6694 Final Regulations -

T.D. 9436 , filed with the Federal Register on December 15, 2008 – the 6694 Final Regulations reflect amendments made by the Small Business and Work Opportunity Act of 2007 (P.L. 110-28) to the return preparer penalties under Code Secs. 6694 and 6695 and related Code Secs. 6060, 6107, 6109, 6696 and 7701 have been amended and finalized by the IRS. The tax return preparer regulations were amended to extend the application of the income tax return preparer penalties to all tax return preparers, including those who prepare estate, gift, and generation-skipping transfer (GST) tax returns; heighten the standards for both disclosed and undisclosed positions that must be met by preparers to avoid the Code Sec. 6694(a) penalty; and increase the Code Sec. 6694 penalty. The final regulations provided that only one person within a firm would be considered primarily responsible for each position giving rise to an understatement. The final regulations also clarify that a tax return preparer may rely on advice furnished by another advisor, return preparer, or other party, even if the advisor or tax return preparer is within the tax return preparer's same firm. However, the tax return preparer must meet the diligence standards in order to rely on the provided information. Furthermore, while the amendments made to Code Sec. 6694 by the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (P.L. 110-343) (the 2008 Act) changed the language from the previously used "reasonable belief that the position would more likely than not be sustained on its merits" standard to the "reasonable to believe" standard, the IRS interpreted the two standards to have the same meaning. However, the terminology was changed in the final regulations. The final version of Reg. §1.6694-2 does not contain substantive guidance regarding the amendments made by the 2008 Act. Accordingly, the IRS reserved Reg. §1.6694-2(c), and simultaneously issued Notice 2009-5, which provides interim guidance on the amendments. The final regulations modified the definition of adequate disclosure and removed provisions addressing the burden of proof regarding whether a tax return preparer has willfully attempted to understate the liability for tax. The final regulations are effective for advice given and returns and claims for refund filed after December 31, 2008.

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AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations implementing amendments to the tax return preparer penalties under sections 6694 and 6695 of the Internal Revenue Code (Code) and related provisions under sections 6060, 6107, 6109, 6696, and 7701(a)(36) reflecting amendments to the Code made by section 8246 of the Small Business and Work Opportunity Tax Act of 2007 and section 506 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008. The final regulations affect tax return preparers and provide guidance regarding the amended provisions.

DATES: Effective Date: These regulations are effective on December 22, 2008.

Applicability Date: For dates of applicability, see §§1.6060-1(d), 1.6107-1(e), 1.6109-2(d), 1.6694-1(g), 1.6694-2(f), 1.6694-3(g), 1.6694-4(d), 1.6695-1(g), 1.6695-2(d), 1.6696-1(k), 20.6060-1(b), 20.6107-1(b), 20.6109-1(b), 20.6694-1(b), 20.6694-2(b), 20.6694-3(b), 20.6694-4(b), 20.6695-1(b), 20.6696-1(b), 20.7701-1(b), 25.6060-1(b), 25.6107-1(b), 25.6109-1(b), 25.6694-1(b), 25.6694-2(b), 25.6694-3(b), 25.6694-4(b), 25.6695-1(b), 25.6696-1(b), 25.7701-1(b), 26.6060-1(b), 26.6107-1(b), 26.6109-1(b), 26.6694-1(b), 26.6694-2(b), 26.6694-3(b), 26.6694-4(b), 26.6695-1(b), 26.6696-1(b), 26.7701-1(b), 31.6060-1(b), 31.6107-1(b), 31.6109-2(b), 31.6694-1(b), 31.6694-2(b), 31.6694-3(b), 31.6694-4(b), 31.6695-1(b), 31.6696-1(b), 31.7701-1(b), 40.6060-1(b), 40.6107-1(b), 40.6109-1(b), 40.6694-1(b), 40.6694-2(b), 40.6694-3(b), 40.6694-4(b), 40.6695-1(b), 40.6696-1(b), 40.7701-1(b), 41.6060-1(b), 41.6107-1(b), 41.6109-2(b), 41.6694-1(b), 41.6694-2(b), 41.6694-3(b), 41.6694-4(b), 41.6695-1(b), 41.6696-1(b), 41.7701-1(b), 44.6060-1(b), 44.6107-1(b), 44.6109-1(b), 44.6694-1(b), 44.6694-2(b), 44.6694-3(b), 44.6694-4(b), 44.6695-1(b), 44.6696-1(b), 44.7701-1(b), 53.6060-1(b), 53.6107-1(b), 53.6109-1(b), 53.6694-1(b), 53.6694-2(b), 53.6694-3(b), 53.6694-4(b), 53.6695-1(b), 53.6696-1(b), 53.7701-1(b), 54.6060-1(b), 54.6107-1(b), 54.6109-1(b), 54.6694-1(b), 54.6694-2(b), 54.6694-3(b), 54.6694-4(b), 54.6695-1(b), 54.6696-1(b), 54.7701-1(b), 55.6060-1(b), 55.6107-1(b), 55.6109-1(b), 55.6694-1(b), 55.6694-2(b), 55.6694-3(b), 55.6694-4(b), 55.6695-1(b), 55.6696-1(b), 55.7701-1(b), 56.6060-1(b), 56.6107-1(b), 56.6109-1(b), 56.6694-1(b), 56.6694-2(b), 56.6694-3(b), 56.6694-4(b), 56.6695-1(b), 56.6696-1(b), 56.7701-1(b), 156.6060-1(b), 156.6107-1(b), 156.6109-1(b), 156.6694-1(b), 156.6694-2(b), 156.6694-3(b), 156.6694-4(b), 156.6695-1(b), 156.6696-1(b), 156.7701-1(b), 157.6060-1(b), 157.6107-1(b), 157.6109-1(b), 157.6694-1(b), 157.6694-2(b), 157.6694-3(b), 157.6694-4(b), 157.6695-1(b), 157.6696-1(b), 157.7701-1(b), and 301.7701-15(g).

