TAX PREPARER PENALTIES

Transcription

1 TAX PREPARER PENALTIES Prepared by the Tax Department of GIBSON & PERKINS, PC Suite W. Sixth Street, Media, PA

2 LEARNING OBJECTIVES: Course participants will gain both a foundational and nuanced understanding of tax preparer penalties under the Internal Revenue Code. Following completion of the course, participants will be familiar with circumstances in penalties may be imposed upon the tax preparer, and how to avoid these situations. INSTRUCTIONAL DELIVERY METHOD: Self-study. PROGRAM KNOWLEDGE LEVEL: The course level is basic. PREREQUISITE EDUCATION AND EXPERIENCE: This course is aimed primarily towards professionals with a basic understanding of tax preparation. RECOMMENDED CPE CREDIT AND FIELD OF STUDY: 2.0 CPE credit hours Tax ADVANCE PREPARATION: None required. PROGRAM DESCRIPTION: This course approaches tax preparer penalties from both an aerial view, in which the basics are discussed, including who constitutes a tax preparer. The course proceeds to a ground based examination of those penalties which the IRS may impose on a tax preparer, how liability for those penalties is determined, and how such penalties are assessed. COURSE REGISTRATION REQUIREMENTS: To receive credit for this course, please complete all Review Questions and the Final Examination located at the end of these materials. Instructions on requesting course credit are provided with the Final Examination.

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5 Table of Contents Section One: Overview I. Overview 1 II. This Course 1 Section Two: Who is a Tax Return Preparer? I. Overview 3 II. Definitions 3 Section Three: 6694(a) - Penalty for Understatement Due to An Unreasonable Position I. Background 11 II. Tax Return Preparer Penalties Under Code Sec. 6694(a) 12 III. Tax Shelters and Reportable Transactions 13 IV. Other Than Tax Shelters and Reportable Transactions 19 V. Exception for Reasonable Cause And Good Faith 27 Section Four: 6694(b) Penalty for Understatement Due To Willful, Reckless, Or Intentional Conduct I. In General Sec. 6694(b) 31 II. Willful Attempt To Understate Liability 31 III. Reckless Or Intentional Disregard 31 IV. Examples 32 V. Section 6694(b) Penalty Reduced By Section 6694(a) Penalty 33 Section Five: Who is the Responsible Tax Return Preparer? I. Overview 35 II. Responsibility of the Tax Return Preparer 35 III. Abatement of Penalty Where Taxpayer s 38 Liability Not Understated IV. Verification of information Furnished By Taxpayer or Other Third Party 39 V. Income Derived (or To Be Derived) With Respect to The Return Or Claim For Refund 41 i

6 Section Six: Other Assessable Penalties With Respect To The Preparation Of Income Tax Returns For Other Persons I. Failure To Furnish Copy To Taxpayer 47 II. Failure To Sign Return 47 III. Failure To Furnish Identifying Number 48 IV. Failure To Retain Copy or Record 49 V. Failure To File Correct Information Returns 49 VI. Negotiation of Check 50 VII. Tax Return Preparer Due Diligence Requirements For Determining Earned Income Eligibility 51 Section Seven: Assessment Procedure I. In General 55 II. Assessment 55 III. Notice and Demand 55 IV. Preparers Options 55 V. Levy or Proceeding in Court for Collections 56 VI. Preparer Must Bring Suit In District Court To Determine Liability For Penalty 57 VII. Suspension Of Running Of Period Of Limitations On Collection 57 Index of Definitions 59 Answers to Review Questions 61 Final Exam 67 ii

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9 UNIT ONE Overview I. Tax Return Preparer Penalties. A. The Internal Revenue Code in sec. 6694(a) and 6694(b) provides two penalty provisions which apply specifically to tax return preparers. B. Anyone who prepares tax returns for compensation should be familiar with these provisions and what they require of the tax preparer to avoid penalty. C. This is particularly important because recent legislation has changed the standard by which tax return preparers will be judged under these provisions. II. 1. In The Small Business and Work Opportunity Tax Act (the Small Business Act ) adopted tougher standards in regard to tax preparer penalties under Code Sec These changes were to be effective for returns prepared after May 25, In The Emergency Economic Stabilization Act of 2008 (the EES Act ), which was signed into law which repealed retroactively the changes made by the Small Business Act enacted new standards for returns prepared after May 25, Note: The changes made by the Small Business Act and the EES Act relate only to the Code Sec. 6694(a) preparer penalty for understatements due to unreasonable positions. The heavier Code Sec. 6694(b) preparer understatement penalty for willful, reckless or intentional conduct is unaffected. This Course. Among the question to be answered by this Course are the following: A. What are the specific penalties under Code Secs. 6694(a) and 6694(b) which apply to tax return preparers. B. When are you considered a tax return preparer subject to those Code sections. C. What are the standards of practice that must be adhered to avoid penalty under Code sec. 6694(a) and 6694(b). 1

