Section 6694 realistic possibility

Realistic possibility of position being sustained on the merits

A position is considered to satisfy the realistic possibility standard if a reasonable and well-informed analysis by a person knowledgeable in tax law would lead that person to conclude that the position has approximately a one-in-three, or greater, likelihood of being sustained on its merits (Reg. 1.6694-2(b)(1)). This numerical benchmark, which applies to returns prepared on or before May 25, 2007, is intended to help prevent erosion of the standard.

In determining whether a position has a realistic possibility of being sustained, the authorities considered are the same as those analyzed for purposes of the substantial authority determination made for purposes of the accuracy-related penalty (Reg. §1.6694-2(b)(2)). The possibility that a position will not be challenged by the IRS may not be taken into account (Reg. §1.6694-2(b)(2)).

Example (1):
A taxpayer has engaged in a transaction that is adversely affected by a new statutory provision. Prior law supported a position favorable to the taxpayer. The preparer believes that the new statute is inequitable as applied to the taxpayer's situation. The statutory language is unambiguous as it applies to the transaction (e.g., it applies to all manufacturers and the taxpayer is a manufacturer of widgets). The committee reports do not specifically address the taxpayer's situation. A position contrary to the statute does not satisfy the realistic possibility standard.


Example (2):
Assume the same facts as in Example (1), except the committee reports indicate that Congress did not intend to apply the new provision to the taxpayer's transaction (e.g., widget manufacturers). Thus, there is a conflict between the general language of the statute, which adversely affects the transaction, and the specific statement in the committee reports that transactions such as the taxpayer's are not adversely affected. A position consistent with either the statute or the committee reports satisfies the realistic possibility standard. However, a position consistent with the committee reports constitutes disregard of a rule or regulation and, therefore, must be adequately disclosed in order to avoid the willful or reckless conduct penalty of Code Sec. 6694(b) (and possibly a penalty imposed under the negligence component of the accuracy-related penalty).


Example (3):
In the course of researching whether a position has a realistic possibility of being sustained on the merits, a preparer discovers that identical language appearing in another place in the Code has consistently been interpreted in a manner that would be favorable to the taxpayer if the interpretation were applied to the phrase applicable to the taxpayer's situation. No authority has interpreted the phrase applicable to the taxpayer's situation. The interpretations of identical language are relevant in arriving at a well reasoned construction of the language at issue, but the context in which the language arises also must be taken into account in determining whether the realistic possibility standard is satisfied (Reg. §1.6694-2(b)(3)).


Exceptions precluding imposition of understatement penalty due to unrealistic position. There are two exceptions to the realistic possibility standard. If the requirements of either the adequate disclosure or the reasonable cause and good faith exception are met, then no penalty is imposed under Code Sec. 6694(a) even if the position taken on the return or refund claim does not satisfy the realistic possibility standard. The preparer bears the burden of proof with respect to these issues (Reg. §1.6694-2(e)).