When someone drives down the highway and spots a police car on the side of the road, a sense of paranoia overwhelms the individual even though no law has been broken.
Tax practitioners should have that same feeling each time they prepare and sign a tax return. While the current busy season will soon be in the rear-view mirror, it is never too late to review the laws that govern our profession.
The first “moving” violation for a tax preparer is not having a Preparer Tax Identification Number, commonly known as a PTIN. Preparing returns without a PTIN is just like driving without a license. Any tax practitioner who touches a tax return, even an intern, must have a PTIN. Attorneys and CPAs who are active and in good standing with their licensing agencies have no additional requirements aside from renewing their PTINs annually.
Supervised preparers and non-1040 preparers also do not have additional requirements. A “supervised preparer” is an individual who does not sign tax returns; when applying for or renewing a PTIN, supervised preparers must provide the PTIN of their supervisor. All other preparers, including Enrolled Agents and Registered Tax Return Preparers, will need to pass a competency test, renew their PTIN annually, and take continuing education courses annually. It might not be a bad idea to have drivers in Georgia take a competency test every year as well.
Tax preparers can apply for a PTIN through the IRS Web site or they can paper file Form W-12, IRS Paid Preparer Tax Identification Number Application and Renewal. Do not worry about a bad hair day because no photo is required.
Practitioners must also navigate around the accuracy-related penalties under Section 6662 of the Tax Code that apply to taxpayers. Taxpayers can be assessed penalties for negligence, disregard of rules and regulations, substantial understatement of income tax, substantial valuation misstatement, substantial overstatement of pension liabilities, or substantial estate or gift tax valuation understatement. Pursuant to Treasury Regulation Section 1.6662-3(b)(2), the term “disregard” includes any careless, reckless, or intentional disregard of rules or regulations, including the Tax Code, temporary or final Treasury regulations, and IRS revenue rulings and notices. Carelessly, recklessly and intentionally avoiding the law are certainly serious issues when filing tax returns or driving, and practitioners must help clients avoid these accuracy-related penalties
An income tax liability is substantially understated if the understatement exceeds the greater of 10 percent of the required tax, or $5,000. For corporations, the liability is substantially understated if the misstatement exceeds the lesser of 10 percent of the “correct” tax, or $10,000,000. For reportable transactions, the penalty is 20 percent and in some circumstances can be 30 percent.
The amount of the penalty is generally 20 percent of the underpayment. Here is an important new provision: under Section 6662(b)(6) of the Tax Code, a 40 percent penalty will be enforced on any portion of an underpayment attributable to an undisclosed transaction that lacks economic substance. The economic substance doctrine was codified when legislation in 2010 added in Section 7701(o) of the Tax Code. Penalties under Section 6662 generally can be reduced if the taxpayer has substantial authority for the position taken, or if the position is adequately disclosed on the return and has a reasonable basis.
Another reason to get pulled over is Section 6694 of the Tax Code, which applies to preparers. If a practitioner prepares any return or claim for refund, and there is an “understatement of liability,” the preparer can be assessed a penalty in an amount equal to the greater of $1,000, or 50 percent of income derived with respect to the return or claim. Penalties under this section might be avoided if there is substantial authority for the position taken, if there is a reasonable basis for the position and it is disclosed on the return, or there is reasonable cause. For a tax shelter, a position must be more likely than not to be sustained on the merits.
Practitioners must be particularly careful when their clients hold foreign assets, as the IRS has been continuing to crack down on failures to report income from undisclosed offshore accounts and increasing the reporting requirements in relation to foreign held assets. Taxpayers already had to file the Report of Foreign Bank and Financial Accounts, commonly known as the FBAR, if they have a financial interest in or signature or other authority over a foreign bank account and the account value exceeds $10,000 anytime during the year.
For the 2011 tax year, taxpayers owning foreign assets may also now need to file the new Form 8938, Statement of Specified Foreign Assets, in addition to the mandatory FBAR filings. An unmarried taxpayer living in the United States must file if he or she is living in the U.S. and has an interest in any financial asset valued at $50,000 on the last day of the year, or more than $75,000 at any time during the year. For married taxpayers, the thresholds are $100,000 and $150,000, respectively. A 40 percent penalty is imposed under Section 6662(b)(7) for any understatement attributable to undisclosed foreign financial assets.
Tax practitioners must also steer around a series of road blocks under Section 6695 of the Tax Code. Under this code section a preparer can be penalized for failure to sign a return, provide the client a copy of their tax return, furnish an identification number, or retain information and copies of returns. Tax practitioners are also held accountable for failure to be diligent in determining the taxpayer’s eligibility for the Earned Income Tax Credit. Paid preparers of any return claiming the earned income credit must submit Form 8867, Paid Preparer’s Earned Income Credit Checklist, with the tax return, and retain the required documentation in their files. Taxpayers must proceed through three pages of “stoplights” on this form to be eligible to claim the credit.
Another area through which a tax practitioner must proceed with caution is Section 7216 of the Tax Code, which governs the disclosure or use of information by preparers of returns. Tax practitioners must be extremely careful about the use of tax return information, and there must be written consent for tax return information to be used for any purpose other than for preparing the tax return. The rules for consent are found in Treasury Regulation Section 301.7216-3, which generally provide that a preparer may not disclose or use tax return information prior to obtaining a written consent from the taxpayer.
A common pitfall that can occur under these rules is when a client asks a practitioner to send their tax return to a mortgage broker when refinancing their mortgage. The tax preparer cannot send the tax return to the broker without specific written consent. An easy way to avoid this issue is to send all documents directly to the client, who can then forward the information to their broker.
Just as there is a range of punishments you can receive when being ticketed for driving violations, such as points on your license or jail time, penalties for paid preparers range from a fine or criminal misdemeanor to time in prison. All practitioners should be familiar with Circular 230, the AICPA Code of Professional Conduct and Statement of Standards for Tax Services, the aforementioned sections of the Internal Revenue Code, and Rev. Proc. 2012-15 which provides updated guidance on when disclosures of information will be considered adequate for purposes of reducing understatement penalties under Section 6662 and avoiding preparer penalties under Section 6694.
Watch out for common errors such as uncritically relying on client information, “same as last year,” or analogous provisions of the law, paying insufficient attention to contrary authorities, or missing the forest for the trees.
For each and every return, stop to think before signing, to consider if the reporting makes sense, and to ask yourself if you are missing anything. Use checklists. If you speed through the rest of busy season, you risk committing a violation punishable under the tax law. Protect yourself by having substantial authority and proper documentation.
Also, do not forget to file Schedule UTP, Uncertain Tax Position Statement, or Form 8275/8275-R if you are uncertain about a position taken on a return. Once you are pulled over by the IRS, it is not likely that you will get away with just a warning, so remember that it’s always better to be safe than sorry when driving or preparing tax returns.
Patricia Dampf is a tax senior .
Patricia Dampf is a tax senior in the Personal Financial Services group at Bennett Thrasher PC. She specializes in compliance and strategic income tax planning for high net-worth individuals and their businesses. She also has experience in partnership, fiduciary, and corporation compliance. Prior to joining Bennett Thrasher, she worked for Deloitte Tax LLP in the firm's Federal Lead Tax Services group serving large corporate taxpayers. She is a Georgia CPA and a member of the American Institute of CPAs.
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