new return preparer penalty...

[Duke2Earl]

On 5/25/07, the President signed the Small Business and Work Opportunity Tax Act of 2007. (don't you love how they name these things?) As part of these festivities they significantly changed the return preparer penalty under section 6694. It used to be that a paid return preparer could sign a return without penalty so long as the preparer believed that the position on the return had at least a "reasonable possibility of success." (Defined in the regulations as at least a 33% probability of prevailing).

But under the new law (already in effect for all returns prepared after 5/25/07) a preparer is subject to a penalty if there was not a reasonable belief that the position would more likely than not be sustained. As before, the penalty can be avoided if there is disclosure of the position on Form 8275.

A couple of points... you can easily be a return preparer without being the guy who signs as preparer on page 1 of the return. Anyone who is paid to furnish tax advise that a taxpayer relies on in preparing the return is a preparer. Under this definition many of the tax protest gurus can easily be preparers. And the penalty here is the greater of $1000 ($5000 in the case of willful or reckless conduct) or 50% of the fee the preparer received.

The reason this is terminally silly is nobody bothered to coordinate this change with the substantial understatement penalty in section 6662. Putting aside protesters and other frauds for a moment.... a taxpayer can avoid all understatement penalties (assuming no tax shelter items) under 6662 so long as there is at least substantial authority for the positions taken on the return. However, that same taxpayer's preparer can't sign that same return without being subject to a penalty. This is madness, friends. I suspect in a few years you are going to see major companies complaining to Congress that they can't find anyone to prepare their returns. For example, I recently signed an 1120 for a major corporation. The return was over 650 pages. There is no possible way in hell I could ever possibly ascertain that every single tiny position taken on that return was at least more likely than not.... simply is not possible. Yes, we look in detail at the major stuff... but every position, every single deduction, every single calculation methodology... want me to finish this in under a year?

[Quixote]

(2) UNREASONABLE POSITION- A position is described in this paragraph if--
(A) the tax return preparer knew (or reasonably should have known) of the position,
(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
(ii) there was no reasonable basis for the position.
(3) REASONABLE CAUSE EXCEPTION- No penalty shall be imposed under this subsection if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

(Emphasis added.)

Is it reasonable for you to have known of every position taken in that 650 page return? And can you convince the IRS or the court that it isn't?

Is taking your client's word for the numbers they supplied reasonable cause for the understatement?

I have no answers, but maybe the IRS will provide some if they ever get around to issuing regulations on this.

[jg]

From page 35 of the TECHNICAL EXPLANATION OF THE “SMALL BUSINESS AND WORK OPPORTUNITY TAX ACT OF 2007” AND PENSION RELATED PROVISIONS CONTAINED IN H.R. 2206 AS CONSIDERED BY THE HOUSE OF REPRESENTATIVES ON MAY 24, 2007 Prepared by the Staff of the JOINT COMMITTEE ON TAXATION May 24, 2007 JCX-29-07
at http://www.house.gov/jct/x-29-07.pdf

Understatement of Taxpayer’s Liability by Tax Return Preparers (sec. 8246 of the bill and secs. 6694 and 7701 of the Code)
Present Law:
An income tax return preparer is defined as any person who prepares for compensation, or who employs other people to prepare for compensation, all or a substantial portion of an income tax return or claim for refund.38 Under present law, the definition of an income tax return preparer does not include a person preparing non-income tax returns, such as estate and gift, excise, or employment tax returns. An income tax return preparer who prepares a return with respect to which there is an understatement of tax that is due to an undisclosed position for which there was not a realistic possibility of being sustained on its merits, or a frivolous position, is liable for a first-tier penalty of $250, provided the preparer knew or reasonably should have known of the position.39 For purposes of the penalty, an understatement is generally defined as any understatement with respect to any tax imposed by subtitle A (i.e., income taxes). An income tax return preparer who prepares a return and engages in specified willful or reckless conduct with respect to preparing an income tax return is liable for a second-tier penalty of $1,000.
Explanation of Provision:
The provision broadens the scope of the present-law tax return preparer penalties to include preparers of estate and gift tax, employment tax, and excise tax returns, and returns of exempt organizations. The provision also alters the standards of conduct that must be met to avoid imposition of the penalties for preparing a return with respect to which there is an understatement of tax. First, the provision replaces the realistic possibility standard for undisclosed positions with a requirement that there be a reasonable belief that the tax treatment of the position was more likely than not the proper treatment. The provision replaces the not-frivolous standard accompanied by disclosure with the requirement that there be a reasonable basis for the tax treatment of the position accompanied by disclosure. The provision also increases the first-tier penalty from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty is imposed. The provision increases the second-tier penalty from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the tax return preparer.
38 Sec. 7701(a)(36)(A).
39 Sec. 6694.

