Accuracy-Related Penalties for Tax Preparers

Accuracy-Related Penalties for Tax Preparers

by Howard Godfrey, Ph.D., CPA

The increased emphasis on taxpayer penalties is expected to be accompanied by an increase in the number of preparer penalties assessed.

... [A] preparer who is assessed a preparer penalty may in some cases be referred to the IRS Office of Professional Responsibility which can impose a wide range of sanctions, including censure which is a public reprimand, and suspension or disbarment from practice before the IRS.

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Applying the Accuracy-Related Preparer Penalty.

Preparer Penalty for Understatement Due to Unreasonable Position. An understatement penalty may be imposed on a tax preparer who prepares a tax return or a claim for refund, if the return or refund claim shows an understatement of the tax liability. The penalty is imposed where any part of an understatement is due to an unreasonable position taken on the return or refund claim, and the preparer knew (or reasonably should have known) of the position. The amount of the penalty is the greater of $1,000 or 50 percent of the income earned by the tax return preparer with respect to the return or claim. [IRC § 6694(a)(1).] The penalty may also be imposed on the employer of the tax return preparer. [Treas. Reg. § 1.6694-2(a)(2).]

Unreasonable Position. A position (taken on a tax return or tax refund claim) is generally unreasonable if the position does not have (or did not have) substantial authority in the tax law. If the return contains adequate disclosure of details about the position, it is unreasonable unless there is a reasonable basis for the position. [IRC § 6694 references IRC § 6662(d)(2)(B)(ii)(I) which requires disclosure of the relevant facts affecting the item's tax treatment in the return, or in a statement attached to the return.] However, a position taken with respect to a tax shelter or a reportable transaction must meet the "more likely than not" standard to avoid being classified as "unreasonable." This higher standard is met if it is reasonable to believe that the position would "more likely than not" (greater than 50 percent chance) be sustained on its merits if challenged by the IRS. [A tax shelter is defined in IRC § 6662(d)(2)(C)(ii) . A reportable transaction is one to which IRC § 6662A applies.] The possibility that a return will not be audited or, if audited, that an item will not be raised on audit, is not relevant in determining when determining whether there s adequate support for a position. [Treas. Reg. § 1.6694-2(b).]

Reasonable Cause Exception. The understatement penalty is not imposed if there is reasonable cause for the understatement and the tax return preparer acted in good faith. [IRC § 6694(a)(3).]...

Willful Understatement of Tax or Reckless Conduct. An enhanced penalty applies when a tax return preparer prepares a return or claim for refund with respect to which any part of an understatement of liability is due to: (1) a willful attempt in any manner to understate the liability for tax on the return or claim, or (2) a reckless or intentional disregard of rules or regulations. [IRC § 6694(b)(2).] A preparer willfully attempts to understate liability if the preparer disregards information furnished by the taxpayer or other persons, in an attempt wrongfully to reduce the tax liability of the taxpayer.

For example, if a preparer disregards information concerning certain items of taxable income furnished by the taxpayer or other persons, the preparer is subject to the penalty. Similarly, if a taxpayer states to a preparer that the taxpayer has only two dependents and the preparer reports six dependents on the return, the preparer is subject to the penalty. [
Treas. Reg. § 1.6694-3(b).]

The amount of this enhanced penalty is equal to the greater of: (1) $5,000, or (2) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim. [IRC § 6694(b)(1).] The penalty described above for an unreasonable position will not apply when the enhanced penalty for willful understatement or reckless conduct applies. [IRC § 6694(b)(3).]

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Authority for Positions Taken on Tax Return.

IRC § 6694 identifies three standards or levels of legal authority for positions taken on tax returns. Those standards are:

  1. More Likely Than Not;
  2. Substantial Authority; and
  3. Reasonable Basis

Treas. Reg. § 1.6662-4 identifies the sources of authority for purposes of determining if there is "substantial" authority for a position...

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Conclusions in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals are not authority. The authorities underlying such expressions of opinion where applicable to the facts of a particular case, however, may give rise to substantial authority for the tax treatment of an item.

Loss of Authority when Modified or Overruled. An authority ceases to be an authority when it is overruled or modified, implicitly or explicitly, by a body with the power to overrule or modify the earlier authority. A district court opinion on an issue is not an authority if overruled or reversed by the United States Court of Appeals for such district. A Tax Court opinion is not considered to be overruled or modified by a court of appeals to which a taxpayer does not have a right of appeal, unless the Tax Court adopts the holding of the court of appeals. Similarly, a private letter ruling is not authority if revoked or if inconsistent with a subsequent proposed regulation, revenue ruling or other administrative pronouncement published in the Internal Revenue Bulletin. [Treas. Reg. § 1.6662-4(d)(3).]

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LEXIS users can view the complete commentary HERE. Additional fees may apply. (Approx. 22 pages)

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