Internal Revenue Code Section 6694 imposes penalties on tax return preparers who prepare returns taking positions that may not be fully supported by current law. Congress amended this section last May by extending the application of the income tax return preparer penalties to all tax return preparers and by raising the standard that preparers must meet to avoid the section 6694(a) preparer penalty. The Department of Treasury and IRS recently issued Notice 2008-13 in order to provide interim guidance regarding implementation of the tax return preparer penalty provisions until final regulations are published. In addition to Notice 2008-13, additional guidance has been provided in Notice 2008-12 with respect to the implementation of the tax return preparer signature requirement under Section 6695(b), and in Notice 2008-11, which clarifies the transition relief provided in Notice 2007-54, issued earlier this year. The following questions and answers highlight many of the issues addressed by these notices.
Why is the IRS issuing this notice?
The revised standards for return preparers were effective for returns prepared after May 25, 2007. Transitional relief for the rest of the 2007 year was provided in Notice 2007-54 and clarified in Notice 2008-11. The regulations will be significantly revised in the upcoming year to update the regulatory scheme governing tax return preparer penalties that has remained substantially unchanged since the late 1970’s. Until then, this notice provides interim guidance on the application of the tax return preparer penalties as amended by the Act for this filing season.
What is the effective date of this notice?
This notice is effective as of: (1) January 1, 2008, for all tax returns, amended tax returns, and claims for refund (other than 2007 employment and excise tax returns) filed on or after that date and with respect to advice provided on or after that date; and (2) February 1, 2008, for all 2007 employment and excise tax returns filed on or after that date and with respect to advice provided on or after that date.
Who is a tax return preparer subject to this notice?
A tax return preparer is any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of a tax return or claim for refund of tax imposed by the Internal Revenue Code. Only one individual associated with a firm is a preparer with respect to the same tax return or refund claim. A person who prepares a return or claim for refund for a taxpayer with no explicit or implicit agreement for compensation is not a preparer, even though the person receives a gift or return service or favor. A person who prepares a return or claim for refund of an employer by whom the person is regularly and continuously employed is also not a preparer. If an attorney or CPA hires someone else to prepare one’s own personal return, the attorney or CPA is the taxpayer and not a preparer for purposes of that return.
What forms prepared by a tax return preparer are subject to the Section 6694 penalty?
Exhibit 1 in the notice provides a list of tax returns and claims for refund that report tax liability that will subject a tax return preparer to a Section 6694 penalty. Exhibit 2 in the notice provides a list of information returns that report information that is or may be reported on another tax return that may subject a tax return preparer to the Section 6694(a) penalty if the information reported constitutes a substantial portion of the other tax return. Exhibit 3 lists forms that would not subject a tax return preparer to the section 6694(a) penalty unless prepared willfully in any manner to understate the liability of tax on a return or claim for refund or in a reckless or intentional disregard of rules or regulations.
Is the list of forms in the Exhibits intended to be all inclusive? If so, are there any other tax returns that need to be included in any of the Exhibits?
Yes. The notice, however, states that we may choose to add or remove documents from any of the categories or exhibits to this notice in future guidance as we gain experience in implementing the provisions of the Act and receive public comments.
Will a person who prepares all or a substantial portion of a form or document listed in Exhibit 3 be penalized under Section 6694(a) or 6694(b)?
If the form or document in Exhibit 3 was 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, the preparer may be subject to a penalty under either Section 6694(a) or 6694(b).
Is the current de minimis safe harbor in Treasury Regulation section 301.7701-15(b)(2) is still in effect?
Yes. A tax return preparer will not be considered to have prepared a “substantial portion” of a return or claim for refund if the schedule, entry, or other portion of a return or claim for refund involves amounts of gross income, amounts of deductions, or amounts on the basis of which credits are determined which are (i) less than $2,000; or (ii) less than $100,000, and also less than 20 percent on the gross income (or adjusted gross income if the taxpayer is an individual) as shown on the return or claim for refund. We are considering whether revisions to these current de minimis rules are necessary in any future regulations.
If a taxpayer brings a tax organizer to an appointment with a tax return preparer and the organizer reflects that the taxpayer made certain dollar amount of charitable contributions, does a preparer need to see documentation of the payments?
