from the step dad. He told me his step son was a 50% partner. I should have requested the partnership operating agreement for verification.

At least for tax purposes I see no reason not to accept corrected or updated numbers from the client, assuming they are still consistent with everything else you know. You might ask for more documentation to support the accounting changes.

I agree here also and I have requested documentation to support the changes. I want to be able to see if any transactions were accidently entered into the wrong period that may have caused the difference. The books were not audited but I did do a pretty thorough review. I guess this set me off a little because there is always some question from this guy every time something is done. I setup the chart of accounts according to GAAP and then he adds accounts and changes things continually and tells me what should be expensed and what should be capitalized all while he has no idea of what depreciation or amortization is. He has created a large amount of miscelleanous expenses from personal fishing trips. I warned him about co-mingling of funds so he calls them miscelleanous. I told him I would have to make an amendment to the notes as to why the financials were amended and he told me that wasn't necessary because no one had seen the financials. The list goes on and on. I am prepared to pull my engagement and if it causes me to lose the step son's business as well, then that may be a risk I have to take.

Thanks for your input.

[kcjenkins]

A partnership does not have to be written to be legal. Just telling you that they had converted the business into a partnership made it a fact. Clearly now the dad has decided he does not want to stay with that, but it does not change what he told you at the time. I'd talk to the son before making a decision if I wanted to continue with this job or not. But that is your call.

[Terry D EA]

Thanks for all of the help and suggestions with this topic. Here is my final take and I am wondering how any of you would proceed.

1. I did as the Step dad asked and adjusted the financials and removed his step son (my orignal client and friend) as a partner and issued him a 1099 MISC. I then gave the step dad a link to the IRS pages regarding determining if a person is an employee or a sub contractor. My professional opinion is the step son is an employee and his income is subject to withholdings and the required payroll tax should be paid. Step dad of course disagrees. I advised him that I disagree and that it is his call and that he will utlimately be the one to face the IRS and I will not help him either. I will keep my notes to CMA.

2. I am not sure the step son knows what has happened here. He will now have income of 25,000.00+ that he will have to pay the self-employment tax plus penalties for not paying estimated taxes. I feel obligated to speak with him as he was my client first. Had he remained a partner, then he would have shared in a loss. Granted, the self-employment tax he had to pay either way, his wife works and there is withholdings from her income,Plus, they may have been counting on a refund based on the intended loss because this was discussed with me in the step dad's office. I am still concerned about putting myself in a position of revealing information that is privileged. What is the best way to handle this?

Finally, I will fulfill my end of the engagement by completing the company tax return and then fire this guy. He doesn't even know this is now a disregarded entity and goes on a schedule C. No doubt I will tick him off when I charge him for the partnership return I have completed that now is trash. Maybe after that, he'll quietly drop me instead.

[kcjenkins]

I would certainly discuss with the stepson the options he has, INCLUDING FILING AN 8919. Seems to me this guy has been shafted enough already, without having to pay both halves of the payroll taxes as well. Either he was a partner, and thus self-employed, or he was an employee of the A--...., one or the other. Filing him as self-employed seems to be giving him the worst of both.

[Terry D EA]

KC I couldn't agree with you more. It is just that, the step son is getting the screws put to him and I feel terrible about it. The step son has been my friend and loyal client for the last 10 years and I have left him a message to call me. After some thought, he was involved in alot of the discussions and nothing was to be withheld from him so I will let him know what he is facing.

I have recently realized that every conversation with the step dad always leans toward what someone else has told him, that contradicts what I have advised him. I advised him his step son was an employee from my perspective as well as the IRS regs. Someone else, probably a barber shop accountant or tax preparer, told him he wasn't.

After I speak with the step son, I will probably terminate my engagement. Thanks for your help and suggestions and as always they are greatly appreciated.

[kcjenkins]

Is the son still going to continue working for him? That makes a difference in how he treats it, naturally. But he ought to have a clear idea of how much it's costing him to go that way. Maybe stepDad will pay his extra cost.....at least it's worth considering.

[Terry D EA]

KC,

I did speak with the step son and he is fine with the arrangements. I asked him several times after explaining the situation if he clearly understood and he said he was okay with it. So, there you have it. He is going to continue to work for his step dad so maybe there is some agreement that I don't know about that makes this all okay. Anyway, I am done with the back and forth stuff and feel I have done my part.