The IRS has issued proposed regulations on tax return preparer penalties under Internal Revenue Code sections 6694 and 6695. Among other matters, the proposed regulations address the new standards of conduct that must be met to avoid imposition of the tax return preparer penalty under section 6694 and the broadened scope of the definition of income tax return preparers. According to the Service, the regulations will be finalized by the end of 2008, with the expectation that the final regulations will apply to returns and refund claims (and advice given) after they are published, but in no event sooner than Dec. 31, 2008.
The proposed regulations conform existing regulations to the changes made by the Small Business Act, discussed below. In applying the proposed regulations, the IRS says that it will attempt to avoid a heavy handed approach and implement a "balanced enforcement program" for tax return preparers. I must take a wait and see approach on that statement, however, before I swallow the Kool-Aid. The IRS also intends to modify its internal guidance so that a referral by revenue agents to the IRS Office of Professional Responsibility (OPR) will not be per se mandatory when IRS assesses a section 6694(a) tax return preparer penalty against a tax return preparer who is also a practitioner under Circular 230 (i.e., the final regs governing the rules of practice before IRS). In matters involving non-willful conduct, IRS will generally look for a pattern of failing to meet the required section 6694(a) penalty standards before making an OPR referral, although any egregious conduct subjecting a tax return preparer to penalty may form a basis for a such a referral.
As to the penalties and the standards, a summary of the Small business Act are discussed below. For returns prepared after May 25, 2007, the Small Business Act:
- Expanded the tax return preparer penalties to all types of tax returns, not just income tax returns, including estate and gift tax, employment tax, and excise tax returns. Section 7701(a)(36), as amended by Small Business Act § 8246(a)(1))
- Raised the penalties imposed on return preparers for understatements due to unreasonable positions from $250 to the greater of $1,000 or 50% of the income derived (or to be derived) by the preparer with respect to the return or claim. It also raised penalties for understatements due to willful or reckless conduct from $1,000 to the greater of $5,000 or 50% of the income derived by the preparer with respect to the return or claim.
- Established a higher standard of conduct for preparers to avoid imposition of penalties when IRS alleges that the preparer knew or reasonably should have known of an unreasonable position. For undisclosed positions, the old standard required the position taken on the return to have a "realistic possibility of being sustained on its merits," which section 1.6694-2(b) translated as a one in three (approximately 33%) or greater likelihood of being sustained on its merits. The new standard for undisclosed positions requires "a reasonable belief that the position would more likely than not be sustained on its merits," which translates to approximately 51% or greater likelihood. This is significantly higher than the substantial authority standard that applies to taxpayers other than preparers.
- Established a higher standard of conduct for disclosed unreasonable positions. Under the old standard, a preparer could avoid penalties on disclosed unreasonable positions if the position wasn't frivolous. The new standard requires a preparer to have a reasonable basis for the disclosed position—the same standard for disclosed positions as for taxpayers other than preparers. Section 6694, as amended by Small Business Act § 8246).
See the full text of the proposed regulations attached below.
Download temp_proposed_regulations_1500292.PDF