To me, the inclusion of estate tax returns in these provisions seems a potential area for abuse by over zealous agents.

For Filing Year 1992, the focus year of the post-audit study, IRS tax examiners completed 11,338 formal Federal estate tax audits, representing 19.2 percent of the 59,178 estates for which returns were filed during the year. Overall net tax liability for estates increased by $560 million as a result of audit, an increase of 5.5 percent of the reported, pre-audit total tax liability for 1992. While most estate tax audit cases, 60.1 percent, were closed with additional tax owed, 21.0 percent were closed with a tax reduction, and 18.9 percent were closed with no change in reported net estate tax.

See http://www.irs.gov/pub/irs-soi/92esaudt.pdf

So, either there will be a shift from the manner in which estate tax returns have been prepared or the positions taken on the majority of estate tax returns will, by definition, subject the preparer to potential penalties as they are not more likely than not to be sustained on the merits.
I am presuming that the 60% closed with additional tax due equates to not able to be sustained on the merits; but I do not see how it can be otherwise interpreted.

Also, inclusion or omission of workers on a quarterly payroll tax report (and adjustments for misclassification as contractors rather than employees) would appear to potentially subject the preparer to penalties as a position which was not more likely than not to succeed on the merits.

Unless the preparers are given safe harbors (or clarification as to what reasonably should have been known) these provisions do increase the chance that preparers taking aggresive tax positions can be punished, almost at will, by the governmental agencies for taking those positions.

Hopefully proposed regulations will be issued in short order and the tax practitioner community will be vocal in the hearing process to finalize meaningful regulations.

But, until then we are apparently once again in the situation described in the article, Tax Preparer Penalties and Client Conflicts, at http://www.nysscpa.org/cpajournal/1996/ ... 380196.htm

The current patchwork of standards has created a complex system that provides different and often conflicting incentives for tax preparer and taxpayer reporting. A major consequence of this system is that preparers and advisors can now be expected to frequently face difficult issues of professional ethics and judgment, especially with respect to information disclosure.

...

Presently, there is no acceptable baseline rule of reporting whereby preparers can easily comply with their duties to both the government and taxpayers (e.g., extreme conservatism may be compatible with duties to the government, but not to the taxpayer, who must bear the cost of an audit). The outlook, therefore, is that preparers will have to continue to work with these standards on a case-by-case basis and draw upon their professional judgment, at least until more uniform standards of reporting are adopted.

[Sertsa]

A couple of points... you can easily be a return preparer without being the guy who signs as preparer on page 1 of the return. Anyone who is paid to furnish tax advise that a taxpayer relies on in preparing the return is a preparer. Under this definition many of the tax protest gurus can easily be preparers. And the penalty here is the greater of $1000 ($5000 in the case of willful or reckless conduct) or 50% of the fee the preparer received.

I don't see where they changed the requirement that the advice must, at least, be substantial in order to be considered a return preparer under 7701 (unlike 7216). However, I think the one-preparer-per-firm rule in the 6694 regs will fall by the wayside, as will the limitations on imposing the penalty on firms.

[jg]

Transitional Penalty Relief Provided to Tax Return Preparers IR-2007-115, June 11, 2006

WASHINGTON — The Internal Revenue Service and Treasury Department today released Notice 2007-54, providing guidance and transitional relief for the return preparer penalty provisions amended by the Small Business and Work Opportunity Act of 2007. The new amendments are effective for returns prepared after May 25, 2007.

