Sanctions against return preparers

The scope of return preparer penalties was expanded to apply to all tax return preparers for returns prepared after May 25, 2007 (Code Sec. 6694, as amended by the Small Business Tax Act of 2007 (P.L. 110-28)). The phrase, "tax return preparer," covers preparers of not only income tax returns but, also, estate and gift tax, employment tax, excise tax, and exempt organization returns (see Code Sec. 7701(a)(36)(A), as amended by P.L. 110-28).

Under Code Sec. 6694(a), as amended, an "unreasonable position" penalty applies to preparers if the preparer knew (or reasonably should have known) of the position, did not have a reasonable belief that the position would more likely than not be sustained on its merits, and either did not disclose the position as provided in Code Sec. 6662(d)(2)(B)(ii) or did not have a reasonable basis for the position. Prior to amendment, Code Sec. 6694(a) imposed the penalty with respect to a position which had no "realistic possibility" of being sustained on its merits. The Small Business Tax Act of 2007 replaces the "realistic possibility" standard with a requirement that the preparer have a reasonable belief that the tax treatment of an undisclosed position would more likely than not be sustained on its merits. A proposed amendment to §10.34 of Treasury Department Circular 230 governing duties and restrictions in practicing before the IRS reflects the revised "more likely than not" standard contained in Code Sec. 6694(a).

For disclosed positions, Code Sec. 6694(a) requires that there be a reasonable basis for the tax treatment of the position; this replaces the not-frivolous standard previously applied.

An enhanced penalty is imposed on willful or reckless conduct, although the Small Business Tax Act of 2007 (P.L. 110-28) did not alter the standard of conduct under Code Sec. 6694(b).

The return preparer penalty for understatement of a taxpayer's liability due to an unreasonable position is increased to from $250 to the greater of $1,000 per return or 50 percent of income derived from the return (Code Sec. 6694(a)(1), as amended by P.L. 110-28) while understatement due to willful or reckless conduct is increased to the greater of $5,000 per return or 50 percent of income derived from the return (Code Sec. 6694(b)(1), as amended by P.L. 110-28).

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).

Interim guidance clarifies that the transitional relief applies to timely amended returns or claims for refund (other than 2007 employment and excise tax returns) filed on or before December 31, 2007, and to timely amended employment and excise tax returns or claims for refund filed on or before January 31, 2008. Such transitional relief also applies to original returns (other than 2007 employment and excise tax returns) filed on or before December 31, 2007 which were due on extension after that date, and to original employment and excise returns filed on or before January 31, 2008. (Notice 2008-11, I.R.B. 2008-3, December 31, 2007 at ¶46,227). However, no transitional relief is available under Code Sec. 6694(b) for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.

For tax returns, amended tax returns, and claims for refund (other than 2007 employment and excise tax returns) filed on or after January 1, 2008 with respect to advice provided after that date, and for 2007 employment and excise tax returns filed on or after February 1, 2008, with respect to advice provided on or after that date, the returns and claims for refund to which the Code Sec. 6694 penalty may apply have been identified on an exhibit to Notice 2008-13, I.R.B. 2008-3, December 31, 2007. A second exhibit contains a list of those information returns reporting information reported on another tax return which may subject a tax return preparer to the Code Sec. 6694 penalty if the information reported constitutes a substantial proportion of the latter return. Finally, a third exhibit identifies those documents that include information that might otherwise constitute a substantial portion of the taxpayer's return or claim for refund but which will not subject a tax return preparer to the Code Sec. 6694(a) penalty. However, for these documents a tax return preparer remains subject to the Code Sec. 6694(b) willful or reckless conduct penalty if the information reported on the document constitutes a substantial portion of the tax return or claim for refund, and is prepared willfully to understate the tax liability, or in reckless or intentional disregard of the rules or regulations (Notice 2008-13, I.R.B. 2008-3, December 31, 2007, at ¶46,229). The IRS supplemented Notice 2008-13 by expanding the list of returns and other documents to which the tax return preparer penalty may apply effective as of April 16, 2008 (Notice 2008-46, I.R.B. 2008-18, April 16, 2008.

Until further guidance is issued, a return or claim for refund is deemed prepared on the date of the tax return preparer's signature; if the signing preparer fails to sign the tax return, the tax return is deemed prepared on the date it is filed. In the case of a nonsigning preparer, the relevant date is the date such person provides the advice, as determined based on all the facts and circumstances. These interim rules will apply instead of Reg. §1.6694-2(b)(5). (Notice 2008-13, I.R.B. 2008-3, December 31, 2007.

For returns prepared on or before May 25, 2007, an income tax return preparer is liable to pay a penalty of $250 for an understatement of taxpayer's liability due to an unrealistic position which the tax return preparer knew or reasonable should have known and was not disclosed or was frivolous (Code Sec. 6694(a), prior to amendment byP.L. 110-28). If any part of the understatement was due to willful or reckless conduct, the penalty is increased to $1,000 per return (Code Sec. 6694(b), prior to amendment by P.L. 110-28).

The following chart summarizes the penalties and sanctions that may be imposed.





Must Be
Paid in
Full
Tax De- Before Willful Amount
ficiency Claiming Cause of
Description Code § Reg. § Required? Refund? Standard? Penalty


Understatement from
unreasonable position 6694(a) 1.6694-2 Yes No Yes $1000


Willful or reckless
conduct 6694(b) 1.6694-3 Yes No Yes $5,000


Failure to furnish copy 1.6695-
of return to taxpayer 6695(a) 1(a) No Yes Yes $50 *


Preparer's failure to 1.6695-
sign return 6695(b) 1(b) No Yes Yes $50 *


Failure to show
preparer's 1.6695-
identification numbers 6695(c) 1(c) No Yes Yes $50 *


Failure to retain copy
of return or list of 1.6695-
taxpayers 6695(d) 1(d) No Yes Yes $50 *


Failure to file correct 1.6695-
information returns 6695(e) 1(e)(2) No Yes Yes $50 *


Negotiation of refund 1.6695-
check by preparer 6695(f) 1(f) No Yes No $500


Failure to conduct due
diligence in claiming
EIC 6695(g) -- No -- No $100


Promoting Abusive Tax
Shelters 6700 -- Yes No Yes $1,000


Aiding and abetting
understatements of tax
liability 6701 -- Yes No Yes $1,000
_________________________
* Per failure, with a maximum of $25,000 for any calender year.





In addition to these penalties, the IRS has the authority to seek an injunction prohibiting a preparer from engaging in certain prohibited practices (Code Sec. 7407).

The IRS has also instituted the "Return Preparers Program" for the purpose of monitoring return preparers. As part of this program, IRS examiners must determine during field and office examinations whether there has been any violation by a paid return preparer (Internal Revenue Manual 20.1.6.1.2, July 31, 2001). In particular, an IRS examiner must determine whether a paid tax return preparer has negligently, intentionally, or willfully understated a client's tax liability in the preparation of a return or claim for refund. An examiner who determines that return preparer violations exist is instructed to document this fact for purposes of a penalty investigation.

Also a part of the IRS's Return Preparers Program, is procedure called "Program Action Cases" under which returns prepared by a particular preparer may be examined if information indicates a pattern of noncompliance with the return preparer provisions. (Internal Revenue Manual 20.1.6.1.6)