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How an Engagement Letter Saved Manafort’s Accountant

Philip Ayliff testified at Paul Manafort’s trial about unreported offshore accounts and foreign financial interests. Without his engagement letter, Ayliff might have been in a lot of trouble.

Last August, Paul Manafort was convicted of five counts of tax fraud, one count of failure to file a foreign bank and financial accounts report (FBAR) and two counts of bank fraud. He avoided a second trial by pleading guilty to violating the Foreign Agents Registration Act (FARA) and agreeing to cooperate with the government, an agreement he is allegedly failing.

Recently, New York Magazine published an article titled “What exactly did Paul Manafort do to earn that $66 Million?” The $66 million in question were fees paid to Manafort’s firm for working with Ukrainian President Yanukovych’s political campaigns. Whatever the substance of that work, these fees were clearly paid by foreign persons and foreign entities. Failing to report these transactions is a serious offense.

The United States has a global income tax system. The purpose of the FBAR is to identify income that is outside of the US tax information system (W-2s, 1099s, etc) and report this income to the IRS using form FinCEN 114. Similarly, taxpayers must report whether they have any foreign accounts or other financial interests that exceed $10,000, regardless of whether these assets generate income. Failing to report these is fraud. The convictions for tax fraud and FBAR violations are therefore related.

There are astonishing civil and criminal penalties for failing to report foreign financial information. A willful failure has a civil penalty of $100,000 or 50% of the foreign financial interest, whichever is greater. The criminal penalty increases to $250,000 and up to five years in prison, and may be as high as $500,000 and ten years.

Prosecutors called Manafort’s accountant, Philip Ayliff, to testify about the allegedly unreported foreign income. Circular 230 § 10.34 prohibits tax preparers from signing a return that the preparer knows or reasonably should have known if anything on the return lacks a reasonable basis or is a willful attempt to understate a liability, either affirmatively or by intentionally disregarding the tax rules. There are statutory penalties under the tax code and a violation of Circular 230 means that the preparer can be sanctioned, censured and possibly disbarred.

If Ayliff was aware of the foreign accounts or unreported income, he would have violated tax preparer rules.

This would only be the beginning, however. The rules governing tax practice are the minimum standard of care for tax professionals. Failing to adhere to the standard of care is the test for professional negligence, potentially making Ayliff liable for the tax penalties, including the FBAR, if he were sued for malpractice.

However, Ayliff dodged a potential tsunami of liability by his testimony. First, he presented an engagement letter signed by Manafort in which Ayliff says that his firm “will not audit or verify the data you submit” and that the engagement “does not include any procedures designed to detect material errors, irregularities or illegal acts” (emphasis added).

In addition, Cir. 230 states that a tax preparer may rely in good faith and without verification upon the information provided by the client. Ayliff also produced emails and records of conversations in which he directly asked Manafort (and his partner, Gates) if they had any foreign accounts, to which they replied no.

Manafort’s other accountant was granted immunity to testify. Ayliff was not. However, he was able to protect his license, his assets and his partners’ interests by following Cir. 230 and using an engagement letter.

There is an interesting coda towards the end of Ayliff’s testimony. Under the reasonable cause exception to penalties, a taxpayer may be relieved of penalties if the taxpayer reasonably relied on the advice of a tax professional when filing the returns.

The Supreme Court ruled that a taxpayer’s reliance on tax advice is unreasonable if they didn’t give the tax advisor all of the information.

“Can you provide proper tax advice to Mr. Manafort if you are not aware of his foreign accounts?” prosecutor Uso Asonye asked.

“No,” Ayliff replied.

It would appear Manafort is out of options.