The new law amended several provisions of the Internal Revenue Code to extend the return preparer penalties under section 6694 to preparers of all tax returns, including estate and gift tax returns, employment tax returns, and excise tax returns. Prior to the new law, these penalties applied only to the preparers of income tax returns. The new law also increased the amount of the penalties and changed the standards of conduct that must be met by return preparers in order to avoid penalties under section 6694.

The transitional relief provided by Notice 2007-54 will apply to all returns, amended returns and refund claims due on or before December 31, 2007, including those returns, amended returns and refund claims filed pursuant to extensions to file due on or before December 31, 2007; to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

Part III – Administrative, Procedural, and Miscellaneous PREPARER PENALTY PROVISIONS UNDER THE SMALL BUSINESS AND WORK OPPORTUNITY ACT OF 2007
NOTICE 2007-54

This notice provides guidance and transitional relief for the return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Act of 2007.

SCOPE
The transitional relief provided by this notice will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

BACKGROUND
The Small Business and Work Opportunity Act of 2007, Pub. L. No. 110-28, 121 Stat. ___, (the Act) was enacted into law on May 25, 2007. Section 8246 of the Act amends several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return which reflects an understatement of liability, and increase applicable penalties. The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.
The amendments made by the Act raise questions regarding activities representing preparation of a tax return, who is a return preparer within the meaning of section 7701(a)(36) (as amended), and how the statute applies to signing and non-signing preparers. In order to address these questions, the Internal Revenue Service and the Treasury Department are considering whether regulations or other published guidance are needed, including but not limited to, amendments to Treas. Reg. sections 301.7701-15 and 1.6694-0 through 1.6694-4. Because the Act extends the types of returns subject to the new provisions, changes are also required to the relevant forms and publications. The Service must also alter existing procedures in order to process disclosures with certain forms and in electronic formats. Because the amendments to section 6694 are effective immediately for returns prepared after May 25, 2007, the Service and the Treasury Department believe that effective tax administration requires transitional relief with respect to the new standards of conduct under section 6694(a).

PENALTY UNDER SECTION 6694
Prior to amendment by the Act, the penalty under section 6694(a) applied if:
(1) any part of an understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits,
(2) any person who is an the income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position, and,
(3) such position was not disclosed as provided in section 6662(d)(2)(B)(ii) or was frivolous.

Prior to amendment by the Act, the penalty under section 6694(b) applied if any part of an understatement was due to:
(1) a willful attempt in any manner by an income tax return preparer to understate the liability for tax; or
(2) to any reckless or intentional disregard of rules or regulations by an income tax return preparer.

Section 8246 of the Act amended several provisions of the Code to extend the scope of the income tax return preparer penalties to preparers of all tax returns, amended returns and claims for refund, including estate and gift tax returns, generation-skipping transfer tax returns, employment tax returns, and excise tax returns.

The Act amended section 6694(a) to provide that the penalty would apply if:
(A) the tax return preparer knew (or reasonably should have known) of the position,
(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
(ii) there was no reasonable basis for the position. Although the Act did not alter the standard of conduct under section 6694(b), it increased the amount of the penalty and made the penalty applicable to all tax return preparers.

Section 8246 of the Act amends the standards of conduct under section 6694(a) in two ways. First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position. The Act also increased the first-tier section 6694(a) penalty for understatements from $250 to the greater of $1000 or 50% of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty was imposed. The Act increased the second-tier section 6694(b) penalty for willful or reckless conduct from $1000 to the greater of $5,000 or 50% of the income derived (or to be derived) by the tax return preparer. Under both the prior and current law, disclosure under section 6694(a) is adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).

In addition, under both the prior and current law, the penalty under section 6694(a) would not be imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

TRANSITIONAL RELIEF
In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Service is providing the following transitional relief: For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under section 6694 will be applied in determining whether the Service will impose a penalty under section 6694(a). Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).

For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under section 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the Service will impose a penalty under section 6694(a).

This transitional relief will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

No transitional relief is available under section 6694(b) as transitional relief is not appropriate for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.

EFFECTIVE DATE
This Notice is effective as of May 25, 2007.

CONTACT INFORMATION
The principal author of this notice is Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Hara at (202) 622-4910 (not a toll-free call).