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 the second of a 3-part series. You'll find the other 2 parts on our Web site, IRS.gov. In part 1, we covered the Examination perspective. In this section of the presentation, part 2, we’ll cover several aspects of the new legislation relating to return preparer penalties, and the Notices and the Revenue Procedure issued by the Department of Treasury and the IRS.
Internal Revenue Code Section 6694 imposes penalties on tax return preparers who prepare returns or claims for refund that reflect an understatement of a taxpayer’s liability due to an unreasonable position or an understatement due to willful or reckless conduct. Congress passed Section 8246 of the Small Business and Work Opportunity Tax Act of 2007, Public Law Number 110-28, in May 2007.
The 2007 Act amended the provisions of the Internal Revenue Code relating to paid return preparers in several ways. I’ll describe four of them:
- First, the Act extended the application of the income tax return preparer penalties to include preparers of estate and gift tax, employment tax, and excise tax returns, and returns of exempt organizations;
- Second, for disclosed positions, it heightened the standard of conduct that must be met by preparers to avoid the section 6694(a) penalty from nonfrivolous to reasonable basis. And, for undisclosed positions, it heightened the standard to avoid the section 6694(a) penalty from realistic possibility of success on the merits to reasonable belief that the position would more likely than not be sustained on the merits.
- Third, it increased the section 6694(a) penalty for understatements due to unreasonable positions from $250 to the greater of $1,000 or 50 percent of the income derived by the preparer;
- And fourth, the Act increased the section 6694(b) penalty for willful or reckless conduct from $1,000 to the greater of $5,000 or 50% of the income derived by the preparer.
The changes were effective for tax returns prepared after May 25, 2007.
Let’s talk a little about the Transitional Relief and Interim Guidance that Treasury and the IRS provided for the 2007 Act.
Because the revised standards for return preparers were effective for returns prepared after May 25, 2007, transitional relief for the rest of the 2007 tax year was provided in Notice 2007-54 and clarified in Notice 2008-11.
Notice 2008-12 announced that future regulations will implement the signature requirements under section 6695(b) on preparers of most tax returns, not just income tax returns.
Notice 2008-13 provided interim guidance about the standards of conduct that must be met by a tax return preparer during 2008 to avoid a penalty for an understatement of tax that may result from a position taken on a tax return.
The interim guidance in Notice 2008-13 emphasized two things:
- One: the importance to preparers of understanding the legal basis for positions taken on tax returns; and
- Two: the need for preparers to advise taxpayers about the various penalties that can apply when a position is taken on a return that does not meet the applicable legal standard.
The Final Regulations and Notice 2009-5 supersede these previously issued Notices.
Now, let’s talk about the Tax Extenders and Alternative Minimum Tax Relief Act of 2008.
In October 2008, Congress passed section 506 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008. This section retroactively changed the general standard for preparers under section 6694(a) from reasonable belief that the position would more likely than not be sustained on the merits, to substantial authority for the tax treatment. Substantial authority for the tax treatment of an item has been generally described as a 35-40% standard, and the applicable standard under section 6694(a) is now the same general standard for taxpayers under section 6662.
If the position is a tax shelter or reportable transaction under section 6662A, however, the standard remains the greater than 50% standard, that is, it is reasonable to believe that the position would more likely than not be sustained on the merits.
This rule for tax shelters and reportable transactions is prospective for returns prepared for taxable years ending after the date of enactment of the 2008 Act, October 3, 2008.
Let’s discuss the latest batch of Published Guidance.
In December 2008, the Department of Treasury and Internal Revenue Service issued three documents providing guidance to return preparers in complying with the new statutory requirements imposed by Congress regarding tax return preparer penalties.
The Final Regulations, published on December 22, 2008, provide amendments to the tax return preparer penalty regulations under sections 6694 and 6695. The regulations also amend related provisions under sections 6060, 6107, 6109, 6696, and 7701(a)(36). The Final Regulations will be discussed in part 3 of this series.
Notice 2009-5, as well as Revenue Procedure 2009-11, were issued simultaneously with the Final Regulations.
