Hello, I’m Mike Hara from the IRS Office of Chief Counsel, with a reenactment of an IRS National Phone Forum from January 2009. Barbara Fiebich from the Examination Division presented this topic with me for the January phone forums.
The topic is Section 6694 Return Preparer Penalties and this is Part 1 of a 3-part series. You'll find the other two parts on our Web site, IRS.gov, and it’s best to listen to all three parts in order.
In this section of the presentation, I will cover the Examination audit process and the new legislation.
Legislation passed by Congress in May 2007 under the Small Business and Work Opportunity Tax Act of 2007 and amended in October 2008 by the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, expanded tax return preparer penalties and revised the standards of conduct that must be met by tax return preparers in order to avoid a penalty.
The IRS recognizes that the vast majority of return preparers and practitioners are ethical, honest and serve their clients’ best interests by preparing complete and accurate tax returns. These professionals render great service daily to the tax system by promoting voluntary compliance.
Penalties exist to encourage voluntary compliance by supporting the standards of behavior expected by the Internal Revenue Code. For most taxpayers and tax professionals, voluntary compliance consists of preparing an accurate return, filing it timely, and paying any tax due. Efforts made to fulfill these obligations constitute compliant behavior. Most penalties apply to behavior that fails to meet any or all of these obligations. Some of the enforcement efforts occurring in the IRS’s Small Business and Self-Employed, or SB/SE, Division include investigating allegations of wrong-doing, assessing civil penalties against return preparers, and initiating program action cases. SB/SE Examination currently has more than 600 program action cases in progress against return preparers. These generally result in both penalties against the return preparer, as well as changes and/or examinations to client returns.
Let’s start with General Field Examination Procedures.
There have been no significant changes to the approach the IRS uses when interacting with tax professionals. All examinations should be conducted professionally. Agents should communicate clearly to the taxpayer and their representative about each phase of the audit process.
Each tax examination is separate and distinct from a possible Return Preparer violation case relating to the tax examination. Examiners do not propose or discuss conduct penalties in the presence of the taxpayer.
The penalties and/or Circular 230 guidelines do not come into play during the course of an audit. It is only after the audit has been concluded that a separate Preparer Penalty investigation or, when appropriate, a referral to the Office of Professional Responsibility for a Circular 230 violation is made.
When examining a return, it is an examiner’s responsibility to ensure that the appropriate return preparer standards of the Internal Revenue Code were followed.
If the standards are not followed, it is the examiner’s responsibility to consider the imposition of the return preparer penalties.
During every field and office examination, examiners will determine if violations exist based on oral testimony and/or written evidence during the examination process.
During the interview process of the client, the examiner will ask questions regarding the return preparation, such as:
Did you meet with the preparer?
Did you complete a questionnaire and/or have a face to face meeting with the preparer?
What documentation was provided to the preparer to verify the item or items in question?
Did you receive a copy of the return?
How was the preparer compensated?
After considering the taxpayer’s interview responses, the preparer’s interview responses and the taxpayer examination results, the examiner will determine if the penalty applies.
The IRS will not automatically impose preparer penalties based solely on the determination of deficiencies proposed in related tax return examinations.
Preparer penalties are imposed only after due deliberation on all facts and circumstances. If a penalty does not apply, the penalty case is closed as a no-change.
Let’s move on to the Proposal, Assessment, and Appeal Procedures
If the examiner determines the section 6694 penalty applies, a detailed report is prepared which will include:
Facts – stating the specific issues on the return that caused the penalty proposal
Law & Argument – explaining under what authority the penalty is being imposed
Preparer’s Position – stating the preparer’s explanation and
Conclusion – stating the conclusion based on the facts and circumstances.
The preparer is provided with a copy of the report; this can be done in a “closing conference” via the mail and/or over the telephone after the preparer receives a copy.
If the preparer does not agree with the examiner’s determination then:
If the preparer responds within 30 days, the examiner forwards the case to appeals.
If the preparer does not respond within 30 days, the examiner forwards the case for assessment.
There may be additional actions for both Circular 230 and Unenrolled Return Preparers.
The Office of Professional Responsibility, or OPR, is responsible for overseeing the rules governing certain practitioners. These include:
Attorneys
CPAs
Enrolled agents
Enrolled retirement plan agents, or ERPAs, and
Enrolled actuaries
The Preamble to the Proposed Regulations provide that referral to OPR for section 6694(a) cases will not be mandatory.
If the preparer is an unenrolled agent, consideration may be given to suspending their limited practice under Revenue Procedure 81-38.
Area directors are authorized to revoke an unenrolled return preparer’s limited practice privileges if the preparer’s conduct renders him/her unfit to practice before the IRS.
The unenrolled return preparer is given 30 days to appeal the proposed sanction and request a conference.
If the preparer fails to appeal the proposed sanction, or the preparer is given a conference at the local level and the proposed sanction is sustained, a Final Letter of Determination is prepared and signed by the area director.
The Final Letter of Determination gives the preparer another 30 days to appeal.
If the unenrolled return preparer appeals the Final Letter of Determination, the return preparer coordinator prepares a report stating the Area’s position as to why the sanction against the return preparer should be sustained.
The appeal and the report are forwarded to the Office of Professional Responsibility for final disposition.
We also have Program Action Cases, or PACs, in Examination.
If a preparer's misconduct appears to be pervasive and not isolated to a single taxpayer, consideration will be given to opening a PAC.
A PAC is a preparer investigation where clients of questionable preparers are examined to determine whether preparer penalties and/or injunctive actions against the preparers are warranted.
The return preparer coordinator, or RPC, is responsible for reviewing all referrals to determine whether there is strong evidence of the preparer's misconduct.
If there are no ongoing actions with the IRS’s Promoter Program or our Criminal Investigation Division, the RPC will take the following actions:
First, the RPC will prepare a memorandum summarizing the PAC
Then, he will present it for review by the local Return Preparer Steering Committee.
If approved, the territory manager will submit the memorandum for the area director’s approval.
After approval, the RPC will identify, classify and select an initial sample of client returns from the preparer's client list.
During the PAC, the return preparer coordinator will monitor the examinations of the preparer's taxpayers and the assessment of preparer penalties.
If applicable, consideration will be given to initiate an injunction investigation.
An injunction case is a court proceeding whereby the government seeks to either prevent the preparer from doing in the future that which threatens to cause or is already causing harm to the government, or to compel an affirmative act by the preparer.
The Internal Revenue Manual requires any examiner conducting an investigation under Internal Revenue Code sections 6694, 6695, 6700, or 6701 to consider whether an injunction should be sought under IRC sections 7407 or 7408.
The request will be considered if during the PAC, the activity at issue is continuing or likely to recur and one of the following four factors is met:
- Factor one: Five or more IRC sections 6694 and 6695 penalties have been assessed against the preparer during the past two years and the preparer has failed to correct their behavior.
- Factor two: The preparer's activities are responsible for large dollar losses to the government and/or a large number of returns are affected
- Factor three: The preparer's activities affect more than one Area, or
- Factor four: Any other factor exists that the Return Preparer Coordinator determines affects local compliance.
Currently more than 600 cases are in progress against return preparers, with some 15,000 client returns currently being audited.
In Fiscal Year 2006, changes to client returns totaled approximately $35 million, and Return Preparer penalties totaled just over $1.8 million.
This concludes the first of three segments about the section 6694 Return Preparer Penalty process. In the next segment I will explain a little about the recent legislative changes and the Notices and the Revenue Procedure issued by the Department of Treasury and the IRS.
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