The final 6694 regulations have been uploaded
Just a reminder that you can download the final 6694 regulations from the home page and also from one of the blogs below.
There were more than 10,000 downloads of the proposed regulations and less than half as much on the more important and final 6694 regulations, although the population of those who have found this web page and blog have grown substantially.
Also entered into one of the recent blogs is IRS Notice 2009-5 which addresses the standard of conduct for return preparers. Now that the "substantial authority" standard has replaced the "more than likely standard, you have to have some clarification of how to measure "substantial authority."
Although "substantial authority" is defined in the section 6662 negligence regulations, it is Notice 2009-5, not the final 6694 regulations, that clarify that the IRS will look to section 1.6662-4(d) for the definition of "substantial authority." Those regulations specify all of the tax law: the IRS Code, the regulations under the Code, the case law, legislative history, IRS published positions, and more. In addition, those regulations require the anlysis used to support "substantial authority" must be relevant.
There is a huge body of case law that defines "substantial authority."
WARNING! Do not assume that the standard of conduct for return preparer is "negligence" merely because the proposed regulations, either directly or indirectly through Notice 2009-5 reference the negligence regulations.
Negligence was the standard of conduct for return preparers prior to 1989. What you have to understand is that you can be not-negligent, and still be hit with the $1,000 and $5,000 penalties for each wrong position.
The test is a purely technical test on the quality of the authority you have to support any position in the tax return. A large part of the issues arise in a Form 1040 in Schedule A and Schedule C. That means that if you do not support any of those items with the specificity demanded by the regulations that deal with those issues, you will be hit with those penalties.
The above also applies to the "reasonable basis" standard for disclosed positions. Do not assume that you do not have to apply the specificity of the income tax regulations for disclosded positions. For example, there are high technical substantiation requirements under the travel and entertainment regjulations, as you all know. You are "red meat" for the $5,000 penalty for being "reckless" (within the meaning of 6694(b)) if you do not meet the substantiation requirements of the section 167 regulations.
What does thils really mean for most of the return preparers?
You need to have access to current tax law and regulations. How can you possibly meet the "substantial authority" or "reasonable basis" standards without having immediate access to all of the current tax law? I have always used CCH, a personal habit with me. There are other tax resource services.
The reason we have these new draconian penalties is that return preparers would take any number given to them by their client, put those numbers into software, collect their fees and be done with the return.
No more, now way, Jose! That is the past!
I have represented a fair number of tax return preparerers undergoing civil and criminal examinations. Whether you know it or not, the IRS software is able to identify a high error rate by tax return preparers. In those examinations, the 6694 penalty was never an issue because of the small size of the $250 penalty.
I am certain that the IRS will be motivated to go after the very large draconian penalties. Example, three negligent errors in any tax return is certain to be viewed as "reckless" and translate into $15,000 in penalties ($5,000 x 3). You can take a travel expense of $100 and if you cannot support that travel expense with the technical authority in the regulations, that $100 will cost you $5,000 in penalties because the failure of a tax return preparer to apply long standing IRS regulations is simply "reckless." If you claim $600 for a charitable deduction and do not apply the NEW substantiation requirements, you will be hit with another $5,000 for being reckless. If you make the same mistakes in a typical three year examination, your penalties could be $45,000 ($15,000 x 3).
Because of this new high risk for large penalties that most return preparers cannot afford, I am at a total loss to understand why the ABA, AICPA, NAEA, and NATA professional associationsare not alerting you to this new high financial risk of these new high technical standards for all return preparers.
I deal with IRS examiners on a regular basis. They are aggressive. Do not expect that they are your friends. They are now motivated to go after these large penalties. If you are "negligent" because you misapply any substantiation requilrement, you should expect to be able to expect these penalties.
For the rest of this blog, I will assume that you can access tax research services. If you do not, you will not be return preparers very long unless you restrict your services to tax returns using the standard deduction. But if you work any tax return with itemized deductions, you will not be able to afford to stay in the return preparation business without access to a tax research service which allows you to cite the tax statute, read and apply the relevant regulations and the rest of the tax law.
I will use just one example for those of you who can research the relevant tax law: the business loss-hobby loss issue. I see this issue a lot. Lots of people have small Schedule C businesses that lose money. The IRS examiners will always go after those issues, and they only way to deal with it is to cite the applicable statute, regulations, and find some case law that will support your position. I would disclose those positions to get into the "reasonable basis" standard. Given the fact that there is a lot of litigation in this area and lots of losses of this issue in the Tax Court, I would not bet that you can win this issue with "substnatial authority" on a high frequency basis.
But even if your client does not win the 162 issue, you may prevail on the 6694 issue, depending on the quality of your technical research. But this also means that you have to put a lot of time into the technical research and writing. This is an example of they type of issue you should disclose to the IRS to take advantage of the much lower "reasonable basis" standard. Your client might lose the issue and be hit with the 20% negligence penalty, but you should be able to avoid the 6694 penalty by citing some of the relevant case law and the IRS regulations that deal with this issue.
I have recently uploade some recent case law to illustrate the type of issues that are litigated, and I will continue to do that, particularly in negligence cases which indicate sloppy work by the taxpayer or his tax return preparer.
If you have any comment to make on any of the above, you can reply to this blog without disclosing your identify. Quite a few of you have, instead, contacted me directly at ab@irstaxattorney.com or you can leave a message at 703 425-1400 ex 106 or ex 111.
Good luck in the upcoming final season. You will need it with the risk of $1,000 or $5,000 penalties (or the higher of 50% of your fee).
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