6694 reasonable cause undercut by regulations.

1.6694-2(d) of Proposed Regulations - Exception for reasonable cause and good faith. .

I have previously commented on the "reasonable cause" exception for the 6694(a) penalty. In this blog, my focus is limited to a focus on 1.6694-2(d)(5) below dealing with one of the factors that will be considered: Reliance on advice of others. and in that categoy, you can rely in good faith on the advice of another advisor UNLESS (i) The advice or information is unreasonable on its face;(ii) The tax return preparer knew or should have known that the other party providing the advice or information was not aware of all relevant facts; or (iii) The tax return preparer knew or should have known (given the nature of the tax return preparer's practice), at the time the return or claim for refund was prepared, that the advice or information was no longer reliable due to developments in the law since the time the advice was given.

What I find strange in the extreme is that even if you met all of the complex provisions for good faith and reasonable cause, that exception will not apply unless the return preparer is an expert on the tax law who would know that the technical position taken by the other tax advisor, who might be a tax attorney,was invalidated by new developments or new law that would make the opinion of the tax attorney incorrect. Why rely on a "tax advisor" if you still have the technical responsibility of to know that the tax advosor is incorrect? The proposed regulations expect you to be a tax expert and do the necessary tax research to make sure that there are no new developments that would invalidate the opinion of the tax advisor who has offered a legal opinion that was represented to be a valid analysis of the relevant tax authorities. In short, this proposed regulation requires you to be a reviewer of the technical opinion of the tax advisor. Curiously the AICPA comment on this part of the proposed regulations found no fault with this high standard of technical expertise mandated for all return preparers. Obviously, the AICPA expects all CPA's to have tax research services and that CPAs are being compensated by their clients to have researched the available law before you can rely on a tax advisor. If you are that good, why would you need a tax advisor? As I indicated in a prior blog, the "reasonable cause" exception in the Proposed Regulations is levels more difficult than the regulations under section 6664(d)reasonable cause provisions to abate a negligence penalty. I see no reason for the IRS to draft high threshold standards for the reasonable cause exception for the 6694(a) pwnalty. Is it because return preparers hold themselves out to be tax experts? In the real world, return prepares merely hold themselves out to be competent to prepare tax returns. Apparently, the IRS, with the approval of the AICPA, have created a very high standard of professional expertise on all tax positions for all tax return preparers, whether or not they are CPAs or tax attorneys.

We can all agree that return preparers should strive to improve their knowledge of tax law. It is a different standard when the IRS serves to punish return preparers with the draconian $1,000 or 50% of fees by taking away "reasonable cause" provided by law for all tax return preparers who are not tax experts even when they rely on the opinion of a tax attorney. I believe this high threshold is not consistent with the intent of Congress when they drafted a "reasonable cause" exception to the 6694 statute before and after the current amendment to section 6694. Since there has been no opposition to this section, I expect it to survive into the Final Regulations. However, I expect that this regulation will not stand as a legislative regulation if challanged in the courts because it is clearly inconsistent with the 6694 statute that provides for this exception. If redrafted, the IRS should track the precedent of the regulations and the case law under section 6664(d). Note the following extract from the proposed regulations.

The penalty under section 6694(a) will not be imposed if, considering all the facts and circumstances, it is determined that the understatement was due to reasonable cause and that the tax return preparer acted in good faith. Factors to consider include:

(1) Nature of the error causing the understatement. The error resulted from a provision that was complex, uncommon, or highly technical and a competent tax return preparer of tax returns or claims for refund of the type at issue reasonably could have made the error. The reasonable cause and good faith exception, however, does not apply to an error that would have been apparent from a general review of the return or claim for refund by the tax return preparer.

(2) Frequency of errors. The understatement was the result of an isolated error (such as an inadvertent mathematical or clerical error) rather than a number of errors. Although the reasonable cause and good faith exception generally applies to an isolated error, it does not apply if the isolated error is so obvious, flagrant, or material that it should have been discovered during a review of the return or claim for refund. Furthermore, the reasonable cause and good faith exception does not apply if there is a pattern of errors on a return or claim for refund even though any one error, in isolation, would have qualified for the reasonable cause and good faith exception.

(3) Materiality of errors. The understatement was not material in relation to the correct tax liability. The reasonable cause and good faith exception generally applies if the understatement is of a relatively immaterial amount. Nevertheless, even an immaterial understatement may not qualify for the reasonable cause and good faith exception if the error or errors creating the understatement are sufficiently obvious or numerous.

(4) Tax return preparer's normal office practice. The tax return preparer's normal office practice, when considered together with other facts and circumstances, such as the knowledge of the tax return preparer, indicates that the error in question would rarely occur and the normal office practice was followed in preparing the return or claim for refund in question. Such a normal office practice must be a system for promoting accuracy and consistency in the preparation of returns or claims for refund and generally would include, in the case of a signing tax return preparer, checklists, methods for obtaining necessary information from the taxpayer, a review of the prior year's return, and review procedures. Notwithstanding these rules, the reasonable cause and good faith exception does not apply if there is a flagrant error on a return or claim for refund, a pattern of errors on a return or claim for refund, or a repetition of the same or similar errors on numerous returns or claims for refund.

(5) Reliance on advice of others. For purposes of demonstrating reasonable cause and good faith, a tax return preparer may rely without verification upon advice and information furnished by the taxpayer or other party, as provided in §1.6694-1(e). The tax return preparer may reasonably rely in good faith on the advice of, or schedules or other documents prepared by, the taxpayer, another advisor, another tax return preparer, or other party (including another advisor or tax return preparer at the tax return preparer's firm), and who the tax return preparer had reason to believe was competent to render the advice or other information. The advice or information may be written or oral, but in either case the burden of establishing that the advice or information was received is on the tax return preparer. A tax return preparer is not considered to have relied in good faith if --

(i) The advice or information is unreasonable on its face;

(ii) The tax return preparer knew or should have known that the other party providing the advice or information was not aware of all relevant facts; or

(iii) The tax return preparer knew or should have known (given the nature of the tax return preparer's practice), at the time the return or claim for refund was prepared, that the advice or information was no longer reliable due to developments in the law since the time the advice was given.

(6) Reliance on generally accepted administrative or industry practice. The tax return preparer reasonably relied in good faith on generally accepted administrative or industry practice in taking the position that resulted in the understatement. A tax return preparer is not considered to have relied in good faith if the tax return preparer knew or should have known (given the nature of the tax return preparer's practice), at the time the return or claim for refund was prepared, that the administrative or industry practice was no longer reliable due to developments in the law or IRS administrative practice since the time the practice was developed.