Return preparers 6694 doomsday

What is so striking about the proposed section 6694 regulations is its absolute requirement that the 6694(a) penalty will be assessed unless the return preparer uses the analysis prescribed by section 1.6662-4(d)(3)(ii) of the authorities described in section 1.6662-4(d)(3)(iii) of the regulations. See section1.6694-2(b) of the proposed regulations.

In the real world, most return preparers do not even subscribe to a tax research service. The "authority" requirement references all tax law and the "analysis" requirement goes to the relevancy or competency of the application of the applicable law.

There fundamental requirements would apply even if the "more likely than not" standard is replaced by the "substantial authority" standard of conduct. The former standard represents 51% accuracy and the latteer represents 41% accuracy. Since each standard is subjective and subject to the dicretion of the IRS, I do not see how the lower standard will afford the return preparation industry any rational relief from the threat of the severe 6694 penalty where there ia ANY understatement of income disclosed either by the IRS Service Center or through examination.

Keep in mind that the penalty is $5,000 or 50% of the fee for reckless conduct as prescribed by section 6694(b)(2)(B). I am not sure that I can tell the difference between a negligent error or a reckless error. IRS examiners are generally aggressive and can give you fits over errors they classify as "reckless."

I recently attended a deposition of a CPA who testified that he never appeals any IRS determination to an IRS Office of Appeals because it is a "legal" issue. The CPA was a 50% owner of a 30 person CPA firm. I would take from that experience that a large body of the tax return preparers will not be able to meet the "analysis" and "authority" requirements under the proposed 6694 regulations because they do not have the facility, training, education and/or experience necessary to meet those very technical tax law requirements.

To ease the pain, I recommend that all return preparerers, clever enough to identify a factual or legal issues for which the penalties under 6694 could apply, disclose those positions to get the lesser "reasonable basis" standard. It is also my personal opinion that disclosure will make it nearly impossible for the IRS to apply the 6694(b) penalty, although there is still some risk that the 6694(a) penalty could apply.

The greater risk to the return preparers is that they do not identify an issue that should be or could be disclosed to the IRS. For that reason, return preparer firms should think of maintaining a close relationship with advisors with the resources for resarch and analysis and with solid experience in dealing with tax law issues so that tax issues can more readily be identified and evaluated.

The new penalties and the proposed regulations are "game changers." The return preparation business will never be the same again with these high-threshold requirements to avoid very harsh and severe penalties.

The most concervative and safest route is to 1) identify the problematical issues; 2) disclose those issues to the IRS, even at the risk of examination; 3) and get outside expert opinion that will satisfy the "reasonable cause" exception.

The present "in denial" posture of the return preparation industry can prevail for a few years until the returns filed for 2008 and beyond reach the IRS audit cycle. The resulting penalties will be predictably devistating. I have represented a fair number of return preparers under civil and criminal examination. When a return preparer is examined, the IRS looks at their client list and examines the tax returns of the clients. For that reason, any instance of the imposition of the 6694 penalty will likely be multiplied when other tax returns of clients are examined.

Rather than wait for the 2008 returns to be audited in 2009 or 2010, the 2008 tax year issues should be identified and addressed now - not when the returns are filed in 2009.

Use of the word "doomsday" was to get your attention and to get you to focus on the high risk of getting involved with complex factual or legal issues.

For any questions on the above, contact us at ab@irstaxattorney.com.