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.
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.
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
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.
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.
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.
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
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
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.
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.
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
firstname.lastname@example.org or call 202-737-6600.