Final regulations addressing tax return preparer penalties under §§ 6694 and 6695 have been issued by the IRS. We expect the IRS to increase its enforcement activities and the number of penalties it assesses. These penalty standards apply to all tax preparers. More information and tools for compliance will be posted to the Tax Compliance & Reference database, but here is a summary of the major points:
Increased Penalty for an Unreasonable Position. The penalty is the greater of $1,000 or 50% of the income derived by the tax return preparer, or the greater of $5,000 or 50% of the income derived by the tax return preparer if the conduct was willful or reckless.
New Definition of Tax Return Preparer. 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 the return or claim for refund. A nonsigning tax return preparer is someone who prepares a substantial portion of a return or claim for refund with respect to events that have occurred at the time the advice is rendered.
Penalties for Unreasonable Positions Apply in More Areas. Penalties may apply to all tax return preparers, including preparers of estate, gift, excise and employment tax returns, and to both signing and nonsigning preparers.
New Higher Standard of Conduct to Avoid a Penalty for an Unreasonable Position. A penalty will be imposed if there is an understatement of a tax liability because of the position, and:
- There was no substantial authority for the position
- The preparer knew (or reasonably should have known) of the position, and
- Either there was no reasonable basis for the position or the position was not disclosed.
In other words, in order to avoid penalty, there must be either substantial authority or reasonable basis and adequate disclosure.
Substantial Authority has been described as a 35% to 40% likelihood that the position is correct. There is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. This is the same standard of conduct that applies to taxpayers.
Reasonable Basis has been described as a 20% likelihood that the position is correct. The requirements regarding adequate disclosure vary depending on the position—Form 8275, Form 8275-R, and sometimes even disclosure on the tax return itself may be appropriate and adequate.
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Disclosure on the return may be appropriate for the following items: some Schedule A deductions (medical expenses, taxes, interest, charitable contributions, and casualty and theft losses), some trade and business expenses (casualty and theft losses, legal expenses, specific bad-debt charge-offs, repair expenses, and taxes), moving expenses on Form 3903, and employee business expenses on Form 2106. Rev. Proc. 2008-14 contains a complete list of items that may be disclosed on the return.
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Form 8275 is used to disclose all other positions (except for positions that are contrary to regulations or that are adequately disclosed on the tax return itself).
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Form 8275-R is for disclosing positions contrary to a regulation and should not be used unless you obtain approval from The Tax Institute to do so.
Relying on Information from the Client. You can rely on information the client gives you if it appears correct and complete. If the information does not appear correct or complete, or you have reason to believe it is not correct or complete, ask more questions to determine whether you can rely on the information. You should also document the questions and answers.
New Contemporaneous Documentation Requirement for EITC Due Diligence. Preparers must “contemporaneously document” both the reasonable inquiries they make of clients as well as the responses to those inquiries. |