The IRS has the ability to impose penalties on income tax return preparers for certain conduct. These rules changed last year, which makes it due time to provide an overview of the new rules.
A Little Background
As mentioned above, Congress amended the Code just over a year ago to beef up the tax return preparer penalty. This took the IRS and the tax community by surprise.
The IRS responded by issuing several Notices, which were subject to criticism by the tax community and, as a result, were partially amended by the IRS. The IRS has now issued Proposed Regulations that incorporate the IRS Notices and amendments thereto. These Notices and Proposed Regulations have varying effective dates and they contain a number of new concepts.
Summary of the New Preparer Penalty Rules
Here is a summary of the new rules:
- A tax return preparer can be the person who prepares a tax return or any person who advises the taxpayer or tax return preparer on a line item on the return,
- The recent changes drop the concept of “income” from the term “income tax preparer,” which means that the preparation of tax returns that are not income tax returns may subject the preparer to penalties,
- The penalty is now equal to the smaller amount of $1,000 or 50% of the amount of income the tax return preparer earns for preparing the tax return or providing the tax advice for the specific item on the return that results in an understatement,
- The penalty is increased to the smaller amount of $5,000 or 50% of the amount of income the tax return preparer ears for preparing the tax return or providing the tax advice for the specific item on the return if willful or reckless conduct is involved,
- The penalty applies if the tax return preparer does not reasonably believe that the position will “more likely than not” be sustained on the merits if challenged by the IRS,
- The “more likely than not” standard means that the tax return preparer must believe that there is a 50 percent chance that the position will be sustained,
- The penalty will not be imposed if the position is properly disclosed so long as there is a “reasonable basis” for the position, and
- The “reasonable basis” standard means that the tax return preparer must believe that there is approximately a 10 to 25 percent chance that the position will be sustained.
Issues to Consider About the Tax Preparer Penalty
- Pursuant to the proposed regulations, the amount of the penalty is not reduced if the tax return preparer discounts or refunds a portion of their fees (i.e., to reduce the 50 percent of compensation received), but there is no rule that the tax return preparer’s contractual agreement cannot allocate the amount of compensation between tax return preparation and non-tax return preparation services,
- The penalty only applies to tax return preparation or advice that is provided for compensation and not for services that are provided for free,
- The penalty does not appear to apply to tax advice that does not end up on a tax return (such as telling a taxpayer not to file a tax return),
- There are several types of tax documents that are not “tax returns” for purposes of the penalty,
- There is no clear definition for determining what constitutes a “reasonable” belief,
- There may be no ability to disclose the lack or records or documents to support a position in order to avoid the tax return preparer penalty (which encourages IRS agents to claim that all adjustments on audit are due to lack of documentation, even if the adjustments should be for a legal or other reason), and
- There will generally be only one tax return preparer; however, there can be multiple tax return preparers within any one firm (meaning that a subordinate employee can even be a tax return preparer if the supervisor signs off on the tax return).
These penalties are in addition to the sanctions that the government may impose on Attorneys, CPAs, and Enrolled Agents pursuant to Circular 230.
It will be interesting to see how the IRS administers the return preparer penalty and whether it will be handled by the IRS’s Office of Professional Responsibility (“OPR”). The OPR has had several notable persons appointed to run it, but it has had a difficult time finding its way. This penalty might give the OPR the framework it needs to effectively regulate tax return preparers.