10 D. If there is more than one tax preparer in regard to a particular return upon whom can the penalty be imposed? And can the firm employing those preparers also be held liable? E. What is my duty to audit the information provided by the taxpayer? And can I rely on information provided by other tax preparers? Or tax advisors? Or prior filed tax returns? F. How do I conduct my practice to avoid these penalties? G. Are there any other penalties which apply to tax return preparers under the Code. 2

11 UNIT TWO Who is a Tax Return Preparer? Learning Objectives. Upon completion of this section, you will be able to: > Identify and understand key definitions. I. Overview. A. Regulations - A tax return preparer is defined by the Regulations as: Any person who prepares for compensation or who employs one or more persons to prepare for compensation, all or a substantial portion, of any return of tax or claim for refund of tax under the Internal Revenue Code. B. More Inclusive Definition - The definition is more inclusive than simply a person who actually prepares the physical tax return and may include advisers rendering advice related to specific items on the return. II. Definitions. A. Regulations The Regulations define tax return preparers in terms of signing tax return preparers, and nonsigning tax return preparers. B. Signing Tax Return Preparer. A signing tax return preparer is the individual tax return preparer who physically signs the return and normally has the primary responsibility for the overall substantive accuracy of the preparation of such return or claim for refund. C. Nonsigning Tax Return Preparer. 1. A nonsigning tax return preparer is any tax return preparer who is not a signing tax return preparer but who prepares all or a substantial portion of a return or claim for refund (as discussed in paragraph II.D., below) with respect to events that have occurred at the time the advice is rendered. 3

12 2. In determining whether an individual is a nonsigning tax return preparer, time spent on advice that is given after events have occurred that represents less than 5 percent of the aggregate time incurred by such individual with respect to the position(s) giving rise to the understatement shall not be taken into account. 3. Notwithstanding, time spent on advice before the events have occurred will be taken into account if all facts and circumstances show that: a. The position(s) giving rise to the understatement is primarily attributable to the advice, b. The advice was substantially given before events occurred primarily to avoid treating the person giving the advice as a tax return preparer, and c. The advice given before events occurred was confirmed after events had occurred for purposes of preparing a tax return. 4. Examples of nonsigning tax return preparers are tax return preparers who provide advice (written or oral) to a taxpayer (or to another tax return preparer) when that advice leads to a position or entry that constitutes a substantial portion of the return. 5. Examples. Example 1. Attorney A, an attorney in a law firm, provides legal advice to a large corporate taxpayer regarding a completed corporate transaction. The advice provided by A is directly relevant to the determination of an entry on the taxpayer's return, and this advice leads to a position(s) or entry that constitutes a substantial portion of the return. A, however, does not prepare any other portion of the taxpayer's return and is not the signing tax return preparer of this return. A is considered a nonsigning tax return preparer. Example 2. Attorney B, an attorney in a law firm, provides legal advice to a large corporate taxpayer regarding the tax consequences of a proposed corporate transaction. Based upon this advice, the corporate taxpayer enters into the transaction. Once the transaction is completed, the corporate taxpayer does not receive any additional advice from B with 4

13 respect to the transaction. B did not provide advice with respect to events that have occurred and is not considered a tax return preparer. Example 3. The facts are the same as Example 2, except that Attorney B provides supplemental advice to the corporate taxpayer on a phone call after the transaction is completed. Attorney B did not provide advice before the corporate transaction occurred with the primary intent to avoid being treated as a tax return preparer. The time incurred on this supplemental advice by B represented less than 5 percent of the aggregate amount of time spent by B providing tax advice on the position. B is not considered a tax return preparer. D. Definition of Substantial Portion. 1. Only a person who prepares all or a substantial portion of a return or claim for refund shall be considered to be a tax return preparer of the return or claim for refund. 2. A person who renders tax advice on a position that is directly relevant to the determination of the existence, characterization, or amount of an entry on a return or claim for refund will be regarded as having prepared that entry. 3. Whether a schedule, entry, or other portion of a return or claim for refund is a substantial portion is determined based upon whether the person knows or reasonably should know that the tax attributable to the schedule, entry, or other portion of a return or claim for refund is a substantial portion of the tax required to be shown on the return or claim for refund. 4. A single tax entry may constitute a substantial portion of the tax required to be shown on a return. 5. Factors to consider in determining whether a schedule, entry, or other portion of a return or claim for refund is a substantial portion include but are not limited to: a. The size and complexity of the item relative to the taxpayer's gross income; and b. The size of the understatement attributable to the item compared to the taxpayer's reported tax liability. 6. In the case of a nonsigning tax return preparer a schedule or other portion is not considered to be a substantial portion if 5

