The administration’s budget proposal to conform the penalty standards applicable to preparers and taxpayers has been welcomed by tax professionals concerned about possible conflicts of interest between preparers and their clients.The budget, the administration’s blueprint for legislative proposals, also calls for making permanent the 2001-2003 tax cuts, and offers measures to increase savings and investment and to improve compliance with the tax system. Rather than address Alternative Minimum Tax reform, it proposes a one-year patch to keep the number of taxpayers subject to the tax at around 4 million.

For tax preparers, the budget proposes conforming the penalty standards between preparers and taxpayers to eliminate possible conflicts of interest between preparers and their clients. “We’re very pleased that they support our position on this,” said Tom Ochsenschlager, vice president of taxation at the American Institute of CPAs.

Legislation last year raised the standard that preparers need to satisfy to avoid a penalty for reporting questionable positions on a return. For undisclosed positions, a preparer must have a reasonable belief that the position would more likely than not be sustained on the merits. For disclosed positions, there must be a reasonable basis for the position.

For undisclosed positions that do not involve a significant purpose of tax avoidance or certain reportable transactions, the standard for taxpayers to avoid the penalty is “substantial authority” for the position that caused the understatement.

Since taxpayers are held to a lower standard, conflicts might arise when the tax practitioner wants a position disclosed on a return to avoid the preparer penalty, but the client would rather not disclose anything because the taxpayer standard has been met.

Under the proposal, the standard applicable to preparers when taking an undisclosed position would be the “substantial authority” standard.

“We wanted them to move toward equalizing the standards, but not at the ‘more likely than not’ level,” said Ochsenschlager. “This is exactly what we supported. It sends a clear signal to conferees that the administration does not think the conflicting standards are appropriate.”

However, the tax preparer would still have to meet the higher “more likely than not” standard for reportable transactions under Code Section 6662A.


Meanwhile, some observers would prefer a more lasting solution to the AMT problem than the one-year AMT patch proposed by the budget. Under the AMT proposal, exemption levels would be increased to $46,250 for single filers and $70,050 for married filers.

“Is this something we have to do every year?” asked E. Martin Davidoff, tax liaison chair of the American Association of Attorney-CPAs. “They leave it to permanent tax reform to solve. The easy interim solution they should enact is to increase the exemption for one year but keep it indexed for inflation. ... Obviously, they also need to index the level at which the exemption gets phased out. That’s a core responsible interim approach to this legislation. There’s something else they could do if they want to go a step further and make it a bit fairer. When the AMT rates of 26 and 28 percent were put in, the top tax was 39.6 percent. Today it’s 35 percent. What about lowering those two rates to reflect the fact that the regular rates came down?”

The budget reproposes consolidating three types of current IRAs into a single Retirement Savings Account. RSAs would be dedicated solely to retirement savings. Instead of a list of exceptions for penalty-free early withdrawals, a new Lifetime Savings Account would be created that could be used to save for any purpose, including retirement savings, health care, emergencies and education.

Existing Roth IRAs would be renamed RSAs and be made subject to the new rules for RSAs. Existing traditional and nondeductible IRAs could be converted into an RSA by taking the conversion amount into gross income, similar to a current-law Roth conversion. While contributions would be nondeductible, earnings would accumulate tax-free, and qualified distributions would be excluded from gross income.

“It’s a good concept,” said Davidoff, “but they’re using it as a ‘pay-for.’ They foresee huge revenue increases because people will be converting from a regular type to a Roth type. In a way, they’re mortgaging the future to get some revenue now, and it may encourage people to make bad decisions.” Moreover, by eliminating the ability for the employee to put in pre-tax dollars to get a tax deduction, the proposal reduces the incentive to save in the first place, he noted.

Davidoff believes that the proposal to consolidate employer-based savings accounts is a good one. Under the plan, defined-contribution accounts that permit employee deferrals or after-tax contributions — 401(k)s, Simple 401(k)s, Thrifts, 403(b)s, governmental 457(b)s, Simple IRAs and Sarseps — would be consolidated into Employer Retirement Savings Accounts, which would be available to all employers and have simplified qualification requirements.

ERSAs would follow the existing rules for 401(k) plans, subject to plan qualification simplifications. The taxability of contributions and distributions from an ERSA would be the same as contributions and distributions from the plans that the ERSA would be replacing. Distributions of Roth and non-Roth after-tax employee contributions and qualified distributions of earnings on Roth contributions would not be included in income, while all other distributions would be included.


The budget proposes a standard deduction for health insurance of $15,000 for family coverage or $7,500 for single coverage, for all families who purchase health insurance that meets minimum requirements, whether directly or through an employer. The new SDHI would replace the existing exclusion for employer-based health insurance, the self-employed premium deduction, and the medical itemized deduction.

The SDHI would address the rising cost of health insurance by removing the tax bias for more expensive insurance, while also providing a potent incentive for the uninsured to purchase insurance, according to the proposal.

“It’s a good concept, but bad implementation,” said Davidoff. “Those who get the insurance from their employer are taxable first, then they get the exclusion, so you have to figure out how much it costs the employer on an employee-by-employee basis.”

“It would place a huge burden on small employers,” he warned. “They will have to calculate the cost and put it on W-2s and pay payroll tax on it. ... It would be better if they just stuck to the exclusion for people who pay their own medical insurance.”

One of the budget’s tax compliance proposals would require a business to file an information return for payments aggregating $600 or more in a calendar year to any corporation other than a tax-exempt corporation.

“This means that I have to file an information return for my water company, or Federal Express, or if I buy a computer from Dell or Apple,” said Davidoff.

Another compliance proposal would extend the federal statute of limitations where a state tax adjustment affects federal tax liability. “It’s not good news,” said Davidoff. “If you have a 2005 matter, the federal statute should expire in 2009,” three years after the due date of the return. “Under this proposal, if the state starts auditing you in 2008, the IRS can wait until one year after the state finishes to still get you.”

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