The proposed regulations on preparer penalties, released on June 17, are the latest iteration of rules that tax practitioners should consider carefully when recommending and executing tax strategies. Not heeding them can result in stiff penalties or, worse, the loss of the right to continue to practice tax law and serious damage to a firm’s reputation in the client community.The simple reality is that those responsible for recommending prospective tax strategies are almost always drawn back into the matter by the signing return preparer once the transaction is completed. They are asked about tax benefit matters what was intended and whether things turn out as expected. That after-the-fact advice is enough to subject the practitioner to the label “return preparer” for purposes of the preparer penalties.

If the position taken on the transaction was sufficiently aggressive as to possibly not have greater than a 50-50 chance of being sustained in court and the practitioner (or the tax planner now turned preparer) does not recognize that fact through disclosure, they will be subject to the new, almost draconian preparer penalties, possible referral to the Internal Revenue Service Office of Professional Responsibility and, in some cases, referral to the practitioner’s professional licensing board for censure.

Knowing this scenario in advance, before any advice is given, is obviously putting a chilling effect on creative tax strategies.


Congress started it all back in 2007 by way of a provision in the Small Business and Work Opportunity Act that tightened return disclosure standards, broadened their reach, and significantly raised the penalties imposed to enforce them. The Small Business Tax Act not only expanded the definition of a preparer subject to the higher penalties, but expanded the group potentially subject to the penalties by raising the baseline standard for imposing the penalty. It replaced the “realistic possibility of success” standard for tax benefits to be taken on a return without specific disclosure of the transaction (interpreted under the regs as a 33 percent chance of success). Its replacement was the heightened “more likely than not” standard (considered approximately a 51 percent or greater likelihood).

On the other hand, taxpayers were and continue to be subject to penalties for nondisclosure only if the likelihood for success is 41 percent or greater. As a result, practitioners have not only been burdened with divining various odds of success in complex areas of the tax law, but also are bedeviled by the choice of turning their clients in to the IRS for possible audit through disclosure, or foregoing disclosing the transaction and risking preparer penalties by doing so.

While the new preparer penalty provisions under the Small Business Tax Act have been effective since Jan. 1, 2008, only general principles have applied in practice so far. The IRS, however, intends to hold preparers’ feet to the fire by enforcing the detailed rules that are now in proposed reg form starting with returns filed in 2009. Unfortunately, that means that tax strategies executed now will need to be reported under these heightened standards.


The tax professional who signs a return as its preparer is no longer the only tax professional on the hook for proper transparency of reporting on that return. The proposed regs divide preparers into two categories — signing and non-signing preparers, both of whom may be subject to the same stiff penalties. They further divide the definition of a tax preparer (and, therefore, the reach of the penalties) into “areas of expertise,” acknowledging the fact that the complexity of many returns requires return preparation by committee, within which each participant should be held accountable.

This new approach considers the professional giving compliance advice on a particular specialty issue as having full preparer status for that issue.

A return preparer is an individual who gives tax advice on a transaction that already has taken place. A tax professional who gives purely prospective transactional tax advice will never be considered a preparer for purposes of the preparer penalty rules.

However, the heightened preparer penalties have themselves encouraged preparers who must reflect a completed tax strategy on the return to share the liability. Typically, more preparers are asking (or having the client ask) what tax results were intended for the fee charged, and how they should be reported now that the deal has been completed.

Of course, for those practitioners who do both tax planning and compliance work for clients, the preparer penalties related to tax strategies cannot be avoided. In law and accounting firms in which tax planning and compliance are done by separate groups, the argument has been made that a firewall can be constructed. However, practically speaking, overall firm liability is not reduced and few if any firm members have the leverage to stay out of the line of fire.


The proposed regs also replace the “one preparer per firm” rule with a “preparer-per-position within a firm” approach. While only one person within a firm would be considered primarily responsible for each position giving rise to an understatement and, in turn, be subject to the penalty, the regs also create the situation in which a complicated business return may have many preparers for purposes of the penalty.

As a default, the individual signing the return will continue to be held responsible for all of the positions on a return, but if another individual is determined to have primary responsibility for a position giving rise to an understatement, that other individual will be responsible under Code Sec. 6694.

If the firm is subject to penalty under Code Sec. 6694, then all compensation received by the firm would be included as income derived from the transaction. If both the firm and the preparer are subject to liability, the income derived from the transaction will only count once, meaning that income received by the firm from the client and paid to the preparer will not both be used in determining the maximum penalty.


More dreaded than the occasional preparer penalty that may be incurred by guessing incorrectly on a particular position is the likelihood that a violation of Code Section 6694(a) would automatically trigger referral to the Office of Professional Responsibility, which would affect the tax preparer’s livelihood, as well as expose an entire firm to censure.

The IRS has eased concerns somewhat by promising in the preamble to the proposed regs, “In keeping with a balanced enforcement program for tax return preparers, the IRS intends to modify its internal guidance so that a referral by revenue agents to OPR would not be per se mandatory when the IRS assesses a tax return preparer penalty under Section 6694(a) against a tax return preparer who is also a practitioner within the meaning of Circular 230.”


For a non-signing return preparer, adequate disclosure may be met in one of three ways:

* The preparer may file Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, or on the return in accordance with the annual procedure;

* The preparer may advise the taxpayer of opportunities to avoid potentially applicable Code Sec. 6662 accuracy-related penalties and of applicable standards of disclosure; or,

* The non-signing preparer advises another preparer that disclosure may be required and notes this advice in the other preparer’s files.

Dubbed “the speech,” many practitioners have expressed relief that disclosure for positions with a reasonable basis but not perhaps more-likely-than-not can be kept between the client and the practitioner and not be disclosed to the IRS.

When a tax return position meets the “substantial authority” standard but not the “more likely than not” standard, the tax return preparer has the option of advising the taxpayer of the penalty standards applicable to the taxpayer, and contemporaneously documenting in the tax return preparer’s files that this information or advice was provided.

One immediate problem with using the speech is that the tax planner who is deemed a non-signing return preparer may not be presented with as convenient an opportunity to meet with the client after the transaction to warn that the tax planning strategy may not be as good as first assumed. In defense, practitioners might decide at the time that tax planning advice is given to explain the odds to the client as they relate to probable deductions and other tax benefits, and memorialize that in a client file. An oral presentation usually is more informal than a disclosure document presented to the client, yet protects the practitioner under the proposed regs.


The proposed preparer penalty regulations — the latest edition of the IRS’s view of how the preparer penalties should be applied — are little comfort to many of those who try to do the best for their clients through a variety of tax strategies.

These new rules continue to force disclosure as the safest option in a series of choices that require the odds-making skills of a professional gambler to determine. While the new regs do offer some hope that a “reasonable cause” exception will excuse a practitioner otherwise caught in these gray-area “subjective” choices, those criteria, too, are vague.

Hopefully, comments on the proposed regs will debate this collateral damage, and a less chilling set of final regs will be the result. In the meantime, however, current transactions must be mindful of the reporting standards now in place for them once the calendar turns over a new year. The IRS has indicated that it hopes to finalize the regulations by the end of the year.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.

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