More likely than not standard

Reasonable belief that position would more likely than not be sustained on the merits

For returns prepared after May 25, 2007, the understatement of taxpayer's liability must be due to unreasonable position for the Code Sec. 6694 penalty to apply. A position is unreasonable if:


(1) the tax return preparer knew, or reasonably should have known, of the position;



(2) there was no reasonable belief that the position would more likely than not be sustained on its merits; and



(3) the position was not disclosed or there was no reasonable basis for the position (Code Sec. 6694(a)(2), as amended by the Small Business Tax Act of 2007 (P.L. 110-28)).


The standards of conduct that must be met to avoid imposition of the penalties for preparing a return with respect to which there is an understatement of tax was altered. First, the realistic possibility standard for undisclosed positions was replaced with a requirement that there be a reasonable belief that the tax treatment of the position was more likely than not the proper treatment. Moreover, the provision replaces the not-frivolous standard accompanied by disclosure with the requirement that there be a reasonable basis for the tax treatment of the position accompanied by disclosure (Joint Committee on Taxation, Technical Explanation of the Small Business and Work Opportunity Tax Act of 2007 (JCX-29-07) at ¶39,955.185).

Transitional Relief. For income tax returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing), the standards set forth under the previous law and current regulations under Code Sec. 6694 will be applied in determining whether the IRS will impose a penalty under Code Sec. 6694(a). Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Reg. §1.6694-2(c)(3) and Reg. §1.6662-4(f)(2). For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns due on or before December 31, 2007 (determined with regard to any extension of time for filing), 2007 employment and excise tax returns due on or before January 31, 2008, and 2007 estimated tax returns due on or before January 15, 2008, the reasonable basis standard set forth in the regulations issued under Code Sec. 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether a penalty under Code Sec. 6694(a) will be imposed (Notice 2007-54, I.R.B. 2007-27, June 11, 2007).

Until further guidance is issued, a tax return preparer is considered to have a reasonable belief that the tax treatment of an item is more likely than not the proper tax treatment (without considering that the return might not be audited, that if audited the issue would not be raised, or that the issue might be settled) if such preparer analyzes the pertinent facts and authorities in the manner described in Reg. §1.6662-4(d)(3)(ii) and, based upon such analysis, reasonably concludes in good faith that there is a greater than fifty percent likelihood that the tax treatment of the item would be upheld if challenged by the IRS. This standard will apply instead of Reg. §1.6694-2(b) (Notice 2008-13, I.R.B. 2008-3, December 31, 2007, at ¶46,229). In determining the reasonableness of the tax return preparer's belief that the position satisfies the more likely than not standard, the tax return preparer may rely in good faith and without verification upon information furnished by the taxpayer as well as by another advisor, tax return preparer or other third party, and is not required to independently verify the items reported on tax returns, schedules, or other third party documents to determine if the items meet the reasonable belief standard, but such preparer may not ignore the implications of information received or actually known.

Example:
During an interview conducted by Farley, a tax return preparer, the taxpayer provided a schedule prepared by Smith, another advisor in Farley's firm, for use in preparing the taxpayer's tax return. The schedule did not appear to be incorrect or incomplete, and based on the information Farley completed the tax return. Later the IRS determines there is an understatement of liability for tax resulting from incorrect information on the schedule. Farley was not required to audit or review the schedule to verify independently that it satisfied the standard requiring a reasonable belief that the position would more likely than not be sustained on the merits. Farley should not, therefore, be subject to the penalty under Code Sec. 6694(a).