In November, we devoted a column to the issues surrounding the new return preparer penalty standards under Internal Revenue Code Sec. 6694 enacted as part of the Small Business and Work Opportunity Act of 2007. Those changes focused on the expansion of coverage of Code Section 6694 to tax returns beyond income tax returns; an increase in the penalties imposed, including penalties based on 50 percent of fees derived from return preparation; and an increase in the disclosure standard required to avoid penalties to more likely than not (greater than 50 percent) from a realistic possibility of prevailing on the merits (greater than one third).
Concerns were immediately raised about the impact of the changes, particularly the increase in the penalty standard to a higher standard than that imposed on taxpayers under Sec. 6662 -- a substantial authority standard (greater than 40 percent). Commentators pointed out that this could create conflicts between taxpayers and preparers, and the forced shift in the role of the return preparer from an advocate for the taxpayer to an advisor to the taxpayer.
The Treasury and the Internal Revenue Service quickly responded to the change in Notice 2007-54 by postponing its effect until the end of 2007. At the end of 2007, further interim guidance was released in Notice 2008-13 to assist with returns filed during 2008. Notice 2008-13 also makes clear that additional guidance is anticipated by the end of 2008. The Treasury also is supporting efforts in Congress to lower the preparer standard to the same standard as for taxpayers -- the substantial authority standard.
The focus of Notice 2008-13 is primarily just to help preparers get through the filing season for 2007 returns. Key guidance was provided with respect to the application of the new penalty rules with respect to certain types of returns, the obligations for establishing a reasonable basis for the position taken, and dealing with the conflicting taxpayer and preparer standards.
THE SCOPE OF SEC. 6694
Notice 2008-13 provides three lists, in Exhibits 1 through 3, of types of tax returns and how the requirements apply to each.
Exhibit 1 includes many types of returns that report a tax liability, including individual and corporate income tax returns, Form 990T, estate and gift tax returns, employment tax returns, and miscellaneous excise tax returns. A person who for compensation prepares all or a substantial portion of one of these returns or a claim for refund with respect to such a return is a tax return preparer subject to Code Sec. 6694.
Exhibit 2 includes many information returns such as partnership returns, S corporation returns, employee benefit plan returns, Form 1042-S, and certain information returns on bond issues. A person who for compensation prepares any of these forms, where the form affects an entry on a tax return and constitutes a substantial portion of a tax return or claim for refund, is also a tax preparer subject to Code Sec. 6694.
Exhibit 3 includes a variety of miscellaneous tax filings, including Form 1099, Form W-2, Form 990, estimated tax forms, and extension-of-time-to-file forms. The preparer of one of these forms will not be subject to the unreasonable position penalty under Sec. 6694(a), but may be subject to the willful or reckless conduct penalty under Code Sec. 6694(b) if the information reported on the document constitutes a substantial portion of the tax return or claim for refund and is prepared willfully in any manner to understate the liability of tax, or in reckless or intentional disregard of rules or regulations.
There are already indications that Treasury is in the process of making modifications to these lists.
Notice 2008-13 discusses what it means to form a reasonable belief that the more-likely-than-not standard is met, what a reasonable basis is, and the meaning of reasonable cause and good faith.
The tax return preparer is required to analyze the facts and authority and come to a good-faith determination that the more-likely-than-not standard is met. In order to reach either a reasonable belief that a position would be more likely than not to be sustained or to establish a reasonable basis for a disclosed position, the return preparer may rely in good faith without verification on taxpayer and third-party information, unless there is actual knowledge of a problem with the information or it appears to be incorrect or incomplete. The third party must not be in the same firm as the preparer, and the preparer must have reason to believe that the third party was competent to render the advice.
Good faith will not be considered present if the advice is unreasonable on its face, the preparer knew or should have known that the third party did not have all the relevant facts, or the preparer knew or should have known that the advice was no longer reliable due to developments in the law.
Notice 2008-13 sets forth compliance requirements in four situations. First, compliance is achieved if a reasonable basis is established for the position and the position is disclosed. Second, if the position meets neither the more-likely-than-not standard nor the taxpayer's substantial authority standard, compliance is achieved if the taxpayer is provided with a return that includes disclosure. Neither of these compliance methods requires a documented statement to the taxpayer.
Third, if the position meets the taxpayer's substantial authority standard but not the more-likely-than-not standard, Code Sec. 6694 compliance requires the return preparer to make a statement to the taxpayer as to the difference between the penalty standards applicable to the taxpayer and the return preparer and to contemporaneously document that the statement to the taxpayer was made. This is probably the most significant statement in the interim guidance -- permitting the return preparer to sign the return even if there is no disclosure and the more-likely-than-not standard is not met.
Finally, if the position is with respect to a tax shelter and the more-likely-than-not standard is not met, for compliance the return preparer is to make a statement to the taxpayer of the penalty standard applicable to tax shelters, and also to make a statement to the taxpayer of the difference between the penalty standard applicable to the taxpayer and the return preparer and contemporaneously document in the file that the statements were made.
A nonsigning tax preparer, when advising a taxpayer directly, must find a reasonable basis for the position and make a statement informing the taxpayer of any opportunities to avoid taxpayer penalties through disclosure under Code Sec. 6662. A nonsigning preparer, when advising another return preparer, must find a reasonable basis for the position and make a statement informing the return preparer that disclosure under Code Sec. 6694 may be required.
The statements may be oral, provided that contemporaneous documentation is placed in the file. In most situations, however, the burden is on the preparer to show that the appropriate conversation took place.
Notice 2008-13 provides return preparers with some much-needed assistance in complying with Code Sec. 6694 during the present return filing season. A set of examples are also included in the interim guidance, but these are grouped together and some have created confusion as to just what they are trying to illustrate.
The interim guidance is effective as of Jan. 1, 2008, for all tax returns, amended returns, and claims for refund filed on or after that date with respect to advice provided on or after that date. The effective date is Feb. 1, 2008, for 2007 employment tax returns and excise tax returns filed on or after that date. The date of a return or claim for refund is determined first by looking to the date of the tax return preparer's signature. If the return is not signed, the date is deemed to be the date the return is filed. In the case of a nonsigning preparer, the relevant date is the date that the advice was given.
Return preparers will want to alert the IRS to problems encountered in dealing with the new penalty standards and the interim guidance, so that improvements can be made in the follow-on guidance expected later this year.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH, a Wolters Kluwer business.
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