Tax return preparer defined

For returns prepared after May 25, 2007, a "tax return preparer" is a person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return or claim for refund of tax imposed by this title (Title 26 - Internal Revenue Code). The preparation of a substantial portion of a return or claim for refund shall be treated as if it were the preparation of such return or claim for refund (Code Sec. 7701(a)(36)(A), as amended by Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28)).

For returns prepared on or before May 25, 2007, the preparers' penalties apply only to an "income tax return preparer" who prepares, for compensation, any income tax return or any claim for refund (under subtitle A - Income Taxes) (Code Sec. 7701(a)(36), prior to amendment by P.L. 110-28). For example, the following qualify as income tax return preparers:


(1) A person who does not physically prepare an income tax return is considered a preparer if that person furnishes to a taxpayer or other preparer sufficient information and advice so that completion of the return or claim for refund is largely a mechanical matter (Reg. §301.7701-15(a)(1)).



(2) A preparer of a partnership or an S corporation return is an income tax return preparer with respect to a partner's or S corporation shareholder's return only if the entry or entries on the return reportable on the individual's return constitute a substantial portion of the partner's or shareholder's return (Reg. §301.7701-15(b)(3)). For example, an attorney who provides a partnership with advice regarding the preparation of Schedules K-1 may be considered the preparer of all the partners' personal tax returns (see R.S. Goulding, CA-7, 92-1 USTC ¶50,174.



(3) A firm that offers computerized tax preparation services to practitioners is an income tax return preparer if the program makes substantive tax determinations (Rev. Rul. 85-187.



(4) A person who prepares a computer program and sells it to taxpayers to use in preparing their returns is an income tax return preparer if the program provides substantive tax instructions (Rev. Rul. 85-189, at ¶39,970.75).



(5) A general partner who prepares a partnership return can be an income tax return preparer with respect to a limited partner's return in certain circumstances (Rev. Rul. 81-270, at ¶39,960.55).



(6) A preparer (first preparer) can be a preparer with respect to a return prepared by another preparer (second preparer) if the second preparer relied on information contained in a return prepared by the first preparer (this occurs, for example, when the first preparer negligently overstates the expenses on a prior year's return, thus creating a net operating loss (NOL) and the second preparer, in good faith, applies the NOL carryover in preparing the subsequent year's return) (Rev. Rul. 81-171, at ¶39,960.75).


The following are excepted from the definition of a tax return preparer:


(1) a person who furnishes typing, reproducing or other mechanical assistance;



(2) one who prepares a return or refund claim for the employer by whom he or she is regularly and continuously employed;



(3) a person who prepares as a fiduciary a return or refund claim for any person; and



(4) one who prepares a refund claim for a taxpayer in response to any notice of deficiency issued to that taxpayer or in response to any waiver of restriction after the commencement of an audit of that taxpayer or another taxpayer if a determination in such audit of the other taxpayer directly or indirectly affects the tax liability of such taxpayer (Code Sec. 7701(a)(36)(B), as amended by P.L. 110-28 and Reg. §301.7701-15(d)).


Low income taxpayer clinics (LITC). Qualified LITCs, and employees and volunteers of such LITCs, that provide assistance with a tax return or claim for refund will not be treated as income tax return preparers if the following two requirements are satisfied: First, any such return preparation assistance must be directly related to a controversy with the IRS for which the LITC is providing assistance, or an ancillary part of an LITC's English as a second language (ESL) outreach program. Second, the LITC cannot charge a separate fee or vary a fee based on whether the LITC provides assistance with a tax return or claim for refund, or charges more than a nominal fee for its services (Reg. §301.7701-15(a)(7)).

Signing and nonsigning return preparers. For purposes of Code Sec. 6694, no more than one individual associated with a firm (e.g., a partner or employee) may be treated as a return preparer with respect to the same return or claim for refund (Reg. §1.6694-1(b)(1)). A signing return preparer, who is associated with a firm, is solely liable any penalties imposed for failure to comply with applicable reporting and recordkeeping requirements, regardless of whether he or she relied on the advice of a nonsigning return preparer in completing the return.

This rule is a corollary of the rule that a preparer may not rely on the advice of an individual associated with the same firm for purposes of the reasonable cause and good faith exception to the penalty (Reg. §1.6694-2(d)). If two or more individuals associated with a firm are nonsigning preparers of a return or claim for refund, and there are no signing preparers, only one of the individuals is a preparer for purposes of the understatement penalty. Generally, the individual with overall supervisory responsibility with respect to the return or refund claim is treated as the preparer for penalty purposes (Reg. §1.6694-1(b)(1)).

Example:
Attorney A provides advice to Client C on the proper treatment of a significant item on C's tax return. The advice constitutes preparation of a substantial portion of the return. Before he provided the advice, A discussed the matter with Attorney Y, who is associated with the same firm as A, but A is the attorney with direct supervisory responsibility for the matter.



A is the preparer of C's return and is subject to the Code Sec. 6694 penalty with respect to C's return. Y, on the other hand, is not a preparer of C's return and, therefore, is not subject to the Code Sec. 6694 penalty with respect to a position taken on C's return. Y is not liable for the penalty even if Y recommends that C take a position that has no realistic possibility of being sustained. Finally, A may not avoid the penalty by claiming that he relied on Y's advice (Reg. §1.6694-1(b)(3)).


Firm liability. For purposes of the former unrealistic position penalty of Code Sec. 6694(a) prior to amendment by the Small Business Tax Act of 2007 (P.L. 110-28), and the willful or reckless conduct penalty of Code Sec. 6694(b), an employer or partnership of a return preparer subject to the penalty is also subject to penalty as a firm only if:


(1) one or more members of the principal management of the firm or branch office participated in or knew of the proscribed conduct;



(2) the employer or partnership failed to provide reasonable and appropriate review procedures; or



(3) such review procedures were disregarded (Reg. §1.6694-2(a)(2) and Reg. §1.6694-3(a)(2)).


The term "firm" includes a sole proprietorship. It is unclear how these regulations will be applied under the new" unreasonable position" standard in Code Sec. 6694(a).

Two letter rulings (IRS Letter Ruling 8034159 and IRS Letter Ruling 8035069, CCH IRS LETTER RULINGS REPORTS) indicate that certain organizations and some of their employees may be considered return preparers even though they do not intentionally hold themselves out as such. Organizations that should beware of unintentional classification are those that utilize computer systems to process financial information to prepare financial reports. For example, a farmers' cooperative was classified as an income tax return preparer because it prepared Schedules F for its members from the financial information it gathered in connection with its lending activities. Further, an employee of the co-op was also a return preparer because of the informal tax-planning advice he rendered to members (Rev. Rul. 85-188, at ¶39,960.70).

Interim guidance on tax preparer definition. Until further guidance is issued, the definition of "tax return preparer" will conform to amendments made by the Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28). Thus, for purposes of Proposed Regs. §§16694-1 and 1.6694-3 the word "income" will not modify the phrase "tax return preparer," and the returns to which the penalty may apply will include returns of tax and claims for refund under subtitles A through E of the Code. In addition, the term "substantial portion" under Reg. §301.7701-15(b)(1), which is used in determining whether a person will be considered a tax return preparer, will mean a schedule, entry or other portion of a tax return or claim for refund that, if adjusted or disallowed, could result in a deficiency determination or disallowed refund claim that the preparer knows or reasonably should know is a significant portion of the tax liability (or tax originally reported, or previously adjusted, in the case of a refund claim) (Notice 2008-13, I.R.B. 2008-3, December 31, 2007.