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 3 of a 3-part series. You'll find the other 2 parts on our Web site, IRS.gov. Part 1 discussed the Examination perspective and Part 2 covered several aspects of the new legislation and the Notices and the Revenue Procedure issued by the Department of Treasury and the IRS. In this section of the presentation, we’ll cover several aspects of the Final Regulations relating to return preparer penalties.
Let’s start by talking about the Final Regulations’ definition of tax return preparer.
The Treasury Department and the IRS published Final Regulations on December 22, 2008, that made significant changes to the regulations governing the tax return preparer penalties. Among the changes were those defining a tax return preparer.
Under the Final Regulations:
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A “signing tax return preparer” is the individual preparer who has primary responsibility for the overall accuracy of the preparation of the return or claim for refund.
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A “nonsigning tax return preparer” is any preparer who is not a signing tax return preparer but who prepares all or a substantial portion of a return or claim for refund with respect to events that have occurred at the time the advice is rendered.
The final regulations also provide that whether a schedule, entry, or other portion of a return or claim for refund is a substantial portion is determined based upon facts and circumstances, including the size and complexity of the income relative to the taxpayer’s gross income, and the size of the understatement attributable to the item compared to the taxpayer’s reported tax liability.
Let’s talk about the definition of preparer within a firm.
The old regulations encompassed a “one preparer per firm” rule that treated the signing preparer as the preparer subject to the section 6694 penalty. If there is no signer in a firm, the individual with overall supervisory responsibility for the advice given by the firm with respect to the return or claim is the nonsigner subject to penalty.
Treasury and the IRS realized that the “one preparer per firm” rule was no longer appropriate in light of the recent Code amendments and the evolution in existing business practices, and the Final Regulations adopt a framework defining a preparer-per-position within a firm.
The Final Regulations better target the person or persons responsible for the position(s) giving rise to the understatement and will further compliance and result in more equitable administration of the tax return preparer penalty.
Under the Final Regulations, only one person within a firm will be considered primarily responsible for each position giving rise to an understatement and, accordingly, would be subject to the penalty.
In the course of identifying the individual who is primarily responsible for the position, the IRS may advise multiple individuals within the firm that it may be concluded that they are the individual within the firm who is primarily responsible for the position.
Also, under the Final Regulations, the IRS may assess the penalty against either the signing tax return preparer or the nonsigning tax return preparer with overall supervisory responsibility for the position giving rise to an understatement depending on the facts and circumstances, based upon information received from the signing tax return preparer or other relevant information from a source other than the signing tax return preparer, but not both.
The Final Regulations also expanded the situations when a preparer may rely upon information provided by others
Under the Final Regulations, preparers may continue to generally rely in good faith without verification upon information furnished by the taxpayer.
The Final Regulations expanded the existing regulations to allow a preparer to rely in good faith and without verification on information furnished by another advisor, another tax return preparer, or other party, even when the advisor or tax return preparer is within the tax return preparer’s same firm. Similarly, a tax return preparer may rely in good faith without verification upon a tax return that has been previously prepared by a taxpayer or another tax return preparer and filed with the IRS.
When relying on information supplied by either the taxpayer or third parties, however, the preparer may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer, and must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete.
Let’s turn to a discussion of income derived.
The final regulations also define “income derived, or to be derived”, which is important in computing the amount of the penalty that may be imposed under section 6694.
The final regulations define “income derived, (or to be derived) with respect to a return or claim for refund” as all compensation the 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 taken on the return or claim for refund that gave rise to the understatement.
Specific allocation rules apply when the preparer is compensated directly by the firm, rather than by the taxpayer, and when there are multiple firm engagements.
The final regulations provide that the amount of the penalties assessed against the individual and the firm shall not exceed 50 percent of the income derived, or to be derived, by the firm from the relevant engagements relating to the position giving rise to the understatement.
The Final Regulations also include a discussion of reasonable basis.
In instances in which the taxpayer discloses the position on the tax return, Section 6694 requires there must be a reasonable basis for the tax treatment of the position taken on the tax return.
The Final Regulations provide that the “reasonable basis” standard that must be met for disclosed positions is the same standard as defined in Treasury Regulation section §1.6662-3(b)(3), which is the rule for the accuracy-related penalty for taxpayers.
The Final Regulations also provide that to meet the “reasonable basis” standard, a tax return preparer may rely in good faith, without verification, upon information furnished by a taxpayer, advisor, another preparer, or other party, even when the advisor or preparer is within the tax return preparer’s same firm.
The final regulations also discuss adequate disclosure rules.
The Final Regulations build on Notice 2008-13 in providing disclosure rules for positions that have a reasonable basis but for which there is not substantial authority.
For a signing preparer, the final regulations provide that a position may be disclosed in one of three ways.
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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.
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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 the Internal Revenue Code
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Third, for tax returns or claims for refund that are subject to penalties other than the accuracy-related penalty for substantial understatements, 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.
In the case of a nonsigning tax return preparer, the final regulations maintain the same three disclosure rules that were in the proposed regulations.
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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 annual revenue procedure.
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Second, a nonsigning tax return preparer may meet the disclosure standards if the nonsigning tax return preparer advises the taxpayer of all opportunities to avoid penalties under section 6662 that could apply to the position and advises the taxpayer of the standards for disclosure to the extent applicable.
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Third, disclosure of a position is adequate if a nonsigning tax return preparer advises another tax return preparer that disclosure under section 6694(a) may be required.
The nonsigning tax return preparer must document contemporaneously in the tax return preparer’s files that this advice required by the final regulations was provided.
In order to satisfy the disclosure standards when the position is not disclosed on or with the return, the advice to the taxpayer with respect to each position must be particular to the taxpayer and tailored to the taxpayer’s facts and circumstances. No form of a general boilerplate disclaimer will satisfy these standards.
Disclosure in the case of items attributable to a pass-through entity is adequate if made at the entity level in accordance with the rules. For example, a tax return preparer of a partnership tax return need only advise the partnership in order to satisfy any of the above disclosure rules and does not need to advise each individual partner in the partnership of the applicable penalties.
Finally, let’s discuss the issue of reasonable cause.
The penalty under section 6694(a) will not be imposed if, considering all the facts and circumstances, it is determined the understatement was due to reasonable cause and the tax return preparer acted in good faith. Under the previous regulations, factors to consider include:
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The nature of the error causing the understatement
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Frequency of errors
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Materiality of errors
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The tax return preparer’s normal office practice and
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Reliance on the advice of others
The Final Regulations include the same rules as in the old regulations, but also provide that whether a position is supported by a generally accepted administrative or industry practice is an additional factor to consider in determining whether the preparer acted with reasonable cause and good faith.
The reasonable cause provisions are also expanded to allow a preparer to reasonably rely on information or advice furnished by a taxpayer, advisor, another preparer, or other party, even when the advisor or preparer is within the tax return preparer’s same firm.
The Final Regulations are applicable to returns and claims for refund filed, and advice given, after December 31, 2008.
This concludes Part 3 of the discussion of return preparer penalties. Thanks to our listeners for your interest.
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