section 6694(b) similarity to section 6701

The IRS litigating position is that both penalties may apply. Note that section 6701(f)(2) excludes a 6701 penalty if the 6694 penalty has been assessed. The following litigation guideline of the IRS is dated July 31, 1989 and pertains to the amount of penalties at that time. In the case of tax return preparers both sections 6694(b) and section 6701 penalize the same type of intentional, conscious, knowing conduct that results in an understatement of liability, and both penalties may be proposed when either penalty would apply to a set of facts. The decision to assess either the section 6701 penalty or the section 6694(b) penalty is dicretionary.

A bit more daunting is the fact that the appeal procedures for these two penalties are the same. The assessments may be made capriciously and both sections are subject to the 15% payment/refund procedure.

GL-31
July 31, 1989
Br2:KAZuba

LITIGATION GUIDELINE MEMORANDUM CC:GL
Re: Application of the Penalties Under I.R.C. Sections 6694(b) and 6701 When Both Penalties May Apply
BACKGROUND
The enactment of I.R.C. §6701 has provided the Service with a broadly applicable weapon for penalizing those who aid and abet the preparation and presentation of documents that result in an understatement of liability. This penalty applies to persons who perform any significant activity with respect to any portion of a return, including those persons who are return preparers as defined by I.R.C. §7701(a)(36). Since conduct may also fall within the conduct penalized by I.R.C. §6694, this memorandum provides guidance about how penalties should be asserted and assessed under these sections and considers whether the penalty under I.R.C. §6694(b) or 6701 should be assessed when either penalty would apply to the facts of a case and whether the penalty under section 6694(b) should be assessed alternatively when the section 6701 penalty is assessed.
DISCUSSION