FOR FURTHER INFORMATION CONTACT: Michael E. Hara, (202) 622-4910, and Matthew S. Cooper, (202) 622-4940 (not tollfree numbers).

SUPPLEMENTARY INFORMATION:



Paperwork Reduction Act

The collections of information contained in these final regulations were previously reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1231. The collections of information in this final regulation are in §§1.6060-1(a)(1), 1.6107-1, 1.6694-2(d)(3), 20.6060-1(a)(1), 20.6107-1, 25.6060-1(a)(1), 25.6107-1, 26.6060-1(a)(1), 26.6107-1, 31.6060-1(a)(1), 31.6107-1, 40.6060-1(a)(1), 40.6107-1, 41.6060-1(a)(1), 41.6107-1, 44.6060-1(a)(1), 44.6107-1, 53.6060-1(a)(1), 53.6107-1, 54.6060-1(a)(1), 54.6107-1, 55.6060-1(a)(1), 55.6107-1, 56.6060-1(a)(1), 56.6107-1, 156.6060-1(a)(1), 156.6107-1, 157.6060-1(a)(1), and 157.6107-1.

This information is necessary to make the record of the name, taxpayer identification number, and principal place of work of each tax return preparer, make each return or claim for refund prepared available for inspection by the Commissioner of Internal Revenue, and to document that the tax return preparer advised the taxpayer of the penalty standards applicable to the taxpayer in order for the tax return preparer to avoid penalties under section 6694. The collection of information is required to comply with the provisions of section 8246 of the Small Business and Work Opportunity Tax Act of 2007 and section 506 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008. The likely respondents are tax return preparers and their employers.

Estimated total annual reporting burden: 10,679,320 hours.

Estimated average annual burden per respondent: 15.6 hours.

Estimated number of respondents: 684,268.

Estimated frequency of responses: 127,801,426.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.



Background

This document contains final amendments to the Income Tax Regulations (26 CFR part 1), the Estate Tax Regulations (26 CFR part 20), the Gift Tax Regulations (26 CFR part 25), the Generation-Skipping Transfer Tax Regulations (26 CFR part 26), the Employment Tax and Collection of Income Tax at Source Regulations (26 CFR part 31), the Excise Tax Procedural Regulations (26 CFR part 40), the Highway Use Tax Regulations, (26 CFR part 41), the Wagering Tax Regulations (26 CFR part 44), the Foundation and Similar Excise Tax Regulations (26 CFR part 53), the Pension Excise Tax Regulations (26 CFR part 54), the Excise Tax on Real Estate Investment Trusts and Regulated Investment Companies Regulations (26 CFR part 55), the Public Charity Excise Tax Regulations (26 CFR part 56), the Excise Tax on Greenmail Regulations (26 CFR part 156), the Excise Tax on Structured Settlement Factoring Transactions Regulations (26 CFR part 157), and the Regulations on Procedure and Administration (26 CFR part 301) implementing the amendments to tax return preparer penalties under sections 6694 and 6695 (and the related provisions under sections 6060, 6107, 6109, 6696, and 7701(a)(36)) made by section 8246 of the Small Business and Work Opportunity Tax Act of 2007, Title VIII-B of Public Law 110-28 (121 Stat. 190) (May 25, 2007) (the 2007 Act) and section 506 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, Div. C of Public Law 110- 343 (122 Stat. 3765) (October 3, 2008) (the 2008 Act).

Section 8246 of the 2007 Act amended sections 6694 and 7701(a)(36) and made conforming changes to other Code provisions to make tax return preparer penalties applicable to a broader range of tax returns and claims for refund. The 2007 Act's amendments to section 6694 also changed the standards of conduct that tax return preparers must meet in order to avoid imposition of penalties in the event that a return prepared results in an understatement of tax. For undisclosed positions, the 2007 Act replaced the "realistic possibility" standard with a standard requiring the tax return preparer to have a "reasonable belief that the position would more likely than not be sustained on its merits." For disclosed positions, the 2007 Act replaced the "not-frivolous" standard with a standard requiring the tax return preparer to have a "reasonable basis" for the tax treatment of the position.

The 2007 Act also increased the first-tier penalty under section 6694(a) from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim for refund with respect to which the penalty was imposed. In addition, the 2007 Act increased the secondtier penalty under section 6694(b) from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the tax return preparer. The amendments made by the 2007 Act were effective for tax returns prepared after the date of enactment, May 25, 2007.

The Treasury Department and the IRS released Notice 2008-13 (2008-3 IRB 282) on December 31, 2007, to provide interim guidance under the 2007 Act. Additional guidance was simultaneously provided in Notice 2008-12 (2008-3 IRB 280) with respect to the implementation of the tax return preparer signature requirement of section 6695(b), and in Notice 2008-11 (2008-3 IRB 279), which clarified the earlier transition relief provided in Notice 2007-54 (2007- 27 IRB 12 (July 2, 2007)). Notice 2008-46 (2008-18 IRB 868) was released on April 16, 2008, to add certain returns and documents to Exhibits 1, 2, and 3 of Notice 2008-13.

On June 17, 2008, the Treasury Department and the IRS published in the Federal Register (73 FR 34560) proposed amendments to the regulations (REG-129243-07) reflecting amendments made by the 2007 Act and comments received on the notices. A public hearing was held on these proposals on August 18, 2008. Written public comments responding to the proposed regulations were received.

