Rev. Rul. 85-188, 1985-2 CB 339


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; farmers cooperative credit association.--
A farmers co-operative credit association that prepares Schedule F of Form 1040 as part of a computerized data processing system provided to members is an income tax return preparer if the Schedule F is a substantial portion of a member's return.


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ISSUE 1


Are a farmers cooperative credit association and its employees who prepare Schedule F of Form 1040 (Farm Income and Expenses) income tax return preparers under 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, a farmers cooperative credit association, lends money to member farmers. In connection with this activity, X markets a computerized data processing system which it provides to its members as a service. Using information submitted by members of the cooperative, the system provides a variety of schedules and summaries dealing with each member's financial operations, including a completed Schedule F, a Form W-2 (Wage and Tax Statement), and a Form 941 (Employer's Quarterly Federal Tax Return) for reporting withheld income tax and Federal Insurance Contribution Act taxes. To complete the Schedule F the computer has been programmed to figure the amount of allowable depreciation and to make other tax computations based on the information fed into it.


Some members do not want all these items and request only the schedules and summaries they feel would be useful. X charges a standard fee regardless of whether its members receive all of the information provided.


A, an employee of X, is responsible for explaining the computer system to potential members, helping members assemble and code data for input into the system, reviewing the items furnished to the members, and performing otherduties not directly related to administration of the system. A is familiar with both the financial and operational aspects of farming and has knowledge of farm finance and individual income taxation. A may advise the members on howto classify tax items when assisting them. A also reviews the completed forms to ensure that the correct information is fed into the computer so that forms are completed properly. A does not, however, purport be a tax specialist and does not prepare Form 1040 (U.S. Individual Income Tax Return) for members. Such returns are usually prepared by other income tax return preparers or by the members themselves.


LAW AND ANALYSIS

ISSUE 1


Section 7701(a)(36) of the Code defines an income tax return preparer as any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed by subtitle A or any claim for refund of tax imposed by subtitle A. The preparation of a substantial portion of a return or claim for refund is treated as if it were the preparation of the return or claim. Persons who merely furnish typing, reproducing, or other mechanical assistance are excepted from the definition of preparer.


Section 301.7701-15(b) of the Regulations on Procedure and Administration provides that only a person (or persons acting in concert) who prepares all or a substantial portion of a return or claim is considered a preparer. A person who gives advice directly relevant to the determination of the existence, characterization, or amount of an entry on a return or claim is regarded as having prepared that entry. Whether a schedule, entry, or other portion of a return or claim is a substantial portion of the return or claim is determined by comparing the length and complexity of, and the tax liability or refund involved in, that portion to the length and complexity of, and tax liability or refund involved in, the return or claim for refund as a whole.


To be a preparer under section 7701(a)(36) of the Code, a person must satisfy all the elements of the definition of preparer. In summary, the person must prepare a return for compensation or employ a person who is a preparer with respect to a return or claim.


Form W-2 and Form 941 are specifically excluded from the definition of income tax returns by section 301.7701-15(c)(1)(ii) of the regulations. Schedule F, while not a return in itself, may be a substantial portion of a return if it meets the criteria in section 301.7701-15(b).


Because the amount of depreciation and other tax computations are made for members, the data processing system has been programmed to make substantive tax determinations. A's assistance to the members involves substantive tax advice in instances where A makes determinations about how tax items are to be classified when providing the assistance.


The members pay an amount for the use of the entire system, including preparation of Schedule F. A is compensated for duties, including those related to the operation of the system, although many of A's duties do not involvepreparation of Schedule F.


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 substantive 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 imposed by section 6695(c) of the Code does not fall on a 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.


HOLDING

ISSUE 1


Preparation of a Schedule F by X's computerized data processing system is preparation of a federal income tax return under section 7701(a)(36) of the Code only when the Schedule F constitutes a substantial portion of a Form 1040 filed by a taxpayer. Thus, X is an income tax return preparer with respect to such a return. A also is considered an income tax return preparer with respect to such a return when A makes independent determinations about what items should be fed into the computer (i.e., which items are deductible, which are not) or how the information on completed forms should be categorized.


ISSUE 2


In those situations in which X is considered an income tax return preparer because Schedule F constitutes a substantial portion of the return, X may be subject to the following requirements and/or 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 a member'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 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. Similarly, A also is potentially subject to such a penalty if A is a preparer with respect to a return.


X must furnish a copy of Schedule F to members and retain a list of taxpayers for whom schedules have been prepared and may be penalized under sections 6695(a) and 6695(d) of the Code for failure to do so.


Because neither X nor its employees has primary responsibility for the overall substantive accuracy of a member's return, neither A nor X is required to sign a return and neither is subject to the penalty for failure todo so. Similarly, neither X's nor A's identifying number need appear on the return.


Under section 6060 of the Code, X must keep a record of A and any other person in its employ that meets the definition of income tax return preparer. X is subject to the penalty under section 6695(e) 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 a member for whom a Schedule F was prepared.


Both X and A may be subject to the criminal penalty under section 7216 of the Code if either makes an unlawful disclosure or use of return information. This penalty could apply even if Schedule F does not constitute a substantial portion of a return and even if A is not an income tax return preparer because of the absence of independent determinations with respect to a given return.