The IRS has been focusing on tax return preparer audits. The aim of these audits is to impose penalties on tax return preparers.
The IRS typically provides a means for tax preparers to appeal these penalties administratively, but there are cases where it doesn’t provide this opportunity. In those cases, the IRS will assess the penalties and begin collection efforts if the penalty is not paid.
The courts have previously told us that there is no legal right to an appeals conference. But does this apply to tax return preparer penalties?
This raises the question as to whether a tax preparer has a right to an administrative appeal, before the IRS moves on to collections. The recent McNamee v. Commissioner, T.C. Memo. 2020-37, case provides the answer.
Facts & Procedural History
The IRS started a tax return preparer audit. The audit resulted in tax preparer penalties for several years. This included 36 penalties for tax returns for the 2009 tax year.
Some of the penalties were assessed under Section 6694(a) and some under Section 6694(b). (We’ll address the difference between these two subsections later in this post).
The tax return preparer had until April 19, 2013 to file a protest with the IRS Office of Appeals to contest the penalties. But the IRS only had until April 15, 2013 to assess the penalties given the time period set by Congress for assessing penalties. The IRS asked the tax preparer to sign a statute extension form to provide time to send the case to Appeals.
The tax return preparer must have been aware of this deadline, as he did not sign the extension. Instead, he filed a protest.
The IRS did not wait for the protest. It assessed the penalties on April 15, 2013.
There were several procedural steps along the way, but, eventually, Appeals considered the penalties. Appeals made a final administrative determination for the penalties at that point. The case ended up in litigation in the U.S. Tax Court.
About Tax Return Preparer Penalties
The tax return preparer argued that the IRS erred in making a “final administrative determination” after the assessment period had expired. Put another way, the tax preparer argued that the IRS had to make this decision before the assessment period expired.
To understand this argument, we should pause to consider the tax return preparer rules and the assessment rules. Recall that the IRS assessed Section 6694(a) and Section 6694(b) penalties in this case.
Section 6694(a) penalties are for tax return positions that are unreasonable. A position is “unreasonable” if there isn’t substantial authority for the position. This is a position that an objective person would say has a 25%-50% chance of being sustained if the courts were to review the issue. Tax planning advice is generally provided at a higher level of confidence than this, so that taxpayers can avoid penalties as well.
Section 6694(b) penalties are for tax returns that willfully or recklessly understate tax. This generally means that there was an actual attempt to understate a tax or a disregard of known tax law. Section 6694(b) penalties are for more problematic conduct, as are injunctions barring the preparer from preparing tax returns.
Assessment Periods for Tax Preparer Penalties
With this distinction between the two types of penalties, we can consider the assessment period for each type of penalty. The term “assessment” generally means to record a liability on the IRS’s books.
The IRS typically has three years to make an assessment of tax for a taxpayer. This three-year period can be extended by certain events, such as the taxpayer signing a consent or waiver form and providing it to the IRS.
The rules are similar for tax return preparer penalties under Section 6694(a). Section 6694(a) penalties must be assessed within three years of the date the taxpayer’s tax return was filed.
But Section 6694(b) penalties are not subject to these rules. Section 6694(b) penalties can be assessed at any time.
These assessment rules are provided for in Section 6696.
Final Administrative Decision Before Assessment
In this case, the IRS assessed both Section 6694(a) and Section 6695(b) penalties. It did so before making a final administrative determination–which is the error the tax preparer cited.
Because there was no pending assessment statute for the Section 6695(b) penalties, the IRS conceded that it should have not assessed the penalties before making a final administrative determination for the penalties. The IRS abated these penalties.
This left only the Section 6695(a) penalties. Since there was a pending assessment period for the Section 6695(a) penalties, the IRS did not have to provide a final administrative determination before assessing the penalties. That is what the IRS argued and what the court found.
The result is that the tax preparer was able to avoid the more serious Section 6694(b) penalties, but he was not able to avoid the lesser Section 6695(a) penalties.
For other tax preparers, this shows that there is a right to an administrative appeal with the IRS before assessing Section 6694(b) penalties, but there may not be a similar right for Section 6694(a) penalties.
Tax return preparers should consider extending the assessment statute for Section 6694(a) penalties if they want an administrative appeal for the penalties.