Comment #1 Final 6694 Regulations

The Final 6694 Regulations were uploaded as a blog on December 16, 2008. Those regulations should be listed in the home page shortly.

Section 1.6694-1(a) applies the "substantial authority" standard for undisclosed position (except for tax shelter and reportable transaction facts) and it retains the "reasonable basis" standard for disclosed positions.

This regulation does not make any reference to Reg. 1.6662-4(d)(3)(ii) and (iii) which set the standards for relevant technical "analysis" of all of the relevant technical "authority," as referenced in the proposed regulations. That Reg. reference was necessary in the prior draft because the standard of conduct was the "more likely than not" standard. That reference in the final regulations was not necessary because section 6694(a) as amended uses "substantial authority" as the standard of conduct and that definition is already located in Reg. 1.6662-4(d)(3).
Similarly, the same analysis and technical authority will be used for disclosed positions and the "reasonable basis" standard.

The bottom line is that return preparers will have to support ALL positions taken with relevant "analyis" of the applicable technical "authorities" or else be hit with 6694 penalties.

You can no longer put numbers in software without knowing or understanding the underlying technical support. Obviously, you will have to understand the technical basis of all of your entries in any income tax return. Hopefully, you will know enough to support the positions taken.

MOST IMPORTANT! Section 1.6694-1(e)(1)warns return preparers that you may not ignore the implications of information furnished to you AND you must make appropriate inquiries to determine the existenc of facts and circumstances required by a Code section or regulation as a consition of claiming a deduction or credit.

What I have just pointed out is the most important part of the 6694 final regulations, even for disclosed positions. If you do not strictly follow the detailed standards for the entertainment regulations, the charitable deductions regulations, etc. where there is great specificity for these deductions, you will be hit with 6694 penalties. That means that you CANNOT just rely on client data for those items; you will be required to make sure that data meets all of the regulatory standards for those deductions.

Even if you are preparing a small tax return, if someone is claiming nothing other than a charitable deduction, and ends up with an understatement of tax, you will have earned at least a $1,000 6694 penalty even if that understatement is $5 (an example of a small understatement of liability).

Do not even think that the 6694 penalties will not apply to small tax return preparers. Further, ignoring the applicable regulatory requirements is "reckless" conduct which would support the $5,000 6694(b) penalty (even for that hypothetical $5underpayment of tax).

You will be shortly preparing tax returns for the 2008 tax year and you better know your risks and responsibilities in preparing those tax returns. The era of just putting numbers into software without checking the underlying technical substantiation is a long gone era. We are into a new era where you need to take more time to make sure that all of the data in your client's tax returns is technically valid and accurate.

Also understand that the IRS software may be programed to coordinate IRS examination focus on the 6694 penalties when that software identifies apparent tax return error and negligence.

For any questions, continue to send inquiries to ab@irstaxattorney.com or add your comment to this blog.