14 the schedule, entry, or other portion of the return or claim for refund involves amounts of gross income, amounts of deductions, or amounts on the basis of which credits are determined that are : a. Less than $10,000; or b. Less than $400,000 and also less than 20 percent of the gross income as shown on the return or claim for refund (or, for an individual, the individual's adjusted gross income). c. If more than one schedule, entry or other portion is involved, all schedules, entries or other portions shall be aggregated in applying the de minimis rule in paragraph D6. 7. A tax return preparer with respect to one return is not usually considered to be a tax return preparer of another return merely because an entry or entries reported on the first return may affect an entry reported on the other return: a. Unless the entry or entries reported on the first return are directly reflected on the other return and constitute a substantial portion of the other return. b. For example, the sole preparer of a partnership return of income or small business corporation income tax return is considered a tax return preparer of a partner's or a shareholder's return if the entry or entries on the partnership or small business corporation return reportable on the partner's or shareholder's return constitute a substantial portion of the partner's or shareholder's return. 8. Example. Accountant D prepares a schedule for an individual taxpayer's Form 1040, U.S. Individual Income Tax Return, reporting $4,000 in dividend income and gives oral or written advice about Schedule A, which results in a claim of a medical expense deduction totaling $5,000, but does not sign the tax return. D is not a nonsigning tax return preparer because the total aggregate amount of the deductions is less than $10,000. 6

15 E. Defining Return and Claim For Refund. 1. Definition of Return. a. A return (including an amended or adjusted return) is a document filed by or on behalf of a taxpayer reporting the liability of the taxpayer for tax under the Internal Revenue Code b. A return also includes any information return or other document identified in published guidance in the Internal Revenue Bulletin and that reports information that is or may be reported on another taxpayer's return under the Code if the information reported on the information return or other document constitutes a substantial portion of the taxpayer's return. 2. Claim For Refund. a. A claim for refund of tax includes a claim for credit against tax. b. A claim for refund also includes a claim for payment under section 6420 (the tax on gasoline used on farms), 6421 (gasoline for non-highway purposes, used by local transit, or sold for certain exempt purposes), or 6427 (fuels not used for taxable purposes). F. Mechanical Or Clerical Assistance. 1. A person who furnishes to a taxpayer or other tax return preparer sufficient information and advice so that completion of the return or claim for refund is largely a mechanical or clerical matter is considered a tax return preparer, even though that person does not actually place or review placement of information on the return or claim for refund. 2. An individual providing only typing, reproduction, or other mechanical assistance in the preparation of a return or claim for refund. 3. The mechanical assistance exception described in this paragraph is illustrated by the following examples: 7

16 Example 1. A reporting agent received employment tax information from a client from the client's business records. The reporting agent did not render any tax advice to the client or exercise any discretion or independent judgment on the client's underlying tax positions. The reporting agent processed the client's information, signed the return as authorized by the client pursuant to Form 8655, Reporting Agent Authorization, and filed the client's return using the information supplied by the client. The reporting agent is not a tax return preparer. Example 2. A reporting agent rendered tax advice to a client on determining whether its workers are employees or independent contractors for Federal tax purposes. For compensation, the reporting agent received employment tax information from the client, processed the client's information and filed the client's return using the information supplied by the client. The reporting agent is a tax return preparer. G. Qualifications. 1. A person may be a tax return preparer without regard to educational qualifications and professional status requirements. H. Outside The United States. 1. A person who prepares a return or claim for refund outside the United States is a tax return preparer, regardless of the person's nationality, residence, or the location of the person's place of business, if the person otherwise satisfies the definition of tax return preparer. 2. Notwithstanding the provisions of rules for TINs issued to foreign persons, a foreign person must secure an employer identification number if (i) the person is an employer of another tax return preparer, (ii) is a partnership in which one or more of the general partners is a tax return preparer, (iii) is a firm in which one or more of the equity holders is a tax return preparer, or (iv) is an individual not employed by another tax return preparer. I. Persons Who Are Not Tax Return Preparers. The following persons are not considered tax return preparers: 1. An official or employee of the Internal Revenue Service performing official duties. 8

17 2. Any individual who provides tax assistance under a Volunteer Income Tax Assistance (VITA) program established by the IRS, but only with respect to those returns prepared as part of the VITA program. 3. Any organization sponsoring or administering a VITA program established by the IRS, but only with respect to that sponsorship or administration. 4. Any individual who provides tax counseling for the elderly under a program established pursuant to section 163 of the Revenue Act of 1978, but only with respect to those returns prepared as part of that program. 5. Any organization sponsoring or administering a program to provide tax counseling for the elderly established pursuant to section 163 of the Revenue Act of 1978, but only with respect to that sponsorship or administration. 6. Any individual who provides tax assistance as part of a qualified Low-Income Taxpayer Clinic (LITC), as defined by section 7526 but only with respect to those returns and claims for refund prepared as part of the LITC program. 7. Any organization that is a qualified LITC, as defined by section An individual providing only typing, reproduction, or other mechanical assistance in the preparation of a return or claim for refund. 9. An individual preparing a return or claim for refund of a taxpayer, or an officer, a general partner, member, shareholder, or employee of a taxpayer, by whom the individual is regularly and continuously employed or compensated or in which the individual is a general partner. 10. An individual preparing a return or claim for refund for a trust, estate, or other entity of which the individual either is a fiduciary or is an officer, general partner, or employee of the fiduciary. For purposes of this paragraph, an estate, guardianship, conservatorship, committee, or any similar arrangement for a taxpayer under a legal disability (such as a minor, an incompetent, or an infirm individual) is considered a trust or estate. 9

