The IRS has issued internal memoranda setting forth procedures for consideration of tax return preparer penalties in taxpayer examinations. A memorandum by the Large and Mid-Size Business Division (LMSB) describes procedures for tax return preparer penalty cases, and two audit technique guideline memos by the Small Business/Self-Employed Division (SB/SE) explain similar procedures for excise and employment tax examinations. The memos reflect the expanded application of the preparer penalties under IRC §§ 6694 and 6695 as amended by the Small Business and Work Opportunity Tax Act of 2007 (PL 110-28) to other types of tax returns and claims for refunds besides income taxes. They require examiners to consider the appropriateness of asserting preparer penalties in all taxpayer examinations involving a paid tax return preparer and to document consideration of the issue in the workpapers. They also emphasize that a potential preparer penalty case is separate from a taxpayer examination and requires that files for these matters be maintained separately.
In addition, they prescribe required supervisory approval and procedures for imposing a preparer penalty and for making referrals to the IRS Office of Professional Responsibility. The memos can provide practitioners with useful insights into administrative guidelines examiners are expected to follow in determining and imposing penalties and, therefore, best practices practitioners may follow to avoid incurring penalties.
For example, in an attachment to the LMSB memo (and in a shorter form in the SB/SE excise tax memo) the Service suggests questions for examiners to ask taxpayers in connection with potential preparer penalties, including:
- Are you aware of any errors, omissions or mistakes on the return under examination?
- Did you disclose this transaction on your tax return? Why or why not?
- Was there any discussion regarding whether the transaction is subject to disclosure under Revenue Procedure 94-69?
- Were there any concerns about how the transaction was reported? What sort of process is used to address those concerns, and on what basis are decisions made?
- Was there any discussion regarding potential penalties?
These questions underscore how important it is for preparers to:
- Exercise due diligence in gathering and assembling facts that are potentially relevant to a return position and in determining whether section 6694 standards are satisfied. Although a preparer generally may rely in good faith without verification on information furnished by the client, the preparer must inquire further if the information appears inaccurate, inconsistent or incomplete (Treas. Reg. § 1.6695-2(b)(3)).
- Clearly communicate with the client any concerns about potential reporting positions. This would include discussions with clients about the potential taxpayer penalty consequences of a return position and the opportunity to avoid penalties by disclosure, where relevant.
- Contemporaneously document discussions with clients in these and other areas.
Practitioners also should remain alert to the fact that they may be subject to section 6694 as nonsigning preparers. In addition, tax advice may be subject to section 6694 standards even if the advice is not subject to the covered-opinion rules of Circular 230.
LMSB-04-0308-009 (4/13/08), SBSE-04-1208-068 (12/31/08) (excise taxes), and SBSE-04-0209-008 (2/3/09) (employment taxes)
By Eve Elgin, Esq., LL.M., Washington, D.C., principal in KPMG’s Washington National Tax Office.