I. Overview
I.R.C. §6694(a) imposes a penalty of $100 for each return on which an understatement of tax liability is caused by a tax return preparer's negligent or intentional disregard of rules and regulations. Conduct that constitutes a negligent disregard of rules or regulations is outlined in the regulations, several revenue rulings, and a revenue procedure. A preparer will not incur the penalty where he has exercised due diligence in an effort to apply the rules and regulations to the information given the preparer. Treas. Reg. 1.6694-1(a). See Rev. Rul. 80-28, 1980-1 C.B. 304; Rev. Rul. 78-344, 1978-2 C.B. 334; Rev. Proc. 80-40, 1980-2 C.B. 774. The legislative history of section 6694(a) states that the standard in section 6694(a) should be interpreted in a manner similar to the provision relating to taxpayer's negligent disregard of rules or regulations contained in section 6653(a). H.R. Conf. Rep. No. 1515, 94th Cong., 2d Sess. 484; S. Rep. No. 938, pt. 1, 94th Cong., 2d Sess. 355 (1976).
Section 6694(b) imposes a penalty of $500 on a tax return preparer for each return on which any understatement of liability results from the preparer's willful attempt to understate tax liability. The Senate Report does not attempt to define the meaning of willful attempt, but rather gives examples of conduct that constitutes a willful attempt. See id. at p. 356. The report states that a willful attempt to understate tax liability occurs when a preparer disregards facts or items of income supplied to him by the taxpayer or other persons. A willful attempt also occurs when a preparer intentionally disregards rules and regulations. In the latter case, the Service may assess either or both penalties under section 6694(a)and (b), so long as the amount assessed does not exceed $500 per return. Thus, an intentional disregard of rules and regulations may constitute a violation of the negligence penalty provision and, at the same time, fulfill the requirements of a willful act under section 6694(b). Judisch v. United States, 755 F.2d 823 (11th Cir. 1985). This interpretation of a willful understatement of liability has been adopted by the Service in Treas. Reg. 1.6694-1(b)(2)(iv). Cases and rulings involving the 100 percent penalty under section 6672 have held that the term "willful" when employed in a civil context connotes a voluntary, conscious, knowing, and intentional act. Wall v. United States, 592 F.2d 154, 163 (3d Cir. 1979); Monday v. United States, 421 F.2d 1210 (7th Cir.), cert. denied, 400 US 821 (1970). See, e.g., Mertens Law of Federal Income Taxation 55.38 (1976); Rev. Rul. 54-158, 1954-1 C.B. 247.
Both cases that have examined facts that establish a willful attempt under section 6694(b) have construed that term consistent with this definition. In Judisch, supra, the court held that intentional disregard of rules or regulations was a willful attempt to understate liability. In Pickering v. United States, 691 F.2d 853 (8th Cir. 1982), the court held that the inclusion of deductions for employees' personal expenses in a corporate return without further investigation after notice that the corporate books may have incorrectly included these expenses as corporate expenses was a willful attempt to understate liability. The court stated that willfulness "merely requires a conscious act of omission made in the knowledge that a duty is therefore [sic] not being met." 691 F.2d at 82-6046. Moreover, conduct need not be fraudulent in order to be willful. Id. A willful attempt under section 6694(b), then, is voluntary, knowing intentional conduct, which need not include any bad motive, that understates another's tax liability.
The preparer has the burden to prove that he has not negligently or intentionally disregarded rules and regulations. Treas. Reg. 1.6694-1(a)(5). The Service, however, bears the burden of proving that the preparer willfully attempted to understate the tax liability. Treas. Reg. 1.6694-1(b)(5).
Section 6701(a) provides for a penalty of $1,000 against any person who aids, assists in, procures, or advises with respect to the preparation of a return, claim or other document under the internal revenue laws, which portion the person knows will be used in connection with a matter arising under the tax laws and which portion the person knows, if used, will result in an understatement of tax liability. 1 The $1,000 penalty applies to each document or return. 2
The Senate Report explaining this provision indicates that section 6701 is intended to be analogous to the criminal penalty for willfully aiding and abetting in the preparation of a false return or document. S. Rep. 494, 97th Cong., 2d Sess. 251 (1982) (Senate Report). See I.R.C. §7206(2). The report states that a person will be liable for the penalty if he is "directly involved in aiding or assisting in the preparation or presentation of a false or fraudulent document" or counsels a course of action that leads to such an act. ***** 3
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Whether revenue rulings or court decisions will affect the preparer's liability for these penalties will depend upon whether the preparer was aware of these determinations and, if so, why he did not prepare the return in accordance with them. If the preparer was unaware of a ruling or a decision that has precedential value with respect to his taxpayer, he may at least be liable for negligently disregarding the rules and regulations pursuant to section 6694(a). See generally Rev. Proc. 80-40, 1980-2 C.B. 774. But see Swayze v. United States, 86-1 USTC ¶9291 (9th Cir. 1986) (preparers who prepared family trust tax returns may have a valid defense of good faith reliance on the advice of counsel to penalties under section 6694(a) where the state of the law concerning family trusts was uncertain and the preparers were not qualified to make a professional judgment about the validity of family trusts). While a preparer may be liable for the penalties under section 6694 and section 6701 if he intentionally disregards a rule or authoritative court decisions, he may nonetheless escape liability if he in good faith and with a reasonable basis takes the position that the ruling or the decisions do not accurately reflect the Code. See Treas. Reg. 1.6694-1(a)(4). 8 For example, if a final Court of Appeals decision holds a tax shelter abusive and the preparer subsequently prepares a return for the taxpayer claiming deductions from that shelter, the preparer may be liable for a penalty under section 6694(b) or section 6701 if he simply ignores the decision or makes no reasonable argument that the decision is inapplicable to his taxpayer's tax situation or is incorrectly decided.
What constitutes sufficient authority to subject a preparer to a penalty if he fails to follow it is a complex question that is a matter of debate in the tax community. See Proposed rule; solicitation for extended comments, 51 FR 40340 (Nov. 6, 1986) (to be codified at 31 CFR pt. 10); Banoff, Dealing with the "Authorities": Determining Valid Legal Authority In Advising Clients, Rendering Opinions, Preparing Tax Returns and Avoiding Penalties 1072 Taxes (Dec. 1988); Tax Preparers: Proposed IRS Return Preparer Rules Impose Unfair Standard, Daily Report for Executives (BNA) No. 208 at G-4 (Oct. 28, 1986). As suggested by the Ninth Circuit in Swayze, supra, a court's evaluation of whether a preparer is liable for penalties for the failure to follow rules or court decisions may depend on the court's factual findings regarding the state of the law at the time the return was prepared and the preparer's professional qualifications, as well as whether the preparer's reasons for adopting the position stated in the return constitute a reasonable basis. *****
Since as a practical matter a return preparer will almost invariably be able to articulate a reason for his disagreement with a ruling or a court decision when asked, the imposition of penalties will involve judgment calls based primarily on whether the position is taken in good faith. However, as a matter of policy where rulings and decisions involve abusive tax shelters, the Service has taken the position that penalties should be imposed when a preparer does not follow a ruling or a decision on a shelter. Caution should be used, however, in imposing penalties in this situation inflexibly, for the reasons stated above, where the facts of a case establish that the preparer had a legitimate basis for disagreement with the Service's or a court's position on a particular shelter.
It should also be emphasized that liability for penalties is not based on the cumulative effect of information developed in a number of cases. Each case stands alone, and the facts surrounding the preparation of the return in each case must support each element of the penalty. For example, to show an intentional understatement sufficient to impose liability for either section 6694(b) or section 6701 the facts surrounding each return for which a penalty is asserted must show the understatement was intentional. While the preparer's pattern of conduct in a number of cases will be evidence that his conduct was intentional, that alone will not support a penalty unless it results in an understatement of liability on the return for which the penalty is assessed.
CONCLUSION
In the case of tax return preparers both sections 6694(b) and section 6701 penalize the same type of intentional, conscious, knowing conduct that results in an understatement of liability, and both penalties may be proposed when either penalty would apply to a set of facts. However, section 6701(f) prohibits the alternative assessment of these penalties, and the decision to assess either the section 6701 penalty or the section 6694(b) penalty will be within the discretion of the district director, with the advice of district counsel. ***** 9
ARNOLD E. KAUFMAN
Assistant Chief Counsel
(General Litigation)
1If the document relates to the tax liability of a corporation the penalty is $10,000. I.R.C. §6701(b)(2).

2The section 6701 penalty, however, may only be assessed once with respect to one person for any one taxable period. As stated in the Senate Report, a penalty may not be assessed for two false documents with respect to one person for one period. See Emanuel v. United States, 705 F. Supp. 434 (N.D. Ill. 1989) (penalty could not be assessed with respect to both Form 1040 and Form 1045 which "relate to" the same taxable year, even though the Form 1045 amends different tax periods). Accord Kuchan v. United States, 88-1 U.S.T.C. ¶9377 (N.D. Ill. 1988) (penalty relates to year in which conduct occurs rather than year for which document was prepared).

3The Senate Report indicates section 6701 is meant to penalize certain types of conduct which "are not so abhorrent as to suggest criminal prosecution." Senate Report at 275.

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9This memorandum is based on the assumption that there is no issue about whether the person involved is a return preparer. If there is a question about whether a person is a preparer as defined by I.R.C. §7701(a)(36), penalties may be asserted under section 6701, which is more broadly applicable to persons who aid, assist in, procure, or advise with respect to any portion of a return document relating to matters under the Code.