18 11. An individual preparing a claim for refund for a taxpayer in response to: a. A notice of deficiency issued to the taxpayer; or b. A waiver of restriction on assessment after initiation of an audit of the taxpayer or another taxpayer if a determination in the audit of the other taxpayer affects, directly or indirectly, the liability of the taxpayer for tax. 12. A person who prepares a return or claim for refund for a taxpayer with no explicit or implicit agreement for compensation, even if the person receives an insubstantial gift, return service, or favor. J. Employee. 1. For purposes of paragraph I9, the employee of a corporation owning more than 50 percent of the voting power of another corporation, or the employee of a corporation more than 50 percent of the voting power of which is owned by another corporation, is considered the employee of the other corporation as well. Review Question One Who is a signing tax return preparer? (a) The individual tax return preparer who has the primary responsibility for the overall substantive accuracy of the preparations of such return or claim for refund. (b) The individual tax return preparer who has the primary responsibility for the filing of such return or claim for refund. (c) The individual tax return preparer who decides the overall accuracy of the preparation of such return or claim for refund. (d) The individual tax return preparer who has the sole duty to file the preparation of such return or claim for refund. 10

19 Review Question Two Of the following, who is not considered a tax return preparer? (a) A person who furnishes to a taxpayer or other tax return preparer sufficient information and advice so that completion of the return or claim for refund is largely a mechanical or clerical matter. (b) A person who prepares for compensation or employs one or more persons to prepare for compensation all or a substantial portion of a return of tax or claim for refund, outside the united states. (c) An individual providing only typing, reproduction, or other mechanical assistance in the preparation of a return of claim for refund. (d) A person who renders tax advice on a position that is directly relevant to the determination of the existence, characterization, or amount of an entry on a return of tax or claim for refund. 11

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21 UNIT THREE (a) - Penalty For Understatement Due To An Unreasonable Position Learning Objectives. Upon completion of this section, you will be able to: > Understand the impact of the Small Business Law Act. > Identify the various return penalties under Code Sec (a). > Understand the requirements in relation to tax shelters and other reportable transactions, as well as other than tax shelters and reportable transactions. > Understand substantial authority and reasonable basis standards. > Identify factors considered in determining whether or not there is an exception for reasonable cause and good faith. I. Background. A. Pre Small Business Act Law - Before the changes made by the Small Business Act the law provided the following: 1. The penalty was imposed in an amount equal to the greater of $1,000, or 50% of the income derived (or to be derived) by the tax return preparer for the return or refund claim. 2. The penalty applied where (i) there wasn't a realistic possibility of a position being sustained on its merits, (ii) the preparer knew or should have known, and (iii) the position was undisclosed or frivolous. 3. The penalty also was limited to income tax return preparers and did not apply to preparers of estate, gift, employment and other tax returns. 4. A position was considered to have a realistic possibility of being sustained on its merits if a reasonable and wellinformed analysis by a person knowledgeable in the tax law would lead him to conclude that the position had approximately a one in three, or greater, chance of being sustained 13

22 II. B. The Small Business Act 1. The Small Business Act provided that a tax return preparer was liable for a penalty if he prepared any return or claim for refund for which any part of an understatement of liability was due to an unreasonable position. 2. The standard applied, termed the more likely than not standard, provided that a position was unreasonable if all of the following applied: a. The tax return preparer knew (or reasonably should have known) of the position, b. There was not a reasonable belief that the position would more likely than not be sustained on its merits, and c. The position wasn't properly disclosed or there was no reasonable basis for the position. 3. The more likely than not standard (i.e., a standard requiring a greater than 50% likelihood) created a strong backlash of criticism because it imposed a much stricter standard to tax preparer s than the substantial authority standard which applies to taxpayers. C. The EES Act Repeals the More likely Than Not Standard. 1. Repeal - The EES Act essentially repeals retroactively the more likely than not standard for returns prepared after May 25, 2007, and replaces it with a substantial authority standard, except in the cases involving tax shelters and reportable transactions and cases where adequate disclosure was made. 2. The EES Act therefore effectively eliminates the difference in standards that were created by the Small Business Act between tax preparers and taxpayers. Tax Return Preparer Penalties Under Code Sec. 6694(a). A. Sec. 6694(a). 1. A tax return preparer may be liable for a penalty under section 6694(a) equal to the greater of (i) $1,000 or (ii) 50 percent of the income derived (or to be derived) by the tax return preparer. 14