A preparer may rely in good faith without verification upon information furnished by the taxpayer if it does not appear to be incorrect or incomplete, but may not ignore the implications of information furnished to the tax return preparer or actually known to the tax return preparer. The preparer, however, needs to inquire about the existence of documentation in accordance with the appropriate reporting and substantiation requirements. See Example 8 in the Notice.
What if there is no substantial authority for a position but there is a reasonable basis?
The preparer must provide the taxpayer a prepared tax return with a complete Form 8275 or 8275-R disclosure statement, or disclose the position on the return in accordance with the annual revenue procedure.
If a position is a tax shelter as described in Section 6662(d)(2)(C), how must a preparer advise the taxpayer of the different penalty standards between that section and Section 6694?
The preparer must advise clients that, for tax shelter positions, there needs to be at a minimum substantial authority and a reasonable belief that the tax treatment was more likely that not the proper treatment in order for the taxpayer to avoid a penalty, that disclosure will not protect the taxpayer from penalty, and any differences with the preparer’s own standards under Section 6694.
Is there any general pro forma language that preparers can use in complying with the interim transition rules? If so, are preparers able to use this general pro forma language in every case or does the language need to be specific to the positions taken on the particular return? Does the advice to the client regarding the different penalty standards have to be spoken advice or does a memo included with the return suffice? Will one contemporaneous document cover the entire return or would one document be required for every undisclosed item?
There is no general pro forma language that a preparer may use to comply with the interim transitional rules. There is also no special format required under the Notice to satisfy the interim guidance and documentation requirements of the notice. The important point is that each item subject to the notice must be specifically addressed by the preparer with the taxpayer in a meaningful fashion and the contemporaneous documentation must in turn memorialize the discussion regarding each item. The language of the interim compliance rules also clearly contemplates that the advice and documentation are two separate events. A preparer runs a serious risk of not complying with the interim guidance standards if the only thing the preparer does is include a memo with the return. A preparer may choose to comply with the documentation requirement in one document covering all items, or in multiple documents each covering one item. Note that taxpayers are already permitted to disclose multiple items on a single Form 8275 for purposes of satisfying the penalty disclosure provisions of the Code.
What is “the gross income derived” for purposes of calculating the amount of the Section 6694 penalty and may a preparer limit the potential penalty amount with respect to a given client by intentionally bifurcating billing into various different engagements?
Notice 2008-13 addresses the interim standards applicable to tax return preparers under Section 6694(a), and was not intended to address other aspects of the return preparer penalty. Final guidance under Section 6694, when issued, will address the standards applicable to tax return preparers under Section 6694, as well as all of the other elements of the return preparer penalty under Section 6694, including the penalty amounts and related calculations. Nevertheless, tax return preparers and their clients should understand that the IRS has significant experience in looking through the form of transactions in determining their true substance, and should expect that all billing arrangements between tax return preparers and their clients will be scrutinized to ascertain the actual substance of those arrangements.
Do the rules in the notice apply to returns or claims prepared in other countries?
Yes. Under existing regulations, there are no geographical limitations regarding who may be considered a tax return preparer.
How does a preparer disclose a position in the case of items attributable to a pass-through entity?
Disclosure in the case of items attributable to a pass-through entity (pass-through items) is generally made with respect to the return of the entity. Thus, disclosure in the case of pass-through items must be made on the entity’s prepared tax return with a complete Form 8275 or 8275-R disclosure statement, or on the entity's return in accordance with the annual revenue procedure, if applicable.
Will the IRS automatically assess a Section 6694 penalty if it determines that a non-disclosed position taken on a return is incorrect?
No. This determination will be made on a case-by-case basis and the penalty will only be determined in appropriate cases. Similarly, the IRS will not choose what tax returns to examine based upon the existence or absence of a disclosure.
Under Notice 2008-12, are preparers allowed to continue to sign returns in accordance with the rules prescribed in ?
Yes. Notice 2004-54 provides that paid preparers will be permitted to sign original returns, amended returns, or requests for filing extensions by rubber stamp, mechanical device (such as signature pen), or computer software program. The interim rules provided in Notice 2008-12 do not affect the ability of preparers to continue to sign returns as previously authorized.
*Exhibits applicable to Section 6694 of the Internal Revenue Code are contained within Notice 2008-13.