Section 6694 "loophole" for substantial authority

Treasury "caved" and gave all return preparers a Chirstmas gift of a soft landing for avoiding any of the 6694 penalties. Sanat Claus apparently wrote Notice 2009-5.

Section B of Notice 2009-5 provides a definition for "substantial authhority." That section does reference all of the law in 1.6662-4(d)(iii) as expected to support "substantial authority."

But the loophole in this section is that, for purposes of 6694(a), the substnatial authority is satisfied if the return preparer "RELIES IN GOOD FAITH AND WITHOUT VERIFICATION ON THE ADVICE OF ANOTHER ADVISOR, ANOTHER TAX RETURN PREPARER, OR OTHER PARTY." The large caps are mine.

This language is not in the final regulations. It is part of the reasonable cause exception in the final regulations. But Notice 2009-5 gives tax return preparers a "new out."

In short, Treasury has taken the change in the statute form the more likely than not standard to the substantial authority standard as the basis for this "gift" to avoid penalties.

But the reliance must be made in "good faith" and the Notice references the sandards in 1.6694-2(e)(5) which says that there is NOT GOOD FAITH RELIANCE 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 the relevent facts, OR
(iii) the tax return preparer knew or should have known that the information was no longer reliable due to new developments in the law.

I read this three items as mostly things that can negate "good faith." So if you get an opinion from another person and if there is no good faith problem, you have met the substantial authority standard.

For those who want to be on the safe side, make sure that the opinions that you get are in writing!!!!!!!

Also, do not challange an IRS examiner to go after "good faith." Use a competent tax expert. And to the extent possible, use a competent tax expert who is outside of your firm. Then no IRS examiner could challange your "good faith" which is a very subjective term and determined by circumstantial evidence.

Your client would bear the financial burden of an opinion from an outside expert.

Outside experts will not be inexpensive because once the outside tax expert gives an opinion, the tax expert becomes the "return preparer."

Since your firm can also be liable as a "return preparer" everyone in the firm is off the hook if both the firm and the signing tax return preparer each get the opinion of an outside expert, and both (as far as I can determine) can use the same expert.

To minimize the risk on the tax expert, the position should also be disclosed to the IRS.

For those who engatge Alvin Brown & Associates, a tax law firm, for a written opinion, we will generally insist on disclosing the position unless it appears that the supporting authority is clear.

Note the following copied from Notice 2009-5 and the 6694 regulations:
Notice 2009-5

B. Definition of Substantial Authority

Until further guidance is issued, solely for purposes of section 6694(a), "substantial authority" has the same meaning as in § 1.6662-4(d)(2) (or any successor provision) of the accuracy-related penalty regulations. The analysis prescribed by § 1.6662-4(d)(3)(i) through (ii) (or any successor provisions) applies for purposes of determining whether substantial authority is present. The authorities considered in determining whether there is substantial authority for a position are those authorities described in § 1.6662-4(d)(3)(iii) (or any successor provision).

There is substantial authority for a position for purposes of section 6694 if the taxpayer is the subject of a "written determination" as provided in § 1.6662-4(d)(3)(iv)(A) . In the case of a tax return preparer, however, a written determination with a misstatement or omission of material fact is substantial authority unless the tax return preparer knew or should have known of the misstatement or omission of material fact when the return or claim for refund was filed. The applicability of court cases to the taxpayer's situation by reason of the taxpayer's residence in a particular jurisdiction is not taken into account in determining whether there is substantial authority for a position in accordance with § 1.6662-4(d)(3)(iv)(B) . Notwithstanding the preceding sentence, there is substantial authority for a position if the position is supported by controlling precedent of a United States Court of Appeals to which the taxpayer has a right of appeal with respect to the position. Finally, there is substantial authority for a position only if there is substantial authority on the date the return or claim for refund is deemed prepared, as prescribed by § 1.6694-1(a)(2) , or there was substantial authority on the last day of the taxable year to which the return relates.

Conclusions reached in treatises, legal periodicals, legal opinions, or opinions rendered by tax professionals (including tax return preparers) are not authority. The authorities underlying such expressions of opinion, if applicable to the facts of a particular case, however, may give rise to substantial authority for the position. Solely for purposes of section 6694(a) , a tax return preparer nevertheless will be considered to have met the standard in section 6694(a)(2)(A) if the tax return preparer relies in good faith and without verification on the advice of another advisor, another tax return preparer, or other party. Factors used in evaluating a tax return preparer's good faith reliance on the advice of another are found in § 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.