23 2. In order to be liable for the penalty the tax return preparer must prepare a return or claim for refund that results in an understatement of tax liability due to an unreasonable position. 3. A position that was adequately disclosed is considered to be unreasonable unless there was a reasonable basis for the position. 4. A position that is not disclosed on the return is considered to be unreasonable unless there was substantial authority for the position. 5. In the case of tax shelters and reportable transactions, a position is considered to be unreasonable unless there was a reasonable belief that the position would more likely than not be sustained on its merits. B. Requirements of Sec. 6694(a). 1. Sec. 6694(a) first requires an understatement of tax liability, i.e., if there is no understatement there is no penalty. a. In General - An understatement of liability exists if, viewing the return or claim for refund as a whole, there is either (i) an understatement of the net amount payable with respect to any tax imposed by the Internal Revenue Code, or (ii) an overstatement of the net amount creditable or refundable with respect to any tax imposed by the Code. b. Carryback - The net amount payable in a taxable year with respect to the return for which the tax return preparer engaged in conduct proscribed by section 6694 is not reduced by any carryback. c. Subchapter 68 - Tax imposed by the Code does not include additions to the tax, additional amounts, and assessable penalties imposed by subchapter 68 of the Code. d. Proceeding - The determination of whether an understatement of liability exists may be made in a proceeding involving the tax return preparer that is separate and apart from any proceeding involving the taxpayer. 2. Secondly, the section s unreasonable position standard prescribes a different standard of conduct depending on the circumstances giving rise to the understatement. 15

24 III. a. The initial question is whether or not the transaction involves a tax shelter or a reportable transaction if it does - the position must satisfy the most stringent more likely than not standard. b. If the transaction does not involve a tax shelters or reportable transaction - then the next question is whether the position was adequately disclosed or not (1) If the position was properly disclosed - then there must be a reasonable basis for the position in order to avoid penalty (2) If it was not then there must be substantial authority for the position. Tax Shelters and Reportable Transactions. A. Overview. 1. In the case of tax shelters and reportable transactions, a position is considered to be unreasonable unless there was a reasonable belief that the position would more likely than not be sustained on its merits. 2. Several questions present themselves in the application of this part of Sec. 6694(a): a. First - what is the definition of a tax shelter? And, what is the definition of a reportable transaction? b. Secondly what is required for a position to satisfy the more likely than not standard. Note: That if the transaction involves a tax shelter or a reportable transaction that whether the transaction is adequately disclosed or not is irrelevant the more likely than not standard still applies. B. The Definition of a Tax Shelter and Reportable Transaction. 1. Under sec. 6694(a) the more likely than not standard applies to only to tax shelters and reportable transactions how are those terms defined? 16

25 2. Code Sec. 6662(d)(2)(C)(ii), defines tax shelter as: a. A partnership or other entity, any investment plan or arrangement, or any other plan or arrangement; b. Which has as a significant purpose the avoidance or evasion of federal income tax. 3. A reportable transaction is defined as any transaction for which information must be included with a return or statement because, as determined under regulations issued under Code Sec. 6011, the transaction has a potential for tax avoidance or evasion. C. The More Likely Than Not Standard. 1. If a position is with respect to a tax shelter or a reportable transaction it must be reasonable to believe that a position would more likely than not be sustained on its merits. In practical terms what does this mean? 2. As a general rule the tax return preparer in analyzing the pertinent facts and authorities and, in reliance upon that analysis, must reasonably conclude in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits. 3. In reaching this conclusion, the possibility that the position will not be challenged by the IRS (for example, because the taxpayer's return may not be audited or because the issue may not be raised on audit) is not to be taken into account. 4. The analysis prescribed under the Regulations for purposes of determining whether substantial authority is present applies for purposes of determining whether the more likely than not standard is satisfied (d)(3) (ii) provides the following : The weight accorded an authority depends on its relevance and persuasiveness, and the type of document providing the authority. For example, a case or revenue ruling having some facts in common with the tax treatment at issue is not particularly relevant if the authority is materially distinguishable on its facts, or is otherwise inapplicable to the tax treatment at issue. An authority that merely states a conclusion ordinarily is less persuasive than one that reaches its conclusion by cogently relating the applicable law to pertinent facts. The weight of an authority from which information has been deleted, such as a private letter ruling, is 17

