Rev. Rul. 85-187, 1985-2 CB 338


Section 7701.--Definitions

26 CFR 301.7701-15: Income tax return preparer.

(Also Sections 6107, 6109, 6694, 6695, 7216; 1.6107-1, 1.6109-2, 1.6694-1, 1.6695-1, 301.7216-1.)

Return preparers; computerized tax return preparation service.-- A firm that furnishes a computerized tax return preparation service to tax practitioners is an income tax return preparer when the program used goes beyond mere mechanical assistance.


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ISSUE 1


In the situation described below, is a firm that furnishes a computerized tax return preparation service to tax practitioners an income tax return preparer under section 7701(a)(36) of the Internal Revenue Code?


ISSUE 2


If so, what requirements and/or penalties will apply?


FACTS


X is a firm that offers a computerized tax preparation service to tax practitioners such as attorneys and certified public accountants, including A. Practitioners such as A fill out sheets with information about their clients' income, deductions, etc. This work sheet requires the practitioners to make substantive determinations about categorization of income, allowability of deductions, etc. The practitioners forward the information to X, whose employees enter the information into X's computer, which has been programmed to produce a completed Form 1040, U.S. Individual Income Tax Return, together with appropriate supporting schedules. X then forwards the completed returns to the practitioners, who normally sign the clients' returns as preparers and give the returns to the clients. X does not deal directly with the public.


In 1984, B a client of A, came to A with information concerning income and deductions for the tax year 1983 and requested that A prepare Form 1040 for 1983. A studied the information, asked the requisite questions of B, completed X's worksheet, and mailed the worksheet to X. X then furnished a completed Form 1040 for B to A. A signed the return and gave it to B, who filed the return with the Internal Revenue Service.


The program that X used in computing the tax on B's 1983 return included a computation of an Accelerated Cost Recovery System (ACRS) deduction under section 168 of the Code with respect to property that B put into service during 1983. In computing the allowable deduction, X's program did not reduce the basis of the property by 50 percent of the amount of the credit claimed under section 46(a)(2), as required by section 48(q) as in effect for 1983. X's program would have correctly computed B's tax under the law in effect for 1982 before the amendment made by the Tax Equity and Fiscal Responsibility Act of 1982, section 205(a), 1982-2 C.B. 462, 474. X, however, failed to reprogram the system to take this change into account.


In 1984, the Service examined B's return and determined that the failure to reduce the basis of B's property caused an understatement of tax.


LAW AND ANALYSIS

ISSUE 1


Section 7701(a)(36)(A) of the Code defines an income tax return preparer as any person who prepares any return of tax, or any claim for refund of tax, imposed by subtitle A, for compensation, or any person who employs one or more personsto prepare such returns or claims for refund for compensation.


Section 7701(a)(36)(B)(i) of the Code provides that a person who merely furnishes typing, reproducing, or other mechanical assistance is not an income tax return preparer.


The Code and the regulations contemplate that more than one person can be a preparer with respect to a given return or claim for refund. For example, section 301.7701-15(a) of the Regulations on Procedure and Administration defines an income tax return preparer as any person who actually prepares the return as well as any person who employs (or engages) one or more persons to prepare a return. Similarly, section 301.7701-15(b)(1) of the regulations,in discussing whether preparation of a portion of a return is considered preparation of the return as a whole, speaks of "persons acting in concert". Thus, in this case, the fact that A is the preparer of B's return does not mean that X could not also be considered a preparer because A has engaged X for assistance in preparing a complete return for B.


X is considered a preparer with respect to B's return because X's calculations go beyond mere mechanical assistance to A. X's program has made substantive determinations concerning the application of section 48(q) in computing how much is deductible with respect to B's ACRS deduction, and goes beyond merely furnishing typing, reproducing, or other mechanical assistance.


ISSUE 2


Sections 6694(a) and 6694(b) of the Code provide that any person who is an income tax return preparer may be subject to a penalty if any part of an understatement of liability with respect to a return or claim for refund is due to a negligent or intentional disregard of rules or regulations by an income tax return preparer, or if the understatement is due to a willful attempt to understate the liability by an income tax return preparer.


Rev. Proc. 80-40, 1980-2 C.B. 774, provides guidelines for the application of the penalty under section 6694(a) of the Code. Under section 4.01 of Rev. Proc. 80-40, the following factors will be taken into consideration in determining whether to assert the penalty: The nature of the error causing the understatement; the frequency of errors; and the materiality of errors. Additionally, under section 4.02 of Rev. Proc. 80-40, the preparer's office practice will be taken into account in determining whether to assert the penalty.


Under section 6107(a) of the Code, an income tax return preparer has an obligation to furnish a copy of the return to the taxpayer and may be penalized under section 6695(a) for failure to do so. Under section 6107(b), an income tax return preparer has an obligation to retain a copy of the return or a list of taxpayers for whom returns have been prepared and may be penalized under section 6695(d) for failure to do so. When one preparer employs or engages another, the responsibility for these acts falls on the employer. See section 1.6107-1(c)(1) of the Income Tax Regulations.


Section 6695(b) of the Code imposes an obligation to sign the return and imposes a penalty for failure to do so. Under section 1.6695-1(b)(2) of the regulations, this obligation falls on the person with primary responsibility for the overall subtantive accuracy of the return, and not on every person who may be a preparer with respect to that return.


Section 6109(a)(4) of the Code imposes an obligation on preparers to furnish their identifying numbers. Under section 1.6695-1(c)(2) of the regulations, the penalty for failure to do so under section 6695(c) of the Code does not fall ona preparer engaged by another preparer.


Under sections 6060 of the Code and 1.6060-1 of the regulations, any person who employs an income tax return preparer must retain a record concerning each preparer so employed and may be penalized under section 6695(e) for failure to do so.


Section 6695(f) of the Code imposes a penalty on income tax return preparers who endorse or otherwise negotiate refund checks that are issued to taxpayers.


Section 7216 of the Code imposes a criminal penalty for unlawful disclosure or use of return information by persons who prepare returns or provide services in connection with the preparation of returns.


HOLDINGS

ISSUE 1


X is an income tax return preparer with respect to B's 1983 income tax return.


ISSUE 2


As an income tax return preparer, X may be subject to a number of requirements and penalties. X is potentially subject to a penalty under sections 6694(a) or 6694(b) of the Code if any part of an understatement of liability with respect to B's return is due to a negligent or intentional disregard of rules or regulations by X, or if the understement is due to X's attempt to willfully understate the liability. In order to determine whether the penalty under section 6694(a) will be asserted, the factors discussed in sections 4.01 and 4.02 of Rev. Proc. 80-40 must be considered.


The responsibility for furnishing a copy of the return to B and for retaining a list of taxpayers for whom returns have been prepared falls on A. Accordingly, X is not subject to the penalties under sections 6695(a) or6695(d) of the Code.


Because A had primary responsibility for the overall substantive accuracy of B's return, A correctly signed the return as preparer and X is not subject to the penalty under section 6695(b) of the Code for failure to do so.


Because X was engaged by A, A's identifying number and not X's should be shown on B's return. X is not subject to the penalty under section 6695(c) of the Code.


Under section 6060 of the Code, X must keep a record of any person in its employ that meets the definition of income tax return preparer. X is subject to the penalty under section 6695(e) of the Code for failure to do so.


X may be penalized under section 6695(f) of the Code if X endorses or otherwise negotiates a refund check issued to B.


X may be subject to the criminal penalty under section 7216 of the Code if X makes an unlawful disclosure or use of return information.