Congress hopes to partially remedy the tax gap by making tax preparers more responsible for the positions their clients take on returns.Because paid preparers prepare over 62 percent of all individual income tax returns, they are a critical quality control for tax administration by helping to prevent noncompliance, according to an April report released by the Government Accountability Office.
Congress recognized the opportunity and included in its May Iraq war-funding bill a provision that the American Association of CPAs termed "a fundamental change in the role of tax return preparers" that will "likely cause an increase in preparer fees for taxpayers."
The provision alters the standards of conduct that must be met to avoid the imposition of penalties for preparing a return where there is a tax understatement, according to the congressional report accompanying the legislation.
Previously, a preparer who prepared a return with an undisclosed position that had no realistic possibility of being sustained on its merits was liable for a penalty of $250, provided the preparer knew or reasonably should have known of the position.
The new law replaces the "realistic possibility" standard for undisclosed positions with a requirement that there be a reasonable belief that the tax treatment of the position be more likely than not the proper treatment. The provision increases the penalty from $250 to the greater of $1,000 or 50 percent of the income the preparer receives for preparing the return.
"The new provision puts tax preparers in a position of supporting the IRS, rather than their taxpayer clients," said Tom Ochsenschlager, the American Institute of CPAs' vice president of taxation.
"It certainly is upping the ante, because there has been a long tradition of what comfort level you could have as a return preparer and what you were allowed to do at various levels of comfort," said Bill Smith, director of the CBiz national tax office. "Essentially, you could advocate a position if you thought there was a reasonable possibility of success on the merits, which was defined as a one-in-three chance. By establishing a 'more likely than not' standard, they essentially have taken the comfort level and shoved it up 17 points."
Ochsenschlager emphasized that the new law's requirement is a major change in tax policy, made without a congressional hearing to study the full consequences of the provision: "Because it also raises the standard for tax preparers to a level above the standard for taxpayers, it creates the potential for conflicts of interest between preparers and their clients, and consequently affects the nature of taxpayers' representation."
Smith agreed. "They haven't made their policy consistent," he said. "Now the taxpayer can still avoid the negligence penalty if there is a reasonable possibility of success, while the preparer may be liable for the penalty because he or she is held to the higher more-likely-than-not standard."
WHO'S TO BLAME?
Meanwhile, a recent AICPA study reported that nearly half of the CPA-tax preparers surveyed believed that intentional disregard of the law is the primary cause of the tax gap, with underreporting of income believed to be the major component of the gap.
"The impetus on Capitol Hill for the 'more likely than not' provision is the effect it would have on the tax gap," said Ochsenschlager. "The thought was that taxpayers would not do these aggressive transactions, or if they did, that they would be disclosed."
While 48.4 percent of the 1,290 respondents surveyed in the poll attributed the tax gap to intentional disregard, 28.1 percent thought it was the complexity of the tax laws or constant changes in those laws that were the primary contributors.
"Abusive planning already has to be disclosed on the return as a tax shelter or listed transaction," noted Ochsenschlager. "But there are some aggressive transactions where the preparer has to make a judgment. There may be four court cases against your position and three in your favor, and you think your facts are closer to the facts of the cases which favor you. Why give away the money if you have a chance to win? But if it's not more likely than not that you would succeed, you have to disclose the position."
"For example, a few years ago, farmers were eligible for the manufacturing deduction. The issue was whether revenues they received from not planting crops were eligible for the deduction," he said. "On the one hand, there's no production involved, while on the other hand, it's similar to business interruption insurance payments for a plant that closes due to fire. Most people thought that it was close enough to business interruption insurance and took the deduction. It's clear now that that was the correct position, but the point is that every year there are issues like this where intelligent people that know the code have a good feel as to how it'll turn out, but they don't know for sure that it's more likely than not."
Every year the IRS asks the AICPA and other professional organizations to make suggestions as to where more guidance is needed, explained Ochsenschlager. "We submitted our list a month ago, and it had 100 items. That means there are at least 100 areas where people will need to make disclosures, even though most will turn out the way we expect them to. Many times there is guidance in the form of regulations or rulings, but it's not specific enough for your particular case."
AND NOW, THE COST
Return preparation fees are likely to increase, because more research will be required for tax preparers to feel secure that the more-likely-than-not standard is satisfied, Ochsenschlager said.
Furthermore, the IRS could be overburdened by the provision, he said, because preparers may feel that they must ask their clients to include disclosures for virtually every item on their tax returns for which there is the slightest uncertainty regarding the proper treatment.
"Such excessive disclosures for routine tax return positions would defeat the purpose of the disclosure system and undermine the e-filing initiative, which currently is not capable of processing a large number of disclosures on a return," he said.
The net effect may be to make preparers more conservative in the advice they give, said CBiz's Smith: "It's no longer enough that you have a reasonable position - you have to think you're going to win."
As a consequence, Ochsenschlager said that the AICPA is recommending that Congress equalize the reporting standards for preparers with the current standards for taxpayers.
In a letter to committee chairs and ranking members, the AICPA stated that for tax shelter items, the more-likely-than-not standard should continue to apply, but that for non-tax-avoidance items, the taxpayers' lower substantial authority standard should apply.
This would be consistent with the approach Congress and the Treasury have taken in recent years to utilize directed disclosures that focus on potentially problematic transactions, without overburdening the IRS with unnecessary disclosures or inhibiting the electronic filing system, Ochsenschlager said.
But not everyone is opposed to the new standard.
Judith A. Akin, EA, of Oklahoma City, Okla.-based Akin Tax and Financial Services Inc., had a different take on it. "It's a good deal," she said. "We need to get rid of unscrupulous preparers and the frivolous client. If your client has more than a 50 percent chance of winning, then it's not a frivolous client."
"Also, people submitting frivolous client returns need more than a slap on the wrist," said Akin, a past president of the National Association of Enrolled Agents. "They need a sufficient penalty to make them think twice before doing it again."