26 5. In Notice , IRB the Service provided that solely for purposes of 6694, a position with respect to a tax shelter will not be deemed an unreasonable position if there is substantial authority for the position and the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer in the event that the transaction is deemed to have a significant purpose of Federal tax avoidance or evasion. 2 D. Facts and Circumstances. 1. Whether a tax return preparer meets the standard will be determined based upon all facts and circumstances, including the tax return preparer's diligence. 2. In determining the level of diligence in a particular situation, the tax return preparer's experience with the area of Federal tax diminished to the extent that the deleted information may have affected the authority's conclusions. The type of document also must be considered. For example, a revenue ruling is accorded greater weight than a private letter ruling addressing the same issue. An older private letter ruling, technical advice memorandum, general counsel memorandum or action on decision generally must be accorded less weight than a more recent one. Any document described in the preceding sentence that is more than 10 years old generally is accorded very little weight. However, the persuasiveness and relevance of a document, viewed in light of subsequent developments, should be taken into account along with the age of the document. There may be substantial authority for the tax treatment of an item despite the absence of certain types of authority. Thus, a taxpayer may have substantial authority for a position that is supported only by a well-reasoned construction of the applicable statutory provision. 2 The advice to the taxpayer must explain that, if the position has a significant purpose of tax avoidance or evasion, there needs to be at a minimum substantial authority for the position, the taxpayer must possess a reasonable belief that the tax treatment was more likely than not the proper treatment in order to avoid an accuracy-related penalty under 6662(d) as applicable, and disclosure in accordance with Regs (f) will not protect the taxpayer from assessment of an accuracy-related penalty if 6662(d)(2)(C) applies to the position. The preparer must contemporaneously document the advice in the tax return preparer's files. If a nonsigning tax return preparer provides advice to another tax return preparer regarding a position with respect to a tax shelter, the position will not be deemed an unreasonable position if there is substantial authority for the position and the nonsigning tax return preparer provides a statement to the other tax return preparer about the penalty standards applicable to the tax return preparer under

27 law and familiarity with the taxpayer's affairs, as well as the complexity of the issues and facts, will be taken into account. 3. For purposes of determining whether it is reasonable to believe that the position would more likely than not be sustained on the merits, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer and information and advice furnished by another advisor, another tax return preparer, or other party (including another advisor or tax return preparer at the tax return preparer's firm). E. Qualifying Authority. 1. In determining whether a position satisfies the more likely than not standard only a limited body of authority may be considered specifically those authorities enumerated in (d)(3)(iii) of the Regulations. 2. The Regulations in (d)(3) (iii) provides only the following qualify as authority : a. Applicable provisions of the Internal Revenue Code and other statutory provisions; b. Proposed, temporary and final regulations construing such statues; and c. Revenue rulings and revenue procedures; d. Tax treaties and regulations there under, e. Treasury Department and other official explanations of such treaties; court cases; f. Congressional intent as reflected in committee reports, joint explanatory statements of managers included in conference committee reports, and floor statements made prior to enactment by one of a bill's managers; g. General Explanations of tax legislation prepared by the Joint Committee on Taxation (the Blue Book); h. Private letter rulings and technical advice memoranda issued after October 31, 1976; i. Actions on decisions and general counsel memoranda issued after March 12, 1981 (as well as general 19

28 counsel memoranda published in pre-1955 volumes of the Cumulative Bulletin); j. Internal Revenue Service information or press releases; and k. Notices, announcements and other administrative pronouncements published by the Service in the Internal Revenue Bulletin. 3. A tax return preparer may reasonably believe that a position more likely than not would be sustained on its merits despite the absence of other types of authority if the position is supported by a wellreasoned construction of the applicable statutory provision. 4. Notably conclusions reached in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals are not authority. 5. The applicability of court cases to the taxpayer by reason of the taxpayer's residence in a particular jurisdiction is not taken into account in determining whether it is reasonable to believe that the position would more likely than not be sustained on the merits - Notwithstanding this - the tax return preparer may reasonably believe that the position would more likely than not be sustained on the merits if the position is supported by controlling precedent of a United States Court of Appeals to which the taxpayer has a right of appeal with respect to the item. F. Written Determinations. 1. The tax return preparer may avoid the section 6694(a) penalty by taking the position that the tax return preparer reasonably believed that the taxpayer's position satisfies the more likely than not standard if the taxpayer is the subject of a written determination as provided in the Regulations. 2. Regulation (d)(3)(iv)(A) provides that : There is substantial authority for the tax treatment of an item by a taxpayer if the treatment is supported by the conclusion of a ruling or a determination letter issued to the taxpayer, by the conclusion of a technical advice memorandum in which the taxpayer is named, or by an affirmative statement in a revenue agent's report with respect to a prior taxable year of the taxpayer ( written determinations ). 20