On October 3, 2008, section 506 of the 2008 Act modified the standards of conduct that tax return preparers must meet in order to avoid imposition of the section 6694(a) penalty. Specifically, the 2008 Act changed the standard for undisclosed positions from "reasonable belief that the position more likely than not will be sustained on the merits" to "substantial authority for the position." The 2008 Act maintained the "reasonable basis" standard for disclosed positions. If a position is with respect to a tax shelter (as defined in section 6662(d)(2)(C)(ii)) or a reportable transaction to which section 6662A applies, it must be "reasonable to believe that the position more likely than not will be sustained on the merits." The amendments made by the 2008 Act are retroactively effective for tax returns prepared after May 25, 2007, except that the special rules applicable to positions with respect to tax shelters and reportable transactions to which section 6662A applies are effective for tax returns or claims for refund prepared for tax years ending after October 3, 2008, the date of enactment of the 2008 Act.

After consideration of the public comments and the amendments made by the 2008 Act, the proposed regulations are adopted as revised by this Treasury decision. Section 1.6694-2 of these final regulations does not provide substantive guidance reflecting amendments to the Code made by the 2008 Act. Rather, the Treasury Department and the IRS are reserving §1.6694-2(c) in these final regulations and are simultaneously issuing a notice in the Internal Revenue Bulletin providing interim guidance on the amendments to the Code made by the 2008 Act. With these final regulations, the Treasury Department and the IRS are also simultaneously issuing a revenue procedure in the Internal Revenue Bulletin that specifically identifies the returns and claims for refund subject to penalty under sections 6694 and 6695.



Summary of Comments and Explanation of Revisions

Over 30 written comments were received in response to the notice of proposed rulemaking. All comments were considered and are available for public inspection upon request. A number of these comments are summarized in this preamble. The changes included in these final regulations are discussed in order of the Code sections to which they relate.

In accordance with the 2007 Act, these final regulations amend existing regulations defining tax return preparers, which were previously limited to income tax return preparers, to broaden the scope of that definition to include preparers of estate, gift, and generationskipping transfer tax returns, employment tax returns, excise tax returns, and returns of exempt organizations. These final regulations also revise current regulations to amend the standards of conduct that must be met to avoid imposition of the tax return preparer penalty under section 6694. In addition, these final regulations reflect changes to the computation of the section 6694 tax return preparer penalty made by the 2007 Act. These final regulations also amend current regulations under the penalty provisions of section 6695 to conform them with changes made by the 2007 Act expanding the scope of that statute beyond income tax returns. These final regulations are applicable to returns and claims for refund filed (and advice given) after December 31, 2008.



Furnishing of Copy of the Tax Return and Retaining Copy

The final regulations adopt the proposed amendments to §1.6107-1 regarding the requirement of a signing tax return preparer to furnish a copy of the completed tax return to the taxpayer and also to retain a copy, with modification.

One commentator requested that the final regulations make clear that a tax return preparer may provide copies of tax returns to taxpayers in either hard copy or electronic formats. The Treasury Department and the IRS recognize that because many returns are prepared and filed electronically and consist of electronic data, it may be unclear what is an acceptable copy of a return that must be furnished to the taxpayer. Upon further consideration, the Treasury Department and the IRS agree that clarification is necessary. Under §1.6107-1(a) of the final regulations, the tax return preparer must provide a complete copy of the return filed with the IRS to the taxpayer in any medium, including electronic, that is acceptable to both the taxpayer and the return preparer. In the case of an electronically-filed return, a complete copy of a taxpayer's return consists of the electronic portion of the return, including all schedules, forms, pdf attachments, and jurats, that was filed with the IRS. The copy provided to the taxpayer must include all information submitted to the IRS to enable the taxpayer to determine which schedules, forms, electronic files, and other supporting materials have been filed with the return. The copy, however, need not contain the identification number of the tax return preparer. The electronic portion of the return can be contained on a replica of an official form or on an unofficial form. On an unofficial form, however, data entries must reference the line numbers or descriptions on an official form.

The same commentator requested that the final regulations specifically provide that the copy of the tax return retained by tax return preparers may be retained electronically. The Treasury Department and the IRS, however, have concluded that revising the existing regulations to include this rule is not necessary. Existing revenue procedures address the maintenance of business records through use of electronic storage systems. See, for example, Rev. Proc. 97-22, 1997-1 CB 652. Tax return preparers may retain copies of tax returns in accordance with existing revenue procedures to comply with the final regulations.

Another commentator agreed with the general approach taken in §1.6107-1(c) but suggested clarification of the language regarding who is a signing tax return preparer for purposes of the section 6107 requirements. Upon consideration, the Treasury Department and the IRS agree that there is a potential for the proposed language to be misconstrued. Section 1.6107-1(c) of the final regulations clarifies that for purposes of complying with the requirements of section 6107, a corporation, partnership or other organization that employs a signing tax return preparer to prepare for compensation (or in which a signing tax return preparer is compensated as a partner or member to prepare) a return of tax or claim for refund shall be treated as the sole signing tax return preparer.



Furnishing Identification Number

A commentator requested that the final regulations clarify whether the tax return preparer's identifying number must be included on the taxpayer's copy of the tax return as well as on the copy filed with the I RS. Section 6109(a)(4) provides that any return or claim for refund prepared by a tax return preparer shall bear an identification number for securing proper identification of the tax return preparer, his employer, or both as may be prescribed. Upon further consideration, the Treasury Department and the IRS agree that for identification purposes, it is only important for the tax return preparer identification number to be included on the return that is filed with the IRS. Section 1.6109-2(a) of the final regulations, therefore, is amended to provide that each filed return or claim for refund containing the identification number of the tax return preparer required to sign the return (and the identification number of the person who has an employment arrangement or association with the individual tax return preparer, if applicable) will meet the needs of the IRS. This modification will assist in maintaining the privacy of the tax return preparer's information. Additional guidance may be provided in the future regarding tax return preparer identification numbers under section 6109.



