Click here to sign up for Tax Pro Today's eNewsletter to get the latest news and behind the scenes commentary you won't find anywhere else.
In every income tax examination, the Internal Revenue Service examiner must address the question of whether preparer penalties apply in the subject examination. Thus, with every IRS audit, the paid preparer is being looked at as well, particularly when there is a proposed assessment.
A recent Accounting Today article cited research suggesting the fear of being audited goes a long way toward keeping companies honest with their tax matters (see IRS Audits Keep Companies Honest, Says Research). As a CPA and attorney, licensed to practice before the United States Tax Court, and having represented many entities with examinations, this practitioner would suggest that the growing fear of preparer penalties has also become a factor in the trend towards corporate self-compliance.
Several years ago, this practitioner would have advised a competent preparer to not be concerned with preparer penalties. Back then, our research and inquiries suggested that preparer penalties would apply to those small inner city shops that mysteriously handle 3,000 tax returns in one tax season, with equally mysterious earned income credits and other such refundable credits in large quantities on every return. That was then.
Now we’re not so sure. But first, let’s remove half of the tax preparer complaints. Why? Because the fastest way for a tax preparer to get into trouble with the IRS’s Office of Professional Responsibility is to not file their own income tax returns. Such cases make up about half of the referrals to OPR. Tax preparation is not the profession to emulate the proverbial “shoemaker with the bad shoes.” Stay tax compliant (and competent) and you’re almost in the clear. In addition, let’s remove the “bad” preparers. Those are the people referred to in the previous paragraph, along with those who take frivolous positions on tax returns (i.e., patently improper), or have patterns of conduct consistent with such frivolous positions.
Enter Form 8275, for the rest of us. While being competent is paramount, being careful could seal the deal with respect to penalty avoidance. Form 8275 was basically designed for that purpose. Quoting the instructions, “Form 8275 is used by taxpayers and tax return preparers to disclose items or positions, except those taken contrary to a regulation, that are not adequately disclosed on a tax return to avoid certain penalties.” We are seeing the use of Form 8275 more and more, but there is still a very large segment of the return preparation industry with no real knowledge of this valuable protective measure. And that includes revenue examiners.
As stated above, preparers are now exposed to risk when signing tax returns. Preparers must therefore carefully review the penalty sections of the code and regulations. In this practitioner’s opinion, simply put, the IRS has basically said, “Look, we know this is complicated stuff. If you think you’re OK with a position, but not positive, disclose it to us by attaching Form 8275. But don’t be frivolous, have bad faith or do something patently improper, and you better have decent books and records as well as substantiation, or else all bets are off.”
We are always asked, “Will using Form 8275 increase my chance of an audit?” As we know, audit selection is the mysterious “black hole” of tax representation. IRS officials will say that it doesn’t increase the chance of audit. This practitioner is not as confident, having successfully defended a tax position on an examined return that included Form 8275. However, since the new standard of tax preparation is to prepare a return as though it would be selected for examination, this practitioner no longer spends too much time worrying about the chance of audit. What we do know is that Form 8275 offers considerable protection for both the preparer and taxpayer, and our job is to try to get it right, with minimal risk.
One final note: Form 8275 must be discussed and the client must be informed about the use of it in their tax return. It’s the client’s tax return. It’s imperative to note that if there is disagreement on this matter, but the preparer believes the use of Form 8275 is necessary, then the return should be delivered to the client with Form 8275 attached. If that task is performed, the preparer complied with their disclosure responsibility, and should document it accordingly. The return is now in the hands of the client for execution and delivery to the IRS.
In summary, in the wake of increased pressures on tax collection, coupled with a new Circular 230 and heightened scrutiny on paid preparers, Form 8275 has emerged as an important weapon in the arsenal of competent tax professionals. When properly used, Form 8275 can protect both the client and preparer from certain penalties related to difficult tax return issues.
Paul Mancinone is a CPA and attorney at law, and represents businesses and individuals before the IRS. His office is located in Springfield, Mass.