What "reckless" means in 6694(b)

Section 6694(b) WILLFUL OR RECKLESS CONDUCT. --If any part of any understatement of liability with respect to any return or claim for refund is due --

6694(b)(1) to a willful attempt in any manner to understate the liability for tax by a person who is an income tax return preparer with respect to such return or claim,
or

6694(b)(2) to any reckless or intentional disregard of rules or regulations by any such person.

There are regulations that define "reckless" -

§1.6662-3(b)(2) Disregard of rules or regulations. --The term "disregard" includes any careless, reckless or intentional disregard of rules or regulations. The term "rules or regulations" includes the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. A disregard of rules or regulations is "careless" if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule or regulation. A disregard is "reckless" if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe. A disregard is "intentional" if the taxpayer knows of the rule or regulation that is disregarded. Nevertheless, a taxpayer who takes a position (other than with respect to a reportable transaction, as defined in §1.6011-4(b) or §1.6011-4T(b), as applicable) contrary to a revenue ruling or notice has not disregarded the ruling or notice if the contrary position has a realistic possibility of being sustained on its merits.

The plain flush language of these regulations say that a person is "reckless" (and therefore subject to the $5,000 6694(b) penalty) if the return preparer does not follow defined rules and REGULATIONS. The "rules" would include IRS published positions.

But what about the "realistic possibility" defense?"


The Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28) changed the “realistic possibility” of success" standard in Code Sec. 6694(a) to a "more-likely-than-not" standard for nonabusive undisclosed items..





Rev. Rul. 78-344, 1978-2 CB 334 is illustrative of how the IRS administers the "realistic possibility" standard under section 694. You will find that this standard requires that you follow all of the Code, regulations, case law, etc. But the standard is less than the "substantial authority" standard. Since both standards are subjective, I do not see how one can avoid the 6694(b) $5,000 penalty if the return preparer does not precisely follow all published regulations that support all deductions, expenses and credits.

Rev. Rul. 78-344 follows:

Section 6694.--Understatement of Taxpayer's Liability by Income Tax Return Preparer

26 CFR 1.6694-1: Understatement of taxpayer's liability by income tax return preparer.

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An income tax return preparer who, following instructions from a taxpayer without consulting the regulations, excludes certain items from the gross income reported on the taxpayer's return that are required by the regulations to be included is subject to the panalty imposed by section 6694(a) of the Code for negligent or intentional disregard of rules and regulations.
[Text]

Advice has been requested whether, under the circumstances described below, an income tax return preparer is subject to the penalty imposed by section 6694(a) of the Internal Revenue Code of 1954 for negligent or intentional disregard of rules and regulations.
A, a tax return preparer, was engaged by B, a taxpayer, to prepare B's federal income tax return. B had certain items of income which B did not believe were properly includible in gross income, and instructed A not to include the items in gross income as reported on the tax return. Although the income tax regulations provide for the inclusion of these items in gross income, A did not bother to consult the regulations, but chose instead to follow B's insructions on the assumption that B was probably correct. A's failure to include these items in B's gross income resulted in an understatement of B's income tax liability.
Section 6694(a) of the Code imposes a penalty on an income tax return preparer who understates a taxpayer's liability by negligent or intentional disregard of rules and regulations. Section 1.6694-1(a)(3) of the Income Tax Regulations provides that the term "rules or regulations" includes the provisions of the Internal Revenue Code and the Treasury regulations issued under the Code.
Section 1.6694-1(a)(4) of the regulations provides that an income tax return preparer who fails to follow an income tax regulation is not considered to have negligently or intentionally disregarded the rules and regulations if the preparer in good faith and with reasonable basis takes the position that the regulation does not accurately reflect the Code. This section further provides that, for purposes of section 1.6694-1(a) the view of the taxpayer concerning a rule or regulation is not material.
In this case, not withstanding that B instructed A not to include the items in gross income because of the belief that they were not properly includible, A did not in good faith and with reasonable basis take the position that these items of income were not includible in B's gross income.
Accordingly, A is subject to the penalty under section 6694(a) of the Code for understating B's income tax liability due to negligent or intentional disregard of the regulations.

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For the 2008 tax season, contact ab@irstaxattorney.com if you have any quresions on whether you are correctly applying IRS tax regulations or other published positions.