Defining the Preparer Within a Firm

The final regulations adopt the proposed amendments to §1.6694-1(b)(1), with modification. Accordingly, the final regulations maintain a framework defining a "preparer per position within a firm", with the focus of any penalty on the position(s) giving rise to the understatement on the return or claim for refund and any responsible parties with respect to such position(s).

Under this framework, an individual is a tax return preparer subject to section 6694 if the individual is primarily responsible for the position on the return or claim for refund giving rise to the understatement. Under §1.6694-1(b)(1), only one person within a firm will be considered primarily responsible for each position giving rise to an understatement and, accordingly, be subject to the penalty.

Three commentators questioned whether this framework will lead to significant problems in return preparer firms, in particular whether the framework may discourage any particular person within the firm from looking at the return in whole. These commentators also questioned whether the IRS will be able to identify the responsible party if individuals at the firm attempt to identify others at the firm who may be more responsible for the position. Two other commentators, however, agreed with this framework in light of the high level of specialization that exists in modern tax practice. The Treasury Department and the IRS continue to conclude that the expansion from a "one preparer per firm" to a "one preparer per position within a firm" will further compliance and will result in more equitable administration of the tax return preparer penalty regime. This framework, therefore, is adopted in the final regulations.

Section 1.6694-1(b)(2) of the proposed regulations provided that the individual who signs the return or claim for refund as the tax return preparer generally will be considered the person within a firm who is primarily responsible for all of the positions on the return or claim for refund giving rise to an understatement. This language is finalized as proposed except for some minor conforming changes.

Proposed §1.6694-1(b)(3) established a similar rule for situations when there are one or more nonsigning tax return preparers at the same firm and either no signing tax return preparer within the firm, it is concluded that the signer is not primarily responsible for the position, or the IRS cannot conclude which individual is primarily responsible for the position for purposes of section 6694. In these situations, the proposed regulations stated that the individual within the firm with overall supervisory responsibility for the position(s) giving rise to the understatement is the tax return preparer who is primarily responsible for the position for purposes of section 6694.

Several commentators requested that this rule for nonsigning tax return preparers not be adopted as proposed because it will lead to more harm than good. Specifically, one commentator requested the deletion of the clause "or the IRS cannot conclude which individual (as between the signing tax return preparer and other persons within the firm) is primarily responsible for the position" from proposed §1.6694-1(b)(3) because a tax return preparer penalty is not appropriate when the IRS is not able to reach a conclusion as to who is primarily responsible for the conduct giving rise to the position. The other commentator recommended qualifying the rule in proposed §1.6694-1(b)(3) with the requirement that the individual with overall supervisory responsibility for the position either possess actual knowledge of the position or fail to exercise appropriate diligence in the review of the position subject to penalty through willfulness, recklessness, or gross indifference.

Upon consideration of these comments, the Treasury Department and the IRS have revised §1.6694-1(b)(3) to provide that if there is no signing tax return preparer for the return or claim for refund within that firm or if, after the application of §1.6694-1(b)(2), it is concluded that the signing tax return preparer is not primarily responsible for the position, the nonsigning tax return preparer within the firm with overall supervisory responsibility for the position(s) giving rise to the understatement generally will be considered the tax return preparer who is primarily responsible for the position for purposes of section 6694. Based upon credible information from any source, however, it may be concluded that another nonsigning tax return preparer within the firm is primarily responsible for the position(s) on the return or claim for refund giving rise to an understatement.

In response to the commentators' concerns that the default rule in proposed §1.6694-1(b)(3) assigning liability for the penalty to the nonsigning tax return preparer may lead to more harm than good, §1.6694-1(b)(4) of the final regulations is added. The final regulations in §1.6694-1(b)(4) provide that, if the information presented would support a finding that either the signing tax return preparer or a nonsigning tax return preparer within a firm is primarily responsible for the position(s) giving rise to the understatement, the IRS may assess the penalty against either one of the individuals within the firm, but not both, as the primarily responsible tax return preparer. This determination will be based upon all the evidence presented and will allow for certainty regarding the identification of the primarily responsible tax return preparer within the expiration of the period of limitations on making an assessment under section 6694(a). It is expected that the IRS will assess the penalty under section 6694 under these rules against the tax return preparer with the greatest amount of responsibility for the position based upon the best information available to the IRS. The rule adopted in §1.6694-1(b)(4) is not a rule reflecting joint and several liability for the penalty among the signing tax return preparer and nonsigning tax return preparer as the penalty may be assessed against one of these individuals, but not both.



Reliance on Information Provided

The final regulations adopt the proposed amendments to §1.6694-1(e), with modification. Most commentators supported expanding the regulations in §1.6694-1(e) to provide that a tax return preparer may rely in good faith and without verification on information furnished by another advisor, another tax return preparer, or other party (even if the advisor or tax return preparer is within the tax return preparer's same firm) as long as the tax return preparer does not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer, and makes reasonable inquiries if the information as furnished appears to be incorrect or incomplete.

Commentators, however, requested that the final regulations clarify that a tax return preparer may rely on "advice" furnished by another advisor, another tax return preparer, or other party (even if the advisor or tax return preparer is within the tax return preparer's same firm.) This recommendation is adopted in §1.6694-1(e)(1) of the final regulations. The same changes are made for conformity to the definitions of "reasonable to believe that the position would more likely than not be sustained on its merits" in §1.6694-2(b)(1), "reasonable basis" in §1.6694-2(d)(2) and "reasonable cause" in §1.6694-2(e)(5). These modifications are consistent with the intent of the rules in the proposed regulations regarding reliance given the heightened standards imposed on tax return preparers by the 2007 and 2008 Acts and the increased complexity of the law.