29 IV. G. When the Standard Must Be Satisfied. 1. For purposes of this section, the requirement that a position satisfies the more likely than not standard must be satisfied on the date the return is deemed prepared. 2. For purposes of the penalties under section 6694, a return or claim for refund is deemed prepared on the date it is signed by the tax return preparer. 3. If a signing tax return preparer fails to sign the return, the return or claim for refund is deemed prepared on the date the return or claim is filed. 4. In the case of a nonsigning tax return preparer the relevant date is the date the nonsigning tax return preparer provides the tax advice with respect to the position giving rise to the understatement. 5. This date will be determined based on all the facts and circumstances. Other Than Tax Shelters and Reportable Transactions. A. General Rule. If the transaction does not involve a tax shelters or reportable transaction - then the first question is whether the position was adequately disclosed or not - if the position was properly disclosed - then there must be a reasonable basis for the position in order to avoid penalty if it was not then there must be substantial authority for the position. B. What does Adequate Disclosure Mean? 1. Signing Tax Return Preparers. In the case of a signing tax return preparer disclosure of a position is adequate if the tax return preparer meets any of the following standards: a. The position may be disclosed on a properly completed and filed Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, as appropriate, or on the tax return in accordance with the annual adequate disclosure revenue procedure 21

30 b. The tax return preparer provides the taxpayer with the prepared tax return that includes the disclosure in accordance with (f). 3 ; and c. For tax returns or claims for refund that are subject to penalties other than the accuracy-related penalty for substantial understatements of income tax under the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer under 6662, and contemporaneously documents the advice in the tax return preparer's files Nonsigning Tax Return Preparers. In the case of a nonsigning tax return preparer disclosure of a position is adequate if the tax return preparer meets any of the following standards: a. The position if it is disclosed on a properly completed and filed Form 8275 or Form 8275-R, as applicable, or on the return in accordance with an annual revenue procedure; b. If the non-signing tax preparer advises the taxpayer of all opportunities to avoid penalties under 6662 that could apply to the position and advises the taxpayer of the standards for disclosure to the extent applicable; or (f)(2) Disclosure On Return provides that the Commissioner may by annual revenue procedure (or otherwise) prescribe the circumstances under which disclosure of information on a return (or qualified amended return) in accordance with applicable forms and instructions is adequate. If the revenue procedure does not include an item, disclosure is adequate with respect to that item only if made on a properly completed Form 8275 or R, as appropriate, attached to the return for the year or to a qualified amended return. 4 Code Sec deals with the imposition of accuracy related penalties which are applicable to tax payers. Under that Code Section a 20% penalty applies to any portion of an underpayment for which there is a substantial understatement of income tax. Any understatement is reduced to the extent it is attributable to an item for which there is substantial authority or with respect to which the relevant facts affecting the item's tax treatment are adequately disclosed in the return or a statement attached to the return. 22

31 c. Advises another tax return preparer that disclosure under 6694(a) may be required. Note: Nonsigning preparers must also document contemporaneously in their files that the information or advice was provided. 3. Advice To Taxpayers. a. If a nonsigning tax return preparer provides advice to the taxpayer with respect to a position for which there is a reasonable basis but for which there is not substantial authority, disclosure of that position is adequate if the tax return preparer advises the taxpayer of any opportunity to avoid penalties under section 6662 that could apply to the position, if relevant, and of the standards for disclosure to the extent applicable. b. The tax return preparer must also contemporaneously document the advice in the tax return preparer's files. c. The contemporaneous documentation should reflect that the affected taxpayer has been advised by a tax return preparer in the firm of the potential penalties and the opportunity to avoid penalty through disclosure Advice To Another Tax Return Preparer. a. If a nonsigning tax return preparer provides advice to another tax return preparer with respect to a position (other than a position with respect to a tax shelter or a reportable transaction to which section 6662A applies) for which there is a reasonable basis but for which there is not substantial authority, disclosure of that position is adequate if the tax return preparer advises the other tax return preparer that disclosure under section 6694(a) may be required. b. The tax return preparer must also contemporaneously document the advice in the tax return preparer's files. 23

32 c. The contemporaneous documentation should reflect that the tax return preparer outside the firm has been advised that disclosure under section 6694(a) may be required. d. If the advice is to another nonsigning tax return preparer within the same firm, contemporaneous documentation is satisfied if there is a single instance of contemporaneous documentation within the firm Requirements For Advice. a. For purposes of satisfying the disclosure standards, each return position for which there is a reasonable basis but for which there is not substantial authority must be addressed by the tax return preparer. b. The advice to the taxpayer with respect to each position, therefore, must be particular to the taxpayer and tailored to the taxpayer's facts and circumstances. c. The tax return preparer is required to contemporaneously document the fact that the advice was provided. d. There is no general pro forma language or special format required for a tax return preparer to comply with these rules. A general disclaimer will not satisfy the requirement that the tax return preparer provide and contemporaneously document advice regarding the likelihood that a position will be sustained on the merits and the potential application of penalties as a result of that position. e. Tax return preparers, however, may rely on established forms or templates in advising clients regarding the 6 6 Contemporaneously prepared documentation in the nonsigning tax return preparer's files is sufficient to establish that the statement was given to the other tax return preparer. If a nonsigning tax return preparer and other tax return preparer are employed by the same firm, contemporaneous documentation of advice provided by any tax return preparer in that firm to the taxpayer regarding applicable penalty standards also is sufficient to establish that the statement was given by a nonsigning tax return preparer to the other tax return preparers within the firm. 24

