6694(b) is triggered by 6662(c) penalties

T.B. Bare, T.C. Summary Opinion 2001-48, involves a common issue involving section 1034.

Under sections 1001 and 61, taxpayers generally must recognize in the year of sale all gain or loss realized upon the sale or exchange of property. Section 1034, however, provides an exception which allows taxpayers to defer recognition of gain when sale proceeds are reinvested in a new principal residence. 2 Section 1034(a) specifies that gain must be reinvested in property "purchased and used by the taxpayer as his principal residence" in order for nonrecognition treatment to be available.

The Tax Court concluded that the 1034 requirements were not met.

This case is interesting because it considered whether the taxpayer was “reckless” within the section 6662(c). The term “reckless” is also used in section 6694(b).

For this reason the reasoning of the Tax Court is relevant to 6694(b) penalty issues.

"Negligence" includes any failure to make a reasonable attempt to comply with the statute, and "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c). Negligence is also defined as the failure to exercise the due care that a reasonable and ordinarily prudent person would employ under the same circumstances. See Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Petitioner bears the burden of proving that the accuracy-related penalties are inapplicable. 3 See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).

Petitioner is a certified public accountant. His purported purchase and resale of the Bowmen Lane property clearly were undertaken solely with the intent to meet the nonrecognition provisions of section 1034. Petitioner knew or should have known that a transaction devoid of any substance does not meet the requirements of section 1034 and the regulations promulgated thereunder.
The negligence penalty was assessed against the CPA/taxpayer.

For the tax return preparers who prepare tax returns that do not meet the statute or regulation requirements, the issue would be, as in this case, whether the tax return preparer KNEW OR SHOULD HAVE KNOWN that the technical requirements were not met.
In those cases, the IRS examiners will “nail” tax return preparers with the 6694(b) $5,000 penalty for each position.

Understand, that negligence does not reach the level of “substantial authority.” A tax return preparer who is not negligent could flunk the “substantial authority” standard. There for the test for 6694(b) $5,000 penalties will always be “negligence.”

If your taxpayer/client is subject to the 6662 penalty, then I would expect the tax return preparer will be hit with the 6694(b) penalty regardless of whether the position was disclosed to the IRS; the transaction would also fail the “reasonable basis” standard.

This case had some factual issues and the Tax Court used substance over form principles to reach its decision.

If you want to read the full case, e-mail me at ab@irstaxattorney.com.

I had a conversation with an IRS examiner this past week and I asked him how many negligence errors he normally finds in an IRS examination. The answer was two or three. I expect to see lots of tax return preparers hit with $10,000 or $15,000 in 6694(b) penalties (representing two or three errors) for tax returns that are examined for the 2008 tax year.

Fees need to go up to help offset the higher risk in preparing tax returns for the 2008 tax year.