Comment #3 Final 6694 regulations

The ABA, the AICPA, the NAEA and the NSTP are strangely silent about the risks of tax return preaparers to draconian penalties. I have been involved with many civil and criminal examinations and it seems that when there is an examination of a client's tax return, there are multiple audit adjustment and, for the sake of this discussion, I venture to say that there would be an average of three examination changes in a return per year for the normal three year examination. That would mean there is an average of nine errors with the potential that each error is "reckless" and vulnerable to the $5,000 preckless penalty. Therefore, at risk, is the potential for $45,000 in return preparer penalties for a typical examination. It absolutely boggles my mind the the professional association have taken the return preparer penalty risk in a passive way, as if they solved all problems by lobbying for the "substantial authority" standard of conduct.

I have given some thought to this passive innvolvement and have concluded that your professional associations believe that return preparers have little risk because they can rely on data given to them by clients. They are wrong!


§1.6694-1(e)(1) In general. --For purposes of sections 6694(a) and (b) (including meeting the reasonable belief that the position would more likely than not be sustained on its merits and reasonable basis standards in §§1.6694- 2(b) and (c)(2), and demonstrating reasonable cause and good faith under §1.6694-2(d)), the tax return preparer generally may rely in good faith without verification upon information furnished by the taxpayer. A tax return preparer, however, may not rely on information provided by a taxpayer with respect to legal conclusions on Federal tax issues. A tax return preparer may also rely in good faith and without verification upon information furnished by another advisor, another tax return preparer or other party (including another advisor or tax return preparer at the tax return preparer's firm). The tax return preparer is not required to audit, examine or review books and records, business operations, or documents or other evidence to verify independently information provided by the taxpayer, advisor, other tax return preparer, or other party. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer. The tax return preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. Additionally, some provisions of the Code or regulations require that specific facts and circumstances exist (for example, that the taxpayer maintain specific documents) before a deduction or credit may be claimed. The tax return preparer must make appropriate inquiries to determine the existence of facts and circumstances required by a Code section or regulation as a condition of the claiming of a deduction or credit.


(e)(2) Verification of information on previously filed returns. --For purposes of section 6694(a) and (b) (including meeting the reasonable belief that the position would more likely than not be sustained on its merits and reasonable basis standards in §§1.6694-2(b) and (c)(2), and demonstrating reasonable cause and good faith under §1.6694-2(d)), a tax return preparer may rely in good faith without verification upon a tax return that has been previously prepared by a taxpayer or another tax return preparer and filed with the IRS. For example, a tax return preparer who prepares an amended return (including a claim for refund) need not verify the positions on the original return. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer. The tax return preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. The tax return preparer must confirm that the position being relied upon has not been adjusted by examination or otherwise.


§1.6695-2(b)(3)(i) In general. --The tax return preparer must not know, or have reason to know, that any information used by the tax return preparer in determining the taxpayer's eligibility for, or the amount of, the EIC is incorrect. The tax return preparer may not ignore the implications of information furnished to, or known by, the tax return preparer, and must make reasonable inquiries if the information furnished to the tax return preparer appears to be incorrect, inconsistent, or incomplete. A tax return preparer must make reasonable inquiries if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information furnished to the tax return preparer appears to be incorrect, inconsistent, or incomplete. The tax return preparer must also contemporaneously document in the files the reasonable inquiries made and the responses to these inquiries.

Looking at the above, does anyone know the meaning of "reasonable inquiries?"
Generally, as as is apparent from §1.6695-2(b)(3)(i) and §1.6694-1(e)the inquiries deal mostly with factual consistencies and logical consistencies. That is correct, but what about the facts required by the Code and regulations?

Consider a simple tax return with itemized deductions and a charitable donation of $500. If your client says I gave $500 to the United Cancer Fund, would you accept that statement because you can "rely on information" given to you my your client?

For any contribution of $250 or more (including contributions of property), taxpayers must obtain a contemporaneous written acknowledgment from the qualified organization.

Suppose you did not know that rule and there were client receipts but not contemporaneous written recipts. Even if there is IRS disclousre, you would not be able to defend yourself against a "reckkess" $5,000 penalty because there was zero compliance with the law. But what about the "reliance on the client" rule? The IRS examiner would mostly argue that you did not make any "reasonable inquiry." You can never defend yourself with the "reasonable inquiry" standard in the regulations because that is a discretionary standard. Further §1.6694-1(e)(1) references the tax Code and Regulations in the context of the "reasonable inquiry" standard.

There is an overlap beteween the technical standards of conduct and the reasonable-reliance-on-the-client-data rule.

My conclusion is that if you cannot rely on client data that needs substantiation with specified rules in regulations. I am sure you can rely on the data in a document showing the contemporaneous documentation for a charitable contribution or you can rely on the total cost of office supplies. This is a very "slippery slope."

My advice is to put much more time into tax reasearch on any expense, deduction, or credit, and spend more time on substantiation, technical compliance, and learning as much about the business affairs as you can for each client. It is a loser to prepare tax returns for $5,000 or less if there is a risk of multiple $5,000 penalties for being reckless because you were negligent, did not exercise reasonable due diligence, or were dead wrong on the substantiation requirements. If you cannot meet these standards, you should not be preparing tax returns. Suddenly, return preparation is a high risk business.

Please note that the Final 6694 regulations have been uploaded to the top of the Home Page.

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