The Treasury and the Internal Revenue Service have long promised a crackdown on firms that sold abusive tax shelters. It looks like federal prosecutors are helping them keep that promise.

KPMG, which became the subject of a criminal probe by the U.S. Attorney’s Office in Manhattan for its past promotion of tax shelters that the IRS says were abusive, got some company on the hot seat last week, when rival Big Four firm Ernst & Young found out it, too, faces a criminal investigation for promoting tax shelters deemed abusive. It doesn’t matter that both firms, and many of the others that have been under intense scrutiny for their tax shelter activities in the 1990s, stopped promoting the shelters in question years ago. In E&Y’s case, it doesn’t even matter that the firm paid a $15 million penalty last year in a civil settlement with the IRS to resolve issues surrounding the firm’s past tax shelter work. That deal didn’t include the Justice Department.

Federal prosecutors impaneled a grand jury as part of the probe.

It’s still unclear whether the investigation is aimed at the firm as a whole, or only at individuals. And it’s been noted that the probe may not result in any criminal charges.

But it isn’t good publicity for the firm, which just last month was barred by a chief administrative law judge from accepting new Securities and Exchange Commission audit clients for six months and ordered to give up $1.686 million in audit fees and prejudgment interest in a case brought by the SEC related to the firm's independence in its audits of former client Peoplesoft.

And, even though it’s a probe of E&Y alone, it isn’t good news for the profession, the reputation of which has taken a substantial battering during the past few years and which has been working double-time to reassure the public and regulators that it isn’t only looking after its own interests.

It doesn’t really help that the news about the investigation broke at the same time the profession was making headlines related to fees for tax advice.

The SEC’s chief accountant made it pretty clear that he didn’t approve of an argument some accounting firms had proposed to justify contingent fees received for tax services provided to audit clients.

Auditor independence rules don’t allow firms to charge audit clients contingent fees, under which firms are paid based on a successful outcome for the client or receive an amount that’s based on the size of the result. But some firms had argued that an exception that’s allowed in instances where the fee is established by a court or governmental entity might allow contingent fees for tax preparation, since the amount charged would depend on the government’s acceptance, rejection or revision of the accounting firm’s work.

SEC chief accountant Donald Nicolaisen made his view clear in a letter to American Institute of CPAs’ Professional Ethics Executive Committee chairman Bruce Webb, who had raised the issue in a letter to Douglas Carmichael, the chief accountant of the Public Company Accounting Oversight Board: “The fact that a government agency might challenge the amount of the client’s tax savings and thereby alter the final amount of the fee paid to the firm heightens, not lessens, the mutuality of interest between the firm and the client. Accordingly, such fees impair an auditor’s independence.”

In other words, as with so many other questionable tax practices, it won’t fly.

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