Willful or Reckless Conduct

For returns prepared after May 25, 2007 , a penalty of $5,000 or 50 percent of income derived from the return, whichever is greater, ($1,000 for returns prepared on or before May 25, 2007) may be imposed on a return preparer who:


(1) willfully attempts to understate the tax liability of another person on a return or in a claim for a refund, or



(2) recklessly or intentionally disregards rules and regulations (Code Sec. 6694(b)(1) and (2), as amended by Small Business Tax Act of 2007 (P.L. 110-28)).


To avoid the stacking of penalties, a penalty imposed for an understatement resulting from the willful or reckless conduct of a return preparer is reduced by the amount of the penalty paid for any understatement due to an unreasonable position (Code Sec. 6694(b)(3), as amended by P.L. 110-28; see also ¶39,957A.01).

The IRS bears the burden of proving that a return preparer willfully attempted to understate the tax liability. However, the return preparer bears the burden of proving that no rule or regulation was recklessly or intentionally disregarded, that any position contrary to a regulation represented a good faith challenge to the validity of the regulation, and that disclosure was adequately made (Reg. §1.6694-3(h)).

"Rules and regulations" are defined to include the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the IRS and published in the Internal Revenue Bulletin (Reg. §1.6694-3(f)).

The willful attempt to understate the liability of a taxpayer occurs if the preparer disregards, in an attempt to wrongfully reduce the tax liability of the taxpayer, information furnished by the taxpayer or others (Reg §1.6694-3(b)).

Example (1):
John indicates to his return preparer that he has three dependents. Preparer X reports six on John's final return. Preparer X has willfully attempted to understate John's tax liability.


Willful or Reckless Conduct: Adequate disclosure exception

A preparer will not be considered to have recklessly or intentionally disregarded a rule or regulation for purposes of the understatement penalty imposed pursuant to Code Sec. 6694(b) if the position taken is not frivolous and is adequately disclosed and, in the case of a position contrary to a regulation, such position must be a good faith challenge to the validity of the regulation (Reg. §1.6694-3(c)(2)).

The disclosure requirements that apply for purposes of the penalty imposed for the willful or reckless understatement of tax liability, vary slightly from the disclosure requirements that apply with respect to an understatement attributable to an unrealistic position that are described in ¶39,957A.023. Like the requirements applicable to understatements attributable to an unreasonable position and the penalty imposed for such understatement under Code Sec. 6694(a), disclosure of a position that is contrary to a rule or regulation by a return preparer is adequate for purposes of the penalty imposed under Code Sec. 6694(b), only if made on Form 8275 (Disclosure Statement) or 8275-R (Regulation Disclosure Statement) as set forth in (Reg. §1.6662-4(f)). However, the provisions of Reg. §1.6662-4(f)(2), under which the proper representation of certain items on a return constitutes adequate disclosure, in accordance with Rev. Proc. 2001-11, at ¶39,960.20, do not apply (Reg. §1.6694-3(e)(1)).

Nonsigning preparers may disclose in the same manner as signing preparers. Their additional disclosure options depend on whether they rendered advice to a taxpayer or to another return preparer. If a nonsigning preparer provides advice directly to a taxpayer with respect to a position that is contrary to a rule or regulation, disclosure is adequate if the advice includes a statement that


(1) because the position is contrary to a rule or regulation, it is subject to the negligence penalty unless adequately disclosed, and



(2) in the case of a position contrary to a regulation, the position must represent a good faith challenge to the validity of the regulation (Reg. §1.6694-3(e)(2)).


If the nonsigning preparer's advice was rendered in writing, then the disclosure statement must also be in writing. If the advice was oral, then the disclosure statement may also be given orally. Contemporaneously prepared documentation of the oral disclosure statement is, generally, sufficient to establish that the advice was given to the taxpayer (Reg. §1.6694-3(e)(2)).

If a nonsigning preparer renders advice to another income tax return preparer, disclosure of that position is considered adequate if the advice includes a statement that Code Sec. 6694 disclosure is required. Written advice mandates a written statement and oral advice requires merely an oral statement (Reg. §1.6694-3(e)(2)(ii)).