33 operation of the penalty provisions of the Internal Revenue Code. f. A tax return preparer may choose to comply with the documentation standard in one document addressing each position or in multiple documents addressing all of the positions. 6. Pass-Through Entities. Disclosure in the case of items attributable to a pass-through entity is adequate if made at the entity level Examples. Example 1. An individual taxpayer hires Accountant R to prepare its income tax return. A particular position taken on the tax return does not have substantial authority although there is a reasonable basis for the position. The position is not with respect to a tax shelter or a reportable transaction to which section 6662A applies. R prepares and signs the tax return and provides the taxpayer with the prepared tax return that includes the Form 8275, Disclosure Statement, disclosing the position (f)(5) provides as follows: Disclosure in the case of items attributable to a passthrough entity (pass-through items) is made with respect to the return of the entity, except as provided in this paragraph (f)(5). Thus, disclosure in the case of pass-through items must be made on a Form 8275 or 8275-R, as appropriate, attached to the return (or qualified amended return) of the entity, or on the entity's return in accordance with the revenue procedure described in paragraph (f)(2) of this section, if applicable. A taxpayer (i.e., partner, shareholder, beneficiary, or holder of a residual interest in a REMIC) also may make adequate disclosure with respect to a pass- through item, however, if the taxpayer files a properly completed Form 8275 or 8275-R, as appropriate, in duplicate, one copy attached to the taxpayer's return (or qualified amended return) and the other copy filed with the Internal Revenue Service Center with which the return of the entity is required to be filed. Each Form 8275 or R, as appropriate, filed by the taxpayer should relate to the pass- through items of only one entity. For purposes of this paragraph (f)(5), a pass-through entity is a partnership, S corporation (as defined in section 1361(a)(1)), estate, trust, regulated investment company (as defined in section 851(a)), real estate investment trust (as defined in section 856(a)), or real estate mortgage investment conduit ( REMIC ) (as defined in section 860D(a)). 25

34 taken on the tax return. The individual taxpayer signs and files the tax return without disclosing the position. The IRS later challenges the position taken on the tax return, resulting in an understatement of liability. R is not subject to a penalty under section Example 2. Attorney S advises a large corporate taxpayer concerning the proper treatment of complex entries on the corporate taxpayer's tax return. S has reason to know that the tax attributable to the entries is a substantial portion of the tax required to be shown on the tax return. When providing the advice, S concludes that one position does not have substantial authority, although the position meets the reasonable basis standard. The position is not with respect to a tax shelter or a reportable transaction to which section 6662A applies. S advises the corporate taxpayer that the position lacks substantial authority and the taxpayer may be subject to an accuracy-related penalty under section 6662 unless the position is disclosed in a disclosure statement included in the return. S also documents the fact that this advice was contemporaneously provided to the corporate taxpayer at the time the advice was provided. Neither S nor any other attorney within S's firm signs the corporate taxpayer's return as a tax return preparer, but the advice by S constitutes preparation of a substantial portion of the tax return, and S is the individual with overall supervisory responsibility for the position giving rise to the understatement. Thus, S is a tax return preparer for purposes of section S, however, will not be subject to a penalty under section C. Reasonable Basis Standard. 1. In General. a. The section 6694(a) penalty will not be imposed on a tax return preparer if the position taken has a reasonable basis and is adequately disclosed. b. For an exception to the section 6694(a) penalty for reasonable cause and good faith, see section III below. 26

35 2. The Reasonable Basis Standard. a. According to the Regulations reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. b. The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim. c. If a return position is reasonably based on one or more of the authorities as referenced paragraph II.C., above (taking into account the relevance and persuasiveness of the authorities, and subsequent developments), the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantial authority standard. d. For purposes of determining whether the tax return preparer has a reasonable basis for a position, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer and information and advice furnished by another advisor, another tax return preparer, or other party (including another advisor or tax return preparer at the tax return preparer's firm). D. Substantial Authority Standard. 1. In General. a. The substantial authority standard is an objective standard involving an analysis of the law and application of the law to relevant facts. b. The substantial authority standard is less stringent than the more likely than not standard (the standard that is met when there is a greater than 50-percent likelihood of the position being upheld), but more stringent than the reasonable basis standard. c. The authority considered relevant to the question is the same body of authority relevant to the application of the more likely than not standard and the reasonable basis standard listed in paragraph III.E., above. 27