Editor's note: This article appears in the February 2009 issue of The Tax Adviser, the AICPA's monthly journal of tax planning, trends and techniques.
The IRS issued final regulations (T.D. 9436) implementing the changes to the Sec. 6694 tax return preparer penalties made by the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28, and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, P.L. 110-343 (the Tax Extenders Act).
CHANGES MADE TO THE PROPOSED REGULATIONS
The IRS issued proposed regulations under Sec. 6694 (REG-129243-07) in June 2008, before the enactment of the Tax Extenders Act, which retroactively replaced the more likely than not (MLTN) standard as the general standard for the application of the tax return preparer penalty with the substantial authority standard. (See Tax Trends, 39 The Tax Adviser 847 (December 2008), for a discussion of the statutory changes.) The proposed regulations have been modified as necessary to conform to the change in the standard.
Besides incorporating the change in the statutory standard, the Service also revised the proposed regulations based on more than 30 written comments received in response to them. The most significant changes the IRS made after considering these comments are summarized below.
Defining the preparer within the firm: The final regulations maintain the proposed regulations’ framework for defining a “preparer per position within a firm,” focusing on the position giving rise to the understatement on the return or claim for refund and any responsible parties for such position. However, the regulations were modified to provide that if there is no signing tax return preparer for the return or refund claim within that firm or if, after the application of Regs. Sec. 1.6694-1(b)(2), it is concluded that the signing tax return preparer is not primarily responsible for the position, the nonsigning tax return preparer within the firm with overall supervisory responsibility for the position(s) giving rise to the understatement generally will be considered the tax return preparer who is primarily responsible for the position for purposes of Sec. 6694. Notwithstanding this rule, based upon credible information from any source, the Service may determine that another nonsigning tax return preparer within the firm is primarily responsible for the position(s) on the return or claim for refund giving rise to an understatement.
In addition, the regulations were modified to provide that if the IRS is given information that would support a finding that either the signing tax return preparer or a nonsigning tax return preparer within a firm is primarily responsible for a position giving rise to the understatement, the Service may assess the penalty against either of the individuals within the firm, but not both, as the primarily responsible tax return preparer. The IRS will make this determination based upon all the evidence presented. This determination will allow the primarily responsible tax return preparer to be identified with certainty before the expiration of the limitations period on making an assessment under Sec. 6694(a).
Reliance on information provided by other parties: The final regulations make two changes to the rule provided in the proposed regulations that a tax return preparer may rely in good faith and without verification on information furnished by another adviser, another tax return preparer or another party (other than legal conclusions). First, the final regulations provide that a preparer, in addition to relying on “information” provided by other parties, may rely on “advice” provided by other parties. Second, the final regulations do not include a prohibition on relying on another party’s legal conclusions.
Reasonable to believe more likely than not: After the Tax Extenders Act, the MLTN standard continues to apply to tax shelters and Sec. 6662A reportable transactions. For purposes of determining if a tax return preparer reasonably believes that a position will more likely than not be sustained on its merits, the final regulations adopt a new rule (taken from Regs. Sec. 1.6662-4(d)(3)(iv)) that limits the use of jurisdictional case law as support for the preparer’s claim. Under this rule, a tax return preparer may rely only on controlling precedent of a federal court of appeals to which the taxpayer has a right of appeal to support his or her claim of a reasonable belief that a position will more likely than not be sustained on its merits. Any other court precedent that applies to the taxpayer due to the taxpayer’s place of residence will not be taken into account.
Adequate disclosure: For a signing tax return preparer, the final regulations provide that disclosure of a position for which there is a reasonable basis but for which there is not substantial authority is adequate:
- If 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.
- If the tax return preparer provides the taxpayer with a prepared tax return that includes the appropriate disclosure in accordance with Regs. Sec. 1.6662-4(f).
- For tax returns or claims for refund that are subject to penalties other than the accuracy-related penalty for substantial understatements, if the return preparer advises the taxpayer of the penalty standards applicable to the taxpayer under Sec. 6662.
In the case of a nonsigning tax return preparer, the final regulations maintain the same three disclosure rules that were in the proposed regulations.
The Service also modified the regulations to clarify certain aspects of the requirements for advice. The final regulations provide that no general disclaimer is allowed for the taxpayer’s specific facts and circumstances and the position for which there is no substantial authority; however, the use of standard language to describe applicable law and the adoption of a standard approach to disclosure issues is allowed.
In addition, the regulations were revised to clarify the contemporaneous documentation requirements for nonsigning tax return preparers. If a nonsigning tax return preparer provides advice to a taxpayer, the contemporaneous documentation should show that a tax return preparer in the nonsigning preparer’s firm has advised the client of the potential penalties and the opportunity, if any, to avoid penalty through disclosure. If a nonsigning preparer is advising another preparer outside the firm, the contemporaneous documentation should confirm that the outside preparer has been advised that disclosure under Sec. 6694(a) may be required. If a nonsigning preparer provides advice to another preparer in the same firm, contemporaneous documentation is satisfied if there is a single instance of contemporaneous documentation within the firm.
Finally, the regulations modify the disclosure rules to clarify that a tax return preparer is not considered to have recklessly or intentionally disregarded a rule or regulation if the position contrary to the rule or regulation has a reasonable basis and is adequately disclosed. In the case of a position contrary to a revenue ruling or notice, a tax return preparer also is not considered to have recklessly or intentionally disregarded the ruling or notice if the position meets the substantial authority standard and the position is not with respect to a Sec. 6662A reportable transaction.
Definition of tax return preparer: In the final regulations, the revised definition provides that a signing tax return preparer is the individual tax return preparer who has the primary responsibility for the overall substantive accuracy of the preparation of such return or claim for refund. The definition of a nonsigning tax return preparer is left unchanged, except that a new anti-abuse rule provides that advice given after an event has occurred will be taken into account in determining whether an individual is a nonsigning preparer in certain situations where an individual acts in a way to avoid being treated as a tax preparer under Sec. 6694.
Other changes: The final regulations also include comment-driven changes to the rules on furnishing and retaining a taxpayer’s return, furnishing the preparer’s identification number, the burden of proof with respect to the penalty, and the negotiation of a taxpayer’s check. The regulations provide a new example illustrating the computation of the income derived for purposes of calculating the penalty, and an example dealing with due diligence for the earned income credit was removed and replaced with a new example.
Even though the Sec. 6694 tax return preparer penalty rules have been greatly improved by the change to the substantial authority standard made by the Tax Extenders Act and through changes made following public comments about the proposed regulations, the rules still represent a radical departure from those in place prior to the passage of the Small Business and Work Opportunity Tax Act of 2007. Due to the large increase in the size of the potential penalty for violating the rules, practitioners should become familiar with them and make a point of considering their possible application to all returns before filing the returns.
, Esq., CPA, is
technical editor of
The Tax Adviser.
This article appears in the February 2009 issue of The Tax Adviser, the AICPA's monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price. Call 1-800-513-3037 or e-mail firstname.lastname@example.org for a subscription to the magazine or to become a member of the Tax Section.