AICPA Urges Congress to Reconsider Preparer Standards

When Congress passed the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007, it contained one major tax policy change not reflected in the title. The law, which was enacted May 25, included a provision that raises the standards applicable to tax return preparers under section 6694 of the Internal Revenue Code for undisclosed, non-tax avoidance items, from the realistic possibility of success standard to the more likely than not standard. As under prior law, if that reporting standard cannot be satisfied and the preparer wants to avoid a possible understatement penalty, the item must be disclosed on the return.

Congress held no hearings on the subject to fully examine the provision’s consequences. Also, this change was not based on a recommendation from the Treasury Department. In its “Blue Book” of recommended legislation, issued in February, the Treasury Department did address the section 6694 penalty. It recommended raising the dollar amount of the penalty. Treasury did not recommend a change in the preparer standards.

The section 6694 understatement penalty was added to the Internal Revenue Code in 1989, as part of an overhaul of the entire penalty regime. At that time, in contrast to the lack of consideration given to making the recent change to the section 6694 reporting standards, Congress spent two years on hearings and studies, an IRS task force created several extensive reports to study the penalty, and various professional organizations added input. Reporting standards and their implications to the tax system and tax policy are too important to be given no consideration prior to a change.

Problems Caused by the Change
First, because the change raises the tax return reporting standard for preparers (more likely than not) above the standard for taxpayers (substantial authority), it creates the potential for conflicts of interest between preparers and their clients. It affects the nature of the representation of taxpayers and a taxpayer’s right to representation.

Second, applying the more-likely-than-not standard to a tax return preparer results in a fundamental change in the preparer’s role, from that of an advocate to that of an adviser.

Third, it will be extremely difficult, if not impossible, to determine the probable correct treatment of some routine items with the degree of certainty required for the stricter more-likely-than-not standard because: (1) there sometimes is little guidance for the tax treatment of an item at the time the item must be reported on a return; and (2) the proper treatment of an item frequently depends on an analysis of unique or unusual facts and circumstances that were not contemplated in published guidance.

Fourth, the potential penalties on a preparer for failure to satisfy the higher standard are so severe that preparers will feel compelled to protect themselves by urging clients to include disclosures for virtually every item for which there is even the slightest uncertainty regarding proper treatment. (Fines under section 6694 and Circular 230 could be imposed on the preparer, possibly totaling 150% of fees derived from the return. In addition, the preparer could be subject to disciplinary action by the IRS Office of Professional Responsibility.) These excessive disclosures for routine tax return positions will overburden tax administration. This would defeat the purpose of the disclosure system and undermine the electronic filing initiative, which currently is not capable of processing a large number of disclosures in a return.

The AICPA’s Proposed Solution
To avoid this disruption to the tax system, the AICPA is recommending to Congress that the section 6694 tax return preparer standards be equalized with the taxpayer standards. For tax shelter (“tax avoidance”) items, the more-likely-than-not standard should continue to apply. For non-tax shelter (“non-tax avoidance”) items, the substantial authority standard should apply.

ACTIVE LEGISLATION

Amendment to Sarbanes-Oxley
The business community continues to press Congress to delay compliance for smaller public companies with Section 404 of Sarbanes-Oxley because of what they see as burdensome costs to implement internal controls.

The House of Representatives adopted an amendment offered by Reps. Scott Garrett, R-N.J., and Tom Feeney, R-Fla., on June 28 that extends through fiscal 2008 the exemption for small businesses from implementing section 404 of the Sarbanes-Oxley Act. Small businesses are non-accelerated filers—companies with a market capitalization of less than $75 million.

The amendment is attached to an SEC funding measure (HR 2829). It passed the House by a vote of 267–154. A similar amendment is expected to be offered and passed in the Senate.

In a recent appearance before the House Financial Services Committee, Treasury Secretary Henry Paulson endorsed the SEC’s current plan for implementation by smaller companies. Neither Paulson nor SEC Chairman Christopher Cox supported legislative changes to SOX or to the unanimously adopted SEC rule. Additionally, in response to questions before the Financial Services Committee on June 26, all five SEC commissioners supported the current plan and none supported legislative changes.

The Sarbanes-Oxley Act was passed in the wake of corporate scandals in 2002. Since then, the enforcing agencies—the SEC and the PCAOB—have responded to stakeholder criticism over auditing costs by rewriting the standard guiding internal controls and, for the first time, providing management with guidance on how to assess internal controls.

Tax Patents
The AICPA is concerned about the patenting of tax strategies and has been a strong supporter of the legislative solution now moving through Congress.

In 1998, the U.S. Federal Circuit Court of Appeals, in State Street Bank & Trust v. Signature Financial Group Inc., held that business methods could be patented. Since then, more than 60 patents for tax strategies have been granted, and 87 patent applications for tax strategies were pending as of July 16.

Patents for tax strategies have already been granted in a variety of areas, including the use of financial products, charitable giving, estate and gift tax, pension plans, tax-deferred exchanges and deferred compensation. We expect many more tax strategy patents to be issued, directly targeting average taxpayers in a host of areas including: (1) income tax minimization; (2) alternative minimum tax (AMT) minimization; and (3) income tax itemized deduction maximization.

Also, these patents limit the ability of taxpayers to fully utilize interpretations of tax law as intended by Congress. They may cause some taxpayers to pay more tax than Congress intended and cause other taxpayers to pay more tax than others similarly situated. The AICPA also feels that the patents complicate the provision of tax advice by professionals, hinder compliance by taxpayers, and mislead taxpayers into believing that a patented strategy is valid under the tax law.

In May, Reps. Rick Boucher, D-Va., Bob Goodlatte, R-Va., and Steve Chabot, R-Ohio, introduced legislation (HR 2365) to provide immunity from patent infringement liability for taxpayers and tax practitioners. The bill also exempts tax preparation software so it would not affect patent protection for products such as TurboTax and TaxCut.

In July, a version of the Boucher-Goodlatte-Chabot legislation was incorporated into a larger patent reform bill (H.R. 1908) and approved by the House Judiciary Committee. The next step is for the House to take up H.R. 1908, which may occur this fall. Bill sponsors are working to have similar legislation introduced in the Senate.

For more information about tax patents, please see “ Tax Patents Considered” in the July 2007 issue of the Journal of Accountancy .

Lisa M. Dinackus is manager of congressional affairs on the AICPA’s Congressional & Political Affairs Team. For further information on these legislative issues and congressional-related inquiries, e-mail congaffairs@aicpa.org or call 202-737-6600.