Notice 2009-5 - hold the celebration

Notice 2009-5 has a rule for 6694(a) that the "substantial authority" standard of conduct can be met if the return preparer relies in good faith and without verification on the advice of another advisor, another tax return preparer, or other party but only if there is "good faith" under 1.6694-2(e)(5).

1.6694-2(e)(5) Reliance on advice of others.

For purposes of demonstrating reasonable cause and good faith, a tax return preparer may rely without verification upon advice and information furnished by the taxpayer and information and advice furnished by another advisor, another tax return preparer or other party, as provided in §1.6694-1(e). The tax return preparer may rely in good faith on the advice of, or schedules or other documents prepared by, the taxpayer, another advisor, another tax return preparer, or other party (including another advisor or tax return preparer at the tax return preparer's firm), who the tax return preparer had reason to believe was competent to render the advice or other information. The advice or information may be written or oral, but in either case the burden of establishing that the advice or information was received is on the tax return preparer. A tax return preparer is not considered to have relied in good faith if --

(i) The advice or information is unreasonable on its face;(ii) The tax return preparer knew or should have known that the other party providing the advice or information was not aware of all relevant facts; or

(iii) The tax return preparer knew or should have known (given the nature of the tax return preparer's practice), at the time the return or claim for refund was prepared, that the advice or information was no longer reliable due to developments in the law since the time the advice was given.

This "reliance" standard is shockingly inconsistent with the final 6694 regjulations because "substantial authority" in the 6662 regulations requires technical support. So this is good news for the return preparer industry, at least for the 2008 tax year. But there is one term that is dangerous. As noted above, the advice cannot be "unreasonable on its face."

Consider the example of the embezzlement of investors in the Madoff Ponzi scheme. Suppose a return preparer says that since the theft loss was discovered in 2008, a taxpayer can take the theft loss in 2008. But we know that would be incorect advice because it is inconsistent with the theft loss regulations that do not allow the loss where there is a possibility for recovery. Can the return preparer rely on the advice of a tax attorney who wrote an eroneous opinion that the loss could be taken in 2008? The advice is "unreasonable on its face" if the return preparer has the technical responsibility to know the 162 tax regulations.
It is my personal opinion that IRS examiners will conclude that the tax return preparer should know that the advice is "unreasonable on its face" and hold the return preparer to know the regulations. This answer is consistent with the reference to the "substantial authority" guidance of the 6662 regulations.

Although Notice 2009-5 is a temporary liberal application of "substantial authority" it is my opinion that the threshold for tax return preparers is to be familiar with tax statutes and tax regulations that clearly provide the technical standards for any tax issue.

The tax preparation industry needs to wake up to the fact that the 2007 Act and the 2008 Act require technical support for all posiitons taken in a tax return. Failure to read clearly defined regulations is "negligence" per se.

Under the embezzlement example, the penalty would likely be the "reckless" $5,000 penalty under section 6694(b) and would apply to both the signing tax return preparer of the firm that employs the return preparer and also the tax attorney giving the clearly bad technical advice.

Comment on this important issue can be made in a reply to this blog or send an e-mail to ab@irstaxattorney.com.