IRS Embarks on Penalty Regime Overhaul

RETURN PREPARER REGULATIONS

T he Service has issued long-awaited proposed regulations that implement changes made by the Small Business and Work Opportunity Tax Act of 2007 to the return preparer penalties in IRC §§ 6694 and 6695 and related provisions (REG-129243-07). The Service describes the proposed regulations as “the first significant step” in a “comprehensive review and overhaul of all the tax return preparer penalties and related regulatory provisions.” The provisions of the proposed regulations would generally be effective for returns and claims for refund filed after the final regulations are published.

Addressing one concern of tax practitioners, the proposed regulations clarify that the IRS will not mandate a referral to the Office of Professional Responsibility (OPR) when penalties are assessed against a preparer under section 6694. In cases of conduct that is not willful, the Service says it will look for a pattern of failure to meet the section 6694 standards before making a referral to the OPR. They caution that “egregious” conduct may form the basis for an OPR referral.

One preparer per firm . In the past, the Service has employed a “one preparer per firm” rule when determining penalties. With these proposed regulations, the IRS is abandoning that rule and moving to a structure in which each position taken on a return can have a different preparer. One person in a firm will be considered primarily responsible for each position taken (Prop. Treas. Reg. § 1.6694-1(b)). The person who signs the return will generally be considered primarily responsible for all the positions on the return, but that presumption can be overcome by evidence that another preparer is primarily responsible for a particular position.

Income derived . Section 6694 subjects preparers to penalties of up to 50% of the income derived (or to be derived) “with respect to the return or claim.” In the case of a preparer who works for a firm, “income” means compensation the preparer receives from the firm that can reasonably be allocated to the return preparation engagement or to providing tax advice.

The same income will not be taken into account more than once in computing penalties against a preparer and his or her firm. The IRS also states that it anticipates that it will not stack section 6694 penalties and Circular 230 penalties for the same conduct.

Meeting the standards . Under the proposed regulations, a preparer will meet the new “more likely than not” (MLTN) standard if the preparer analyzes the “pertinent facts and authorities” (that is, the authorities in Treas. Reg. § 1.6662-4(d)(3)(iii)) and “reasonably concludes in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits.” This will be determined based on the facts and circumstances, including the preparer’s due diligence. In the absence of other authority, the preparer may rely on a “well-reasoned construction” of applicable statutes to meet the MLTN standard.

Follow-up advice . One concern among practitioners has been whether providing follow-up advice after a transaction has occurred would make the adviser a nonsigning return preparer. The proposed regulations contain a de minimis safe harbor for posttransaction advice in the definition of “nonsigning tax return preparer” (Prop. Treas. Reg. § 301.7701-15(b)(2)).

This safe harbor is designed to encourage tax professionals to provide follow-up advice requested by a taxpayer without the concern that, by providing such advice, they would become a tax return preparer.

For a detailed discussion of the issues in this area, see “News Notes” in the August 2008 issue of The Tax Adviser .

— Alistair M. Nevius, editor-in-chief
The Tax Adviser