Section 1.6694-1(e) of the proposed regulations also proposed a new rule providing that a tax return preparer may not rely on legal conclusions regarding Federal tax issues furnished by taxpayers. The purpose behind this proposal was the belief that in general, although it was reasonable to allow a tax return preparer to rely on facts furnished by the taxpayer in good faith without verification, the tax return preparer should not be able to rely on legal conclusions on issues when the taxpayer may not be an expert and looked to the tax return preparer to determine the legal issue for purposes of preparing the return or claim for refund.

Most commentators expressed concern, however, that tax return preparers have long relied on information that involve mixed questions of fact and law furnished by taxpayers, in addition to legal conclusions. Moreover, the commentators point out that many large entity taxpayers have in-house tax departments staffed by tax professionals who are qualified to perform research and analysis necessary to address many legal issues.

The Treasury Department and the IRS acknowledge that the proposed regulations may be unclear on how the "no reliance on legal conclusions by taxpayers" language in proposed §1.6694-1(e) interacts with the language in proposed §1.6694-2(b)(2) regarding unreasonable assumptions. Accordingly, the "no reliance on legal conclusions by taxpayers" is removed from §1.6694-1(e) of the final regulations. While this phrase is removed from the text of the final regulations, the tax return preparer nevertheless must meet the diligence standards otherwise imposed by this regulation in order to rely properly on information and advice provided by taxpayers or other individuals. Tax return preparers must have no reason to believe that the taxpayer is incompetent to make these conclusions, have no knowledge that the conclusions are incorrect or incomplete, and make reasonable inquiries if the information as furnished appears to be incorrect or incomplete.



Use of Estimates

One commentator noted that the nature of accounting, upon which calculations of taxable income are based, requires the use of estimates, and urged the Treasury Department and the IRS to include a specific reference to allow the use of estimates in the final regulations. The Treasury Department and the IRS recognize that there are some circumstances when the use of reasonable estimates may be appropriate in the preparation of tax returns (see, for example, §§1.448-2(d), 1.451-1(a), and 1.451-5(c)(1)(ii)), and there are some circumstances in which there may be no practical alternative to the use of reasonable estimates, for example, when the taxpayer's records are destroyed accidentally or through computer failure. The Treasury Department and the IRS, however, conclude that including a general rule regarding the use of estimates in the preparer penalty regulations that could impact other substantive tax provisions is not appropriate.



Income Derived Determination in Computing Penalty Amount

The final regulations adopt the proposed amendments to §1.6694-1(f), with minor modification. Section 1.6694-1(f) defines "income derived (or to be derived)" with respect to a return or claim for refund as all compensation the tax return preparer receives or expects to receive with respect to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement.

Several commentators requested clarification on this definition of "income derived (or to be derived)" for purposes of computing the section 6694 penalty because it is not necessarily clear what compensation is captured by this definition, which could be interpreted broadly. The final regulations maintain the same definition of "income derived (or to be derived)" as proposed because the Treasury Department and the IRS conclude that the other rules described in §1.6694-1(f) provide appropriate limitations to this definition.

In response to a commentator's request, the final regulations in §1.6694-1(f)(4) also add an example illustrating how the penalty will be computed in cases involving employees and partners who spend a portion of their time on a particular position subject to the section 6694 penalty for which the firm earns a specific amount.



Firm Liability

The final regulations adopt the proposed amendments to §§1.6694-2(a)(2) and 1.6694-3(a)(2), without modification. One commentator requested examples of a firm disregarding its review procedures through willfulness, recklessness, or gross indifference 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. The determination as to whether a firm disregards its review procedures will be made based upon all facts and circumstances. Because any example necessarily would be limited to the facts of a particular firm's review procedures, additional examples on this issue would not meaningfully add to the guidance provided in the proposed regulations.



Reasonable to Believe That More Likely Than Not

Section 1.6694-2(b) of the final regulations defines the "reasonable to believe that the position would more likely than not be sustained on its merits" standard that now applies to positions that are tax shelters and reportable transactions to which section 6662A applies. While the 2008 Act amendment to section 6694 includes a "reasonable to believe" standard rather than the "reasonable belief" standard used in the 2007 Act, the Treasury Department and the IRS are of the view that the two standards have the same meaning. Conforming changes are made throughout the final regulations to reflect the 2008 Act terminology.

Proposed §1.6694-2(b)(1) provided that the "reasonable belief that the position would more likely than not be sustained on its merits" standard will be satisfied if the tax return preparer analyzes the pertinent facts and authorities and, in reliance upon that analysis, reasonably concludes in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits. The proposed regulations stated that whether a tax return preparer meets this standard will be determined based upon all facts and circumstances, including the tax return preparer's due diligence. Moreover, in determining the level of diligence in a particular case, the proposed regulations provided that the IRS would take into account the tax return preparer's experience with the area of tax law and familiarity with the taxpayer's affairs, as well as the complexity of the issues and facts in the case.

Several commentators requested that the final regulations specify that the amount of due diligence required on the part of the tax return preparer should not be disproportionate to the amount of the tax liability that would be affected by the position at issue. There was also some confusion on whether the due diligence rules in the proposed regulations allowed a less educated, sophisticated, or experienced tax return preparer to escape penalty liability more easily than educated, sophisticated, or experienced tax return preparers. This was not the intent of this rule in the proposed regulations. Due diligence is only one of many factors to consider in determining whether a tax return preparer meets the "reasonable to believe that the position would more likely than not be sustained on its merits" standard and all of the facts and circumstances of each specific case will need to be evaluated in making this determination.