Let’s move on to a brief discussion of Revenue Procedure 2009-11
In December 2008, the Department of Treasury and the IRS also released Revenue Procedure 2009-11, which identifies the relevant categories of tax returns and claims subject to the section 6694 penalty.
Rev. Proc. 2009-11 also identifies the returns and claims required to be signed by a tax return preparer in order to avoid a penalty under section 6695(b).
Rev. Proc. 2009-11 is generally consistent with Notice 2008-12.
The Final Regulations and the Revenue Procedure are applicable to returns and claims for refund filed, and advice given, after December 31, 2008.
Next, let’s discuss the interim guidance provided in Notice 2009-5.
The 2008 Act generally changed the standard for imposing the Section 6694(a) penalty for undisclosed positions from “reasonable to believe that the position more likely than not will be sustained on the merits” to “substantial authority for the position”.
In December 2008, the Department of Treasury and the IRS released Notice 2009-5, which provides substantive interim guidance on the 2008 Act’s changes to section 6694(a) that the public will be able to rely upon until further guidance is issued, this Notice also seeks comments on the interim rules.
Notice 2009-5 provides a definition of substantial authority that is consistent with the definition under the section 6662 penalty regulations. The substantial authority standard is an objective standard involving an analysis of the law to relevant facts, and is less stringent than the more likely than not standard but more stringent than the reasonable basis standard. Conclusions reached in treatises, legal periodicals, legal opinions, or opinions rendered by tax professionals (including tax return preparers) are not authority. The authorities underlying such expressions of opinion, if applicable to the facts of a particular case, however, may give rise to substantial authority for the position.
Solely for purposes of section 6694(a), a tax return preparer nevertheless will be considered to have met the standard if the tax return preparer relies in good faith and without verification on the advice of another advisor, another tax return preparer, or other party. Factors used in evaluating a tax return preparer’s good faith reliance on the advice of another are found in Treasury Regulation
§ 1.6694-2(e)(5).
Our next topic is the 2008 Act special rule for tax shelters and reportable transactions.
Although the 2008 Act generally changed the standard for undisclosed positions from “reasonable to believe that the position more likely than not will be sustained on the merits” to “substantial authority for the position,” the 2008 Act maintains the “reasonable to believe that the tax treatment of the position would more likely than not be sustained on its merits” standard for tax shelters and reportable transactions under section 6662A.
It is reasonable to believe that positions have a "more likely than not" chance of being upheld on their merits if a preparer has:
- Analyzed the pertinent facts and authorities; and
- Concluded, in good faith, that there is greater than 50 percent likelihood that the tax treatment will be upheld if the IRS challenges it.
Whether a tax return preparer meets this standard will be determined based on all facts and circumstances, including the tax return preparer’s due diligence.
Notice 2009-5 also provides an interim compliance rule for tax shelter transactions that are not listed or otherwise reportable. A position will not be deemed an “unreasonable position” if there is substantial authority for the position and the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer.
These rules do not apply to a position described in Section 6662A, that is, a reportable transaction with a significant purpose of Federal Tax avoidance or evasion or a listed transaction.
Finally, let’s talk about the effective dates in Notice 2009-5.
Notice 2009-5 effective date provisions provide that tax return preparers may rely on the transitional rules provided in Notice 2007-54 and Notice 2008-11.
Consistent with the 2007 Act, the interim guidance provided by Notice 2008-13 generally held tax return preparers to a more stringent standard under section 6694(a) than the substantial authority standard imposed by the 2008 Act’s revisions to section 6694. Accordingly, for positions other than with respect to tax shelters and reportable transactions to which section 6662A applies, tax return preparers may apply the substantial authority standard consistent with the 2008 Act or may rely upon the interim guidance provided in Notice 2008-13 when preparing returns or claims for refund for the periods covered by that notice.
The 2008 Act’s special rule for tax shelters and reportable transactions to which section 6662A applies does not apply retroactively, and therefore the provisions of Notice 2008-13 will apply to tax shelter and section 6662A reportable transaction positions on returns or claims for refund for tax years ending prior to the date of enactment of the 2008 Act, October 3, 2008, and otherwise covered by Notice 2008-13.
This concludes the second of three segments about the section 6694 Return Preparer Penalty process. In the next segment I will discuss the Final Regulations.
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