Liability of the tax preparation firm

Note the following language in the final 6694 regulations:


§1.6694-1 (b) (5) Tax return preparer and firm responsibility. To the extent provided in §§1.6694-2(a)(2) and 1.6694-3(a)(2), an individual and the firm that employs the individual, or the firm of which the individual is a partner, member, shareholder, or other equity holder, both may be subject to penalty under section 6694 with respect to the position(s) on the return or claim for refund giving rise to an understatement. If an individual (other than the sole proprietor) who is employed by a sole proprietorship is subject to penalty under section 6694, the sole proprietorship is considered a "firm" for purposes of this paragraph (b).


§1.6694-2 (a) (2) Special rule for corporations, partnerships, and other firms. A firm that employs a tax return preparer subject to a penalty under section 6694(a) (or a firm of which the individual tax return preparer is a partner, member, shareholder or other equity holder) is also subject to penalty if, and only if --

(i) One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the conduct proscribed by section 6694(a);

(ii) The corporation, partnership, or other firm entity failed to provide reasonable and appropriate procedures for review of the position for which the penalty is imposed; or

(iii) The corporation, partnership, or other firm entity disregarded its reasonable and appropriate review procedures through willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.

§1.6694-3 (2) Special rule for corporations, partnerships, and other firms. A firm that employs a tax return preparer subject to a penalty under section 6694(b) (or a firm of which the individual tax return preparer is a partner, member, shareholder or other equity holder) is also subject to penalty if, and only if --

(i) One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the conduct proscribed by section 6694(b);

(ii) The corporation, partnership, or other firm entity failed to provide reasonable and appropriate procedures for review of the position for which the penalty is imposed; or

(iii) The corporation, partnership, or other firm entity disregarded its reasonable and appropriate review procedures through willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.

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The feedback that I have received from return preparer clients is that they were not aware of the firm liability plus the return preparer liability. As indicated, an employee of a sole proprietor and the sole proprietor firm may each be liabile for the penalty. In this example, if there are three reckless errors for the 2008 tax year, that would mean $15,000 in 6694(b) penalties for the return preparer and $15,000 in penalties for the firm. Obviously, the 6694 penalties will drive a great many of the return preparers to leave the return preparation industry.

There is no definition of "reasonable and appropriate" procedures. I read that term as requiring a detailed and comprehensive reviewer for every position in every tax return.

The test: what would lead a person of reasonable prudence and competence to investigate or ascertain an unreasonable position`or any problematical position?

It appears to me that the responsible person and the firm reviewer need to be expert on, for example, the tax regulations that interpret every Code provision. This is a bit "scary." It seems obvious that the responsible return preparer and the firm will no longer be able to rely on client data dealing with any deduction, expense or credit without verifying the underlying data IN EVERY 2008 TAX RETURN.

Two more points. The IRS and Treasury will be under pressure to raise tax revenue in this economy for obvious reasons. And you can expect IRS examiners to be aggressive on the 6694 issues. Examiners "follow the money" and a large amount of tax revenue can be raised from the 6694 penalties.

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