Several commentators suggested that the provisions in §1.6694-2(d)(5) of the proposed regulations permitting tax return preparers to rely upon generally accepted administrative or industry practice in establishing reasonable cause relief from penalties under section 6694 should be extended to allow consideration of generally accepted administrative or industry practice in determining whether the "reasonable to believe that the position would more likely than not be sustained on its merits" standard is satisfied. These comments are not adopted in the final regulations because the Treasury Department and the IRS continue to conclude that the authorities contained in §1.6662-4(d)(3)(iii) (or any successor provision) are the appropriate authorities to be considered in determining whether it is reasonable to believe that the position would more likely than not be sustained on its merits. The "reasonable to believe that the position would more likely than not be sustained on its merits" standard relates to the tax return preparer's evaluation of the merits of a return position, and the merits of a tax return position must be considered in light of established relevant legal authorities. Generally accepted administrative or industry practice are less relevant in considering the merits of a tax return position under applicable law and guidance, although they may be appropriate factors to consider in the context of a tax return preparer's reasonable cause and good faith.

Based upon a comment received, the final regulations in §1.6694-2(b)(4) adopt the same rule as in §1.6662-4(d)(3)(iv)(B) regarding the effect of the taxpayer's jurisdiction on meeting the appropriate standard. The Treasury Department and the IRS are of the view that it is appropriate that the same rule apply for purposes of satisfying the "reasonable to believe that the position more likely than not be sustained on its merits" standard. This approach supports uniform disclosure by taxpayers and tax return preparers and prevents conflicts between taxpayers and tax return preparers in complying with the federal tax laws.



Adequate Disclosure

The final regulations adopt the proposed amendments to §1.6694-2(d)(3), with modification based upon comments received and revisions made in the 2008 Act. For a signing tax return preparer within the meaning of §301.7701-15(b)(1), the final regulations provide that disclosure of a position for which there is a reasonable basis but for which there is not substantial authority is adequate in one of three ways. First, the position may be disclosed on a properly completed and filed Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, as appropriate, or on the tax return in accordance with the applicable annual revenue procedure. See Revenue Procedure 2008-14 (2008-7 IRB 435 (February 19, 2008)). Second, disclosure of the position is adequate if the tax return preparer provides the taxpayer with a prepared tax return that includes the appropriate disclosure in accordance with §1.6662-4(f). Third, for tax returns or claims for refund that are subject to penalties other than the accuracy-related penalty for substantial understatements under sections 6662(b)(2) and (d), the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer under section 6662. This third rule is intended to address the situation when the penalty standard applicable to the taxpayer is based on compliance with requirements other than disclosure on the return (for example, section 6662(e)). In the case of a nonsigning tax return preparer within the meaning of §301.7701-15(b)(2), the final regulations in §1.6694-2(d)(3)(ii) maintain the same three disclosure rules that were in the proposed regulations.

Two commentators requested clarification of the prohibition against a boilerplate disclaimer and recommended clarifying that a firm does not violate the prohibition simply by adopting a standard approach to disclosure issues. Section 1.6694-2(d)(3)(iii) of the final regulations is revised to provide that no general disclaimer is allowed with respect to the specific facts and circumstances of the taxpayer and the position for which there is no substantial authority. Tax return preparers, and their firms, may use standard language to describe applicable law and may adopt a standard approach to disclosure issues.

One commentator stated that it is unclear what specifically must be documented by the nonsigning tax return preparer in order to avoid imposition of penalties. The final regulations are revised by clarifying that the documented advice that would constitute adequate disclosure in §1.6694-2(d)(3)(ii)(A) with respect to a nonsigning tax return preparer's advice to a taxpayer, if the firm is advising the taxpayer, should confirm that the affected taxpayer has been advised by a tax return preparer in the firm of the potential penalties and the opportunity, if any, to avoid penalty through disclosure.

Similarly, in §1.6694-2(d)(3)(ii)(B) with respect to a nonsigning preparer's advice to another tax return preparer, if providing nonsigning preparer advice to another preparer in the same firm, contemporaneous documentation should be satisfied if there is a single instance of contemporaneous documentation within the firm. If the firm is advising another preparer outside of the firm, the final regulations provide that this documentation should confirm that the preparer outside the firm has been advised that disclosure under section 6694(a) may be required.

Finally, the disclosure rules in §1.6694-3(c)(2) of the final regulations are revised to clarify that a tax return preparer is not considered to have recklessly or intentionally disregarded a rule or regulation if the position contrary to the rule or regulation has a reasonable basis as defined in §1.6694-2(d)(2) and is adequately disclosed in accordance with §§1.6694-2(d)(3)(i)(A) or (C) or 1.6694-2(d)(3)(ii). In the case of a position contrary to a revenue ruling or notice, a tax return preparer also is not considered to have recklessly or intentionally disregarded the ruling or notice if the position meets the substantial authority standard described in §1.6662-4(d) and is not with respect to a reportable transaction to which section 6662A applies. This modification ensures that tax return preparers may advise their clients to challenge an IRS ruling or notice under the appropriate circumstances.



Reasonable Cause

The final regulations in §1.6694-2(e) adopt the proposed amendments to §1.6694-2(e) regarding reasonable cause, with minor conforming changes.

Section 1.6694-2(e)(5) permits tax return preparers to rely upon generally accepted administrative or industry practice in establishing reasonable cause relief from penalties under section 6694. Several commentators indicated that guidance is necessary to explain how a tax return preparer should determine whether a practice is "generally accepted" and "industry practice." The final regulations do not provide further guidance regarding these terms. An accepted administrative or industry practice will be determined based upon all facts and circumstances.



