You are preparing a current year (Year 2) individual tax return for Robert Lucca, a real estate developer and long-time client. While preparing Robert’s individual tax return you learn that he has interest income from a trust his 75-year-old father created last year (Year 1). Robert’s Year 2 income from the trust is properly reflected on a Schedule K-1 prepared by the accounting firm that prepared the trust’s Year 2 return. Robert prepared the trust’s return for Year 1, and decided that he should not be taxed on any of the trust’s income because the trust distributed nothing to him. Upon reviewing Robert’s copy of the trust instrument, you learn that the instrument calls for mandatory distributions of all the income to Robert every year. Assume that the trust reported $8,000 of taxable income for Year 1 and claimed no distribution deduction and that Robert was in the highest marginal tax bracket for Year 1.
What responsibility do you have to correct the error made for the tax Year 1? Assume instead that an IRS agent has just begun to audit Robert’s Year 1 individual tax return. What is your responsibility if you have discovered the error on the Year 1 trust return, and you are representing Robert in the audit?