6694 proposed regulations - the trap

Section 1.6694-3(a)(2)(ii) provides for the $5,000 penalty or 50% of the income to be derived by the tax return preparer if the return preparer has a "reckless" disregard of a "rule or regulation." The "reckless" provision is separate from the word "willful." A determination that the return preparer is "reckless" is a facts and circumstances issue.

Section 1.6694-3(e) of the proposed regulations defines the term "rules or regulations" to include the provisions of the Internal Revenue Code, revenue rulings or notices issues by the IRS.

Tax regulations and published revenue rulings cover every kind of tax issue and in each instance they are mostly interpretative regulations and revenue rulings. There are multiple factual and legal issues arising out of regulations and revenue rulings.

Suppose a return preparer does not follow the entertanment regulations under section 1.274-2(b) by mistake or ignorence. That is sufficient to trigger the $5,000 or 50% penalty.

I would be hard pressed to distinguish between "negligence" and "recklessness" in the circumsgtances. The fast pace of return preparation results in massive mistakes by tax return preparers. One can argue that any mistake is a reckless mistake because of the subjective nature of that word.

The "reckless" position can be avoided if there is a disclosure to the IRS in accourdance with section 1.6694-2(c). Then one merely has to meet the "reasonable basis" standard." But even the "reasonable basis" standard will not be met if the return preparer cites the wrong law or otherwise makes a mistake on the analysis and authority that forms the basis of the position.

Without question, IRS examiners are generally aggressive. Worse - many of the examiners and not well trained and are often wrong. It will be quite difficult for one to defend against an IRS determination that a negligent mistake is not "reckless."

THERE IS NO "REASONABLE CAUSE" EXCEPTION TO SECTION 6694(b). The "reasonable cause" excption is limited to section 6694(a).

I have represented many tax return preparers involved with civil and ciminal examinations. In most cases, when the IRS examines a return preparer, they review multiple tax returns prepared for the preparer client base. For this reason, if there if the examiner thinks the preparer has been "reckless" in one return, it is likely that the preparer will be found to be "reckless" with other returns. A mere mistake can be determined to be a "reckless" mistake threby triggering multiple $5,000 or 50% penalties on the compensation received.

The problem is not the proposed regulation. The problem is that section 6694(b)(2)(B) references "a reckless or intentional disregard of rules or regulations."

The 6694(b) trap for return preparers because of the work "reckless" can be partially mitigated if the final regulations equate "reckless" to "gross negligence" or intentionally reckless behavior. An even better solution would be to have the final regulations specify that the word "reckless" only applies to legal issues.

Frankly, the section 6694(b) statute should be lobbied to get the word "reckless" out of the statute or get Congress to provide a "reasonable cause" exception to section 6694(b). My main problem with the work "reckless" is that it can easily be applicable to mere "negligence." We have to deal with that word because it is in the statute.