Burden of Proof

One commentator urged that the rules regarding "burden of proof" in tax return preparer penalty litigation cases should be either eliminated or be substantially revised to comport with section 7491. Section 7427 imposes upon the Secretary the burden of proof on the issue of whether a tax return preparer has willfully attempted in any manner to understate the liability for tax. Section 7491(c) imposes upon the Secretary the burden of production in any court proceeding with respect to the liability of any individual for a penalty. After consideration of the comment, proposed §§1.6694-2(f) and 1.6694-3(g) are removed from the final regulations because these other Code sections as well as case law provide the substantive rules regarding burden of proof and burden of production for penalties.



Negotiation of Check

Section 6695(f) and §1.6695-1(f)(1) prohibit a tax return preparer from endorsing or negotiating a refund check relating to a return for which he or she is a preparer. One commentator recommended that the regulations be clarified to state specifically that a tax return preparer is not prohibited from affixing the taxpayer's name on a refund check (typically accomplished via a mechanical stamp) for the purpose of depositing the check into an account in the name of the taxpayer. This comment is adopted in §1.6695-1(f)(1) of the final regulations.



Due Diligence for Earned Income Credit

Section 1.6695-2(b)(3) of these final regulations adopt the rules regarding a signing tax return preparer's due diligence requirements with respect to determining eligibility for the earned income credit, with minor modification. Based upon the concerns of a commentator about one of the examples in this section addressing the representation of married but separated individuals, Example 3 in the proposed regulations is removed. The Treasury Department and the IRS agree that this example may raise conflict of interest issues and, therefore, replace the example with another example focusing on the need of the tax return preparer to ask relevant questions if a taxpayer attempts to claim a niece or nephew as a qualifying child.



Definition of Tax Return Preparer

The final regulations adopt the proposed amendments to §301.7701-15(b)(1) and (2), with modification. Section 301.7701-15(b)(1) and (2) of the final regulations adds to the section 7701 regulations the definitions of "signing tax return preparer" and "nonsigning tax return preparer."

Several commentators requested that the final regulations expressly state who is required to sign a tax return. Section 301.7701-15(b)(1) of the final regulations is revised to provide that a signing tax return preparer is the individual tax return preparer who has the primary responsibility for the overall substantive accuracy of the preparation of such return or claim for refund. Conforming changes are additionally made to §1.6695-1(b). The definitions of nonsigning tax return preparer in §301.7701-15(b)(2) and substantial portion in §301.7701-15(b)(3) are generally adopted as proposed. An anti-abuse rule, however, is added in §301.7701-15(b)(2)(i) based upon several commentators' suggestions. The anti-abuse rule provides that time spent on advice given after events have occurred, even if such time is less than 5 percent of the aggregate time incurred by such individual with respect to the position(s) giving rise to the understatement, will be taken into account if all facts and circumstances show that an individual is primarily responsible for a position taken on a return, gave advice on that position before events occurred primarily to avoid treatment as a tax return preparer subject to section 6694, and for purposes of preparing a tax return the individual confirmed the advice after events had occurred.



List of Returns Subject to Penalty

Several commentators contended that proposed §301.7701-15(b)(4) and the accompanying revenue procedure listing the returns and claims for refund subject to the section 6694 penalty should not include information returns and should limit the definition of return to exclude documents that do not report a tax liability. Similarly, commentators requested excluding Form 8038, Information Return for Tax-Exempt Private Activity Bond Issues, Form 8038-G, Information Return for Government Purpose Tax-Exempt Bond Issues, Form 8038-GC, Consolidated Information Return for Small Tax-Exempt Government Bond Issues, and Form 5500, Annual Return/Report of Employee Benefit Plan. After consideration of the comments, the Forms 8038, 8038-G, and 8038-GC are classified in the contemporaneously issued revenue procedure with forms that will not subject the preparer to a penalty under section 6694(a), but may subject the preparer to a willful or reckless conduct penalty under section 6694(b) if the information reported on the form constitutes a substantial portion of the tax return or claim for refund and is prepared willfully in any manner to understate the liability of tax on a tax return or claim for refund, or in reckless or intentional disregard of rules or regulations. Also, Form 8038-T, Arbitrage Rebate and Penalty in Lieu of Arbitrage Rebate, and Form 8038-R, Request for Recovery of Overpayment Under Arbitrage Rebate Provisions, are added to the list of forms of returns in the revenue procedure subject to the section 6694 penalties. Form 5500 remains in the same category as in Notice 2008-13.

The same commentators also raised the issue of whether the Treasury Department and the IRS should publish the list of returns and claims for refund subject to penalty under sections 6694 and 6695 in these final regulations, rather than in separate guidance in the Internal Revenue Bulletin. The Treasury Department and the IRS continue to conclude that it is appropriate to publish a revenue procedure in the Internal Revenue Bulletin. Notices 2008-12, -13, and - 46, along with the previously issued proposed regulations, provided the public with notice of, and an opportunity to comment on, the forms subject to penalty.

Another commentator requested that the final regulations in both §301.7701-15(f) and Circular 230 specifically define the terms "in-house tax professional" and "employer" and provide other guidance on the applicability of these return preparer rules to in-house counsel in Circular 230. Section 7701(a)(36) and §301.7701-15(f)(ix) already except from the definition of tax return preparer any person who prepares a return or claim for refund of the employer (or of an officer or employee of the employer) by whom he or she is regularly and continuously employed. Additionally, §301.7701- 15(f)(4) of the final regulations deems an employee of a corporation owning more than 50 percent of the voting power of another corporation, or the employee of a corporation more than 50 percent of the voting power of which is owned by another corporation, to be the employee of the other corporation as well. The Treasury Department and the IRS will consider if any other changes are necessary on this issue in future revisions to §10.34 of Circular 230.



