Application of 6694(b) $5,000 penalty

We know that the $5,000 penalty (or the higher of 50% of the return preparer fee) will apply if the return prepare is “reckless.” As previously noted in a prior blog, the term “reckless” is also found in the definition of “negligence” under section 6662(c). For this reason, the IRS can argue that any negligence by a return prepare should justify the $5,000 penalty. Note the language of section 6662(c), as follows:

Section 6662(c) defines, "negligence" for purposes of the negligence and disregard component of the accuracy-related penalty to include any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws and "disregard" for purposes of this component to include any careless, reckless or intentional disregard.

IA-015-90, Dealing with proposed 6662 regulations was published in the Federal Register Publication Date: March 4, 1991 to reflect changes in the Omnibus Budget Reconciliation Act of 1989, Pub.L. 101-239, 103 Stat. 2106 (OBRA 1989). [1990-1 C.B. 210]. OBRA 1989 substantially revised the civil tax penalty provisions of the Internal Revenue Code, generally effective for returns due (without regard to extensions) after December 31, 1989. Section 7721 of OBRA 1989 modified and reorganized the penalties formerly contained in numerous Code sections including 6694

There is a technical relationship between the two statutes. For example, a return preparer who does not follow an IRS regulations will trigger a 6622 penalty on a client and most likely the $5,000 6694 penalty.

Section 1.6662-3 of the regulations provides rules for the penalty for negligence or disregard of rules or regulations. This penalty applies if any portion of an underpayment of tax required to be shown on a return for a year is attributable to negligence or disregard of rules or regulations. "Negligence" includes any failure to make a reasonable attempt to comply with the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return.

The 6662 regulations notes that negligence is strongly indicated where a taxpayer fails to include income shown on an information return, such as a Form 1099, or fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion which would seem to a reasonable and prudent person to be "too good to be true" under the circumstances.

"Disregard of rules or regulations" includes any careless, reckless or intentional disregard of the Code, temporary or final Treasury regulations, or revenue rulings. 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 that demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe. A disregard is "intentional" if the taxpayer knows of the rule or regulation that is disregarded.

I have no doubt that if a return preparer does not follow a tax regulation, including not filing a Form 1099, the $5,000 6694 penalty will apply.

Remember that the proposed 6694 regulations has standards higher than a lack of negligence. That means even if you are not negligent, you may still be hit with the $5,000 if you do not provide an “analysis” of the relevant technical “authorities” to support a position that is not disclosed to the IRS.

It is my personal opinion that the final 6694 regulations need to define “reckless” for purposes of section 6694 to identify the distinctions between 6662(c) and 6694(a)standard enacted as part of the Emergency Economic Stabilization Act of 2008, signed by the President on October 3, 2008, which added 6694(a)(2)(A) (amending 6694(a) under prior law which contained the “more likely than not” standard). The "substantial authority" standard goes to the quality of the technical authority, regardless of whether there is or is not negligence. But it is not clear whether any negligence will automatically trigger the 6694(a) or (b) penalty. More importantly, the final regulations should give examples of when conduct becomes "reckless."