misguidance in the proposed 6694 regulations

The following language appears in section 1.6694(b) of the proposed regulations:

The analysis prescribed by §1.6662-4(d)(3)(ii) (or any successor provision) for purposes of determining whether substantial authority is present applies for purposes of determining whether the more likely than not standard is satisfied. Whether a tax return preparer meets this standard will be determined based upon all facts and circumstances, including the tax return preparer's diligence. In determining the level of diligence in a particular situation, the tax return preparer's experience with the area of Federal tax law and familiarity with the taxpayer's affairs, as well as the complexity of the issues and facts, will be taken into account

The above language would be applicable to the "substantial authority" standard in lieu of the "more than likely standard" under 6649(a)(2)(A) as amended by the Emergenchy Economic Stabilization Act of 2008.

Focus instead on the fact that the tax return preparers will still need to meet the "substantial authority" itemized in 1.6662-3(d)(3)(iii) as well as the "analysis" requirements of (d)(3)(ii). Those are serious technical requirements and standards at a very high technical threshold.

So what is this "facts & circumstances" "familiarity with family" and "due diligence" language and focus on "complexity?" Those are trap terms. If you do not have the requisite technical support, you will be a 6694 penalty victim. In the real world, the IRS examiners are going to take aggressive positions that your technical authority is deficient if it is not entirely comprehensive. On many occasions I find that the IRS examiners do not know or understand the relevant law. Getting them to understand current law is sometimes a miricle. The examiners are not tax attorneys good at technical nuances sufficient to evaluate "due diligence" "complexity" and "facts & circumstances." If the technical support is lacking, I would not expect the examiners to know when the return preparer is more than 40% or more than 30% on target with technical authority, or take into account complexity, or lack of experience as a return preparer.

I believe the drafters of the proposed regulations should put these terms and concepts under "reasonable cause" in section 1.6694-2(d) of the proposed regulations. In fact "complexity" is a concept that is used in determing "reasonable cause" in the IRM dealing with penalties and also under the case law. The same is true of the "facts & circumstances" test and "due diligence." I would hope that the IRS will use that terminology solely for determining "reasonable cause" in the final regulations.

My problem with the location of these terms under the standard of conduct part of the regulations is because these terms are misleading to return preparers. These terms are traps because they imply that return preparers need not have quality technical support under section 1.6662-4(d) of the regulations.

Example 1: return preparer "negligence." Forget about it. There is no technical authority and the penalty will be applied. The fact that the law is complex or that you exercised due diligence will not negate the penalty. Bet on it.

Example 2: no return preparer negligence, but an "employee" was treated as a "subcontractor." I do not care how much "due diligence" was execised or even if you just had a heart by-pass operation, you will get nailed with the penalty. Your only concern will be whether the $5,000 "reckless" penalty will be assessed.

Do not rely on "due diligence" or "facts & circumstances" or "complexity" to save you from 6694 penalties when your technical support is weak or lacking. These terms are traps to blind-sided return preparers to take positions without doing the homework necessary to determine if the positions are supported with "substantial authority." Futther, assume that you will be dealing with incompetent IRS examiners with little training and experience because that is often the case.

We are almost at the end of 2008 there has been very little guidance to return preparers by their professional associations on the need for technical analysis and technical authority. My advice: more authority is better than less technical support and it is better to disclose positions to the IRS for the reduced standards. You will have to allocate more time to return preparation for tax research and consultations with tax experts.

I have received excellent commentary sent to ab@irstaxattorney.com. But you can make comment to these blogs. No seminars will be offered in December.