Rev. Rul. 85-189, 1985-2 CB 341


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; sale of computer pregram.-- A person who prepares a computer program and sells it to a taxpayer to use in preparing the taxpayer's income tax return may be an income tax return preparer.


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ISSUE 1


Is a person who prepares a computer program and sells it to a taxpayer to use in preparing the taxpayer's income tax return considered an income tax return preparer within the meaning of section 7701(a)(36) of the Internal Revenue Code under the circumstances described below?


ISSUE 2


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


FACTS


X has prepared a computer program that is to be used to complete Form 1040, U.S. Individual Income Tax Return, for calendar year 1983 and that X sells to customers. A, a customer of X, used the program to complete A's Form 1040 for calendar year 1983 without any assistance from X. A entered figures into a computer after the computer program explained the requirements for each entry on the return (that is, what constitutes income, what items are deductible, which persons may be claimed as dependents, etc). The computer is programmed to calculate some return items for the taxpayer based on the information fed into it. For example, the program determines whether the taxpayer is eligible for various deductions and credits and the amounts allowable. The computer prints the figures for all the lines of the return on a line printer. X designed the computer program so that customers can use it even if they are not familiar with the provisions of the Code and regulations.


The program used in computing the tax on A'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 A 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 A'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. However, X failed to reprogram the program for 1983 to take this change into account.


In 1984, the Service examined A's return and determined that the failure to reduce the basis of A'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.


Section 301.7701-15(a)(1) of the Regulations on Procedure and Administration provides that if a person furnishes a taxpayer or other preparer enough information and advice to make completing the return or claim for refund largely a mechanical or clerical matter, the person is considered an income tax return preparer, even if he or she does not actually place or review information on the return or claim for refund.


The determination of whether X is considered the preparer of A's return does not depend on whether X or X's employees personally reviewed the completed return or whether X or X's employees actually placed any of the figures on the return. Rather, such a determination depends on whether X has given substantive tax instructions in the computer program.


X is considered a preparer with respect to A's return because X's computer program provides more than mere mechanical assistance. Substantive determinations are performed by X's computer program concerning the application of section 48(q) of the Code to the factual information supplied by A.


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.


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 under statement; 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.


Section 6695(b) of the Code imposes an obligation on preparers to furnish their identifying numbers and section 6695(c) imposes a penalty for failure to do so.


Under sections 6060 of the Code and 1.6060-1 of the Income Tax 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.


The penalties in sections 6695(a)-(e) do not apply if the failure is due to reasonable cause.


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


Section 7216 of the Code imposes a criminal penalty for unlawful disclosure 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 A's 1983 income tax return.


ISSUE 2


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 A's return is due to a negligent or intentional disregard of rules or regulations by X, or if the understatement is due to X's attempt to willfully understate the liability. In the determination of 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.


Sections 6695(a)-(e) of the Code and the regulations thereunder provide that the penalties will not apply if it is shown that the failure is due to reasonable cause and not due to willful neglect. In this case, noncompliance with sections 6695(a)-(e) would be viewed as due to reasonable cause since X had no involvement with the actual preparation of the return. Consequently, the penalties under sections 6695(a)-(e) do not apply to X under these circumstances.


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


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.