Be prepared for $5,000 6694 penalties

6694(b)(1) IN GENERAL . --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a conduct described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --

6694(b)(1)(A) $5,000, or

6694(b)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.

6694(b)(2)(B) a reckless or intentional disregard of rules or regulations.

To emphacize the point, 6694(b)(2)(B) will impose the $5,000/50% penalty if a return preparer is merely "reckless." But the term "reckless" is defined by statute as "negligence."


6662(c) NEGLIGENCE. --For purposes of this section, the term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of this title, and the term "disregard" includes any careless, reckless, or intentional disregard.

§1.6662-3(b) Definitions and rules

(1) Negligence. --The term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return. "Negligence" also includes any failure by the taxpayer to keep adequate books and records or to substantiate items properly. A return position that has a reasonable basis as defined in paragraph (b)(3) of this section is not attributable to negligence. Negligence is strongly indicated where --

(i) A taxpayer fails to include on an income tax return an amount of income shown on an information return, as defined in section 6724(d)(1);

(ii) A taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return which would seem to a reasonable and prudent person to be "too good to be true" under the circumstances.


(2) Disregard of rules or regulations. --The term "disregard" includes any careless, reckless or intentional disregard of rules or regulations. The term "rules or regulations" includes 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 Internal Revenue Service and published in the Internal Revenue Bulletin. A disregard of rules or regulations is "careless" if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule or regulation. A disregard is "reckless" if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe.


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The above language comes only from the Internal Revenue Code and tax regulations. The language quoted is not ambiguous. After May 25, 2007, all return preparers will be jubject to the $5,000/50% penalty if:

1. The position taken is contrary to a "rule or regulation" if a reasonable person would have known or that rule or regulation and relevant IRS notices or rulings. Following the Internal Revenue Code includes, for example, section 6001 record and substantiation regulations. There is little doubt that the failure to comply with the §1.6662-3(b)(1)substantiation mandate can be viewed as "reckless" within the meaning of section 6694(b)
2. A return preparer has not researched the position taken in the tax return and the position is onctrary to any IRS notice.
3. A return preparer misapplies a rule or regulation. "Substantial deviation" is a term that means that the position taken was wrong.
4. §1.6662-3(b)is the provision of the regulations which also defines "reasonable basis." If you play that out to its logical conclusion, 6694(b) can be defined to be equal to 6694(a) wihich provides the "reasonable basis" standard for disclosed positions from extrapolations from the word "reckless."

I have identified a large loophole for IRS examiners to equate 6694(a) with 6694(b), a result that would be clearly contrary to Congressional intent. For this reason, the final 6694 regulations should find a way to limit the definition of "reckless" to something stronger than the definition under section 6662(c).

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