Appraisers

Under Treasury Regulations in place since 1977 and the proposed regulations, an appraiser might be subject to penalties under section 6694 as a nonsigning tax return preparer if the appraisal is a substantial portion of the return or claim for refund and the applicable standards of care under section 6694 are not met. Several commentators have stated that appraisers should not be subject to penalties under section 6694 because they are subject to new, higher standards of conduct under section 6695A as set out in the Pension Protection Act of 2006, Pub. L. No. 109-280. The commentators have also urged that assessment of penalties under section 6694 against appraisers would result in imposition of a gratuitous and unnecessary layer of requirements and sanctions without any additional public policy benefit.

After consideration of the comment, the Treasury Department and the IRS continue to include appraisers in the definition of both signing and non-signing preparers, thereby providing the IRS with discretion to impose the section 6694 and 6695A penalties in the alternative against an appraiser depending on the facts and circumstances of the appraiser's conduct. The IRS, however, will not stack the penalties under sections 6694 and 6695A with respect to the same conduct. A separate regulation will provide guidance under section 6695A.



Disclosure Under Section 6103

One commentator recommended that the Treasury Department and the IRS issue regulations under section 6103 authorizing the disclosure of tax returns and return information to a tax return preparer at the tax return preparer's request upon initiation of an examination of the tax return preparer for tax return preparer penalties to the extent the returns and return information are relevant and material to the tax return preparer examination. The Treasury Department and the IRS conclude that no further guidance on this issue in these regulations is necessary because section 6103(h)(4) already authorizes the disclosure of returns and return information by the Government in federal or state, judicial or administrative tax proceedings if the disclosure meets an item or transaction test and the third-party return or return information is directly related to the resolution of an issue in the case.



Appeal Rights

A number of individual commentators questioned whether the proposed regulations would remove the administrative appeal rights available to tax return preparers who are subject to penalty under section 6694. Under Treasury Regulations in place since 1991, the IRS will send a 30-day letter to the tax return preparer notifying the tax return preparer of the proposed penalty or penalties and offering an opportunity to the tax return preparer to request further administrative consideration and a final administrative determination by the IRS concerning the proposed assessment prior to assessment of a penalty under section 6694 (unless the period of limitations (if any) under section 6696(d) may expire without adequate opportunity for assessment). If the tax return preparer then makes a timely request, assessment may not be made until the IRS makes a final administrative determination adverse to the tax return preparer. These appeal rights are maintained in §1.6694-4(a) of the final regulations.



Applicability Dates

To eliminate any adverse impact that the adoption of these final regulations could have on pending or recently filed returns, these final regulations will apply to returns and claims for refund filed, and advice provided, after December 31, 2008.



Availability of IRS Documents

The IRS notices referred to in this preamble are published in the Internal Revenue Bulletin and are available at http://www.irs.gov.



Effect on Other Documents

The following publications are obsolete as of January 1, 2009:
Notice 2007-54 (2007-27 IRB 12).

Notice 2008-11 (2008-3 IRB 279).

Notice 2008-12 (2008-3 IRB 280).

Notice 2008-13 (2008-3 IRB 282).

Notice 2008-46 (2008-18 IRB 868).



Special Analyses

It has been determined that this final rule is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.

When an agency issues a rulemaking, the Regulatory Flexibility Act (5 U.S.C. chapter 6) (RFA), requires the agency to "prepare and make available for public comment an initial regulatory flexibility analysis" that will "describe the impact of the proposed rule on small entities." (5 U.S.C. 603(a)). Section 605 of the RFA provides an exception to this requirement if the agency certifies that the final rulemaking will not have a significant economic impact on a substantial number of small entities.

The final rules affect tax return preparers. The IRS estimates there are 38,566 tax return preparation firms and 260,338 self-employed tax return preparers that qualify as small entities. Therefore, the IRS has determined that these final rules will have an impact on a substantial number of small entities.

The IRS has determined, however, that the impact on entities affected by the final rule will not be significant. The statute and final regulations would require entities that employ tax return preparers to retain a record of the name, taxpayer identification number and principal place of work of each tax return preparer employed. The IRS estimates that this would not require purchase of additional software and would take five minutes per tax return preparer employed. The statute and final regulations would also require tax return preparers to retain a complete copy of a return (or claim for refund) or a list of the name, taxpayer identification number and taxable year for each return (or claim for refund) and the name of the tax return preparer required to sign the return or claim for refund. Many tax return preparers have copying machines or scanners and already make copies of the returns prepared, and the IRS estimates this would not require the purchase of additional equipment. The IRS estimates that it would take an average of five minutes to make copies or prepare a record of the returns or claims for refund prepared. Accordingly, the burden on employers of tax return preparers to make a record of the name, taxpayer identification number, and principal place of work of each employed tax return preparer, and a copy of each return or claim for refund prepared, or a record, is insignificant.

The final regulations also conform the standards of conduct for the tax return preparer penalties under section 6694(a) to the provisions of the 2007 and 2008 Acts. Tax return preparers already enroll in educational seminars or training programs to keep up to date with the latest changes to the Code, and the provisions of the 2007 and 2008 Acts and the regulations generally will be part of that training.

Based on these facts, it is certified that the collection of information contained in these final regulations will not have a significant economic impact on a substantial number of small entities. Accordingly, a Regulatory Flexibility Analysis is not required.

Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Drafting Information

The principal authors of these final regulations are Matthew S. Cooper and Michael E. Hara, Office of the Associate Chief Counsel (Procedure and Administration).