Section 6694 transitional relief

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)). Penalty for understatement of taxpayer's liability due to unreasonable positions is increased to $1,000 per return or 50 percent of income derived from the return, whichever is greater (Code Sec. 6694(a)(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).

The IRS has clarified that the transitional relief described in Notice 2007-54 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.

Until further guidance is issued, the returns and claims for refund to which Code Sec. 6694 can apply have been identified on an exhibit to Notice 2008-13, I.R.B. 2008-3, December 31, 2007. Also identified are which information returns reporting information reported on another tax return may subject a tax preparer to the Code Sec. 6694 penalty if the information reported constitutes a substantial proportion of the other tax return. Other documents that include information which constitute a substantial portion of the taxpayer's return or claim for refund will be treated as a return to which the Code Sec. 6694(a) penalty can apply unless such documents are identified on an exhibit attached to the Notice. For documents falling in this last category, even though the Code Sec. 6694(a) penalty may not apply, a tax 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 in any manner to understate the tax liability on a tax return or claim for refund, or in reckless or intentional disregard of the rules or regulations.

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, a return preparer may be liable for a penalty in the amount of $250 if:


(1) any part of an understatement of liability with respect to a return or claim for refund is due to a position that did not have a realistic possibility of being sustained on its merits;



(2) the return preparer with respect to that return or refund claim knew or reasonably should have known of the unrealistic position; and



(3) such position was not adequately disclosed in order to avoid the accuracy-related penalty for understatement of income tax (Code Sec. 6662(d)) or was frivolous (Code Sec. 6694(a), prior to amendment by P.L. 110-28).


The penalty will not be imposed, however, where there is reasonable cause for the understatement and the preparer acted in good faith (Code Sec. 6694(a)(3), as amended by P.L. 110-28). The return preparer has the burden of proving that a position taken on a return or in a claim for refund has a reasonable probability of being sustained on its merits, there was reasonable cause for the position and that such position was maintained in good faith, or that the position was adequately disclosed (Reg. §1.6694-2(e)).

Imposition of the penalty under Code Sec. 6694(a) is not intended to automatically initiate a referral to the IRS Director of Practice for an investigation of the return preparer. Instead, the IRS must exercise discretion in selecting the specific cases that are referred for further examination as described in ¶39,956A.01 (House Committee Report on the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239).