Case 2-3
The Tax Return
Brenda Sells sent the tax return she prepared for the president of Purple Industries, Inc., Harry Kohn, to
Vincent Dim, the manager of the tax department at her accounting firm. Dim asked Sells to come to his
office at 9:00 a.m. on Friday, April 12, 2013. Sells had no idea why Dim wanted to speak to her. The only
reason she could come up with was the tax return for Kohn.
“Brenda, come in,” Vincent said.
“Thank you, Vincent,” Brenda responded.
“Do you know why I asked to see you?”
“I’m not sure. Does it have something to do with the tax return for Mr. Kohn?” asked Brenda.
“That’s right,” answered Vincent.
“Is there a problem?” Brenda asked.
“I just spoke with Kohn. I told him that you want to report his winnings from the lottery. He was
incensed.”
“Why?” Brenda asked. “You and I both know that the tax law is quite clear on this matter. When a
taxpayer wins money by playing the lottery, then that amount must be reported as revenue. The taxpayer
can offset lottery gains with lottery losses, if those are supportable. Of course, the losses cannot be higher
than the amount of the gains. In the case of Mr. Kohn, the losses exceed the gains so there is no net tax
effect. I don’t see the problem.”
“Let me tell you the problem,” Vincent stated sharply. “It’s taken me years to gain the trust of Kohn. Our
firm now audits his company’s books, prepares its annual tax return, prepares Kohn’s personal tax return,
and provides financial planning services for both. Kohn and Purple Industries together are the largest
clients in our office. I can’t afford to lose any of the business these clients provide for our firm. As you
know, we are under increasing competition from larger regional firms that are looking for new clients. If we
don’t support Kohn, some other firm will step in and do it. Poof, there goes 20 percent of our revenues.”
Brenda didn’t know what to say. Vincent seemed to be telling her the lottery amounts shouldn’t be
reported. But that was against the law. She turned to Vincent and asked: “Are you telling me to forget about
the lottery amounts on Mr. Kohn’s tax return?”
“I want you to go back to your office and think carefully about the situation. Consider that this is a one-
time request and we value our staff members who are willing to be flexible in such situations. Let’s meet
again in my office tomorrow at 9:00 a.m.
NOTES
This case has the student consider the ethics of keeping a tax client happy, particularly when that tax client
is providing other business for the office, versus doing the right thing. In other words, should client need
outweigh ethical behavior?
Many students will know that gambling losses are allowed up to the extent of gambling winnings.
However, it does not mean that there is not an effect. Gambling winnings are included as other income on
the 1040. This amount is included in the sum of the adjusted gross income (AGI). Gambling losses are
deducted on Schedule A, other itemized deductions.
Most CPAs would not be aware of a client’s gambling winnings and losses unless told about them.
However, once a taxpayer wins more than $600 in one gambling or lottery winnings, then the taxpayer will
receive a 1099G and will have 10% withheld for federal income taxes. In the above situation, most likely
there was a 1099G with the winnings included in the tax information of the client.
Ethical Issues
The students should consider the special roles of being a tax advocate for clients versus being an auditor for
clients. This case also concerns truth telling or disclosure, since the tax burden is not changed for the
taxpayers. The CPA has an obligation to follow tax laws and regulation but support the client if there are
reasonable supportable positions (i.e., realistic possibility of success). The CPA can face preparer penalties
for underreporting income.
Questions
1. Assume Brenda has no reason to doubt Vincent’s veracity with respect to the statement that it is
“a one-time request.” Should that make a difference in what Brenda decides to do? Why or why
not?
An ethical person acts ethically at all times, not after a one time ethical lapse in judgment. Ethics is not
relative to the situation. The fact that it “may” be a one-time request doesn’t permit deviating from the
profession’s ethical standards of integrity and objectivity. If it should not be a one-time request, the next
2. Analyze the alternatives available to Brenda using Kohlberg’s six stages of moral development.
That is, what would Brenda’s position be when she meets with Vincent assuming her judgment
was influenced by relevant factors at each of the six different stages of moral development?
Vincent is reasoning at stage 3 — trying to keep the client happy first and foremost. Brenda is reasoning at
stages 5 and 6 – law and order and universal values. Brenda should rely on those values to argue against
3. Assume Brenda decides to go along with Vincent and omits the lottery losses and gains. Next year
the same situation arises, but now it’s with gambling losses and gains. If you were Brenda, and
Vincent asked you to do the same thing you did last year regarding omitting the lottery losses and
gains, what would you do this second year? Why?
Now, Brenda is caught in her own cover-up and may feel reluctant to go against the client. Still, it’s never
too late to take the ethical high road. Even if Vincent gives her a hard time about it because she went along