THE ELITE QUARTERLY Ethics for Enrolled Agents

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1 THE ELITE QUARTERLY Ethics for Enrolled Agents Published by CPElite, Inc The Leader in Continuing Professional Education Newsletters Special Edition Ethics and Professional Conduct for Enrolled Agents 2 Hours of CPE Credit Phone and fax # , cpeliteinc@aol.com, web site Enrolled Agents must complete two hours of continuing education on ethics or professional conduct each year. If for 2014, you (1) order the unlimited option, or (2) subscribe to The Elite Quarterly, there is no additional cost for the 2014 Special Edition. Otherwise, the cost is $20 (2 hours of CPE credit at $10 per hour). If you need non-ethics hours, please see our website ( for CPE hours through our newsletters and courses. As always, we thank you for being a customer we appreciate your business! LEARNING OBJECTIVE AND CONTENT LEVEL The primary objectives of this Special Edition are to familiarize accounting and tax practitioners with recent guidance from the courts, IRS and Treasury relating to Circular 230 for tax practitioners (Part I), and certain penalties affecting income tax preparers (Part II). PREREQUISITES There are no prerequisites nor is advance preparation required for this Special Edition. PART I RECENT CIRCULAR 230 DEVELOPMENTS DISTRICT COURT RULES TREASURY OVERSTEPPED ITS AUTHORITY TO PROHIBIT CONTINGENT FEES FOR PREPARING REFUND CLAIMS Section 10.27(a) of Circular 230 states that a tax practitioner may not charge an unconscionable fee in connection with any matter before the IRS. Section 10.27(b) generally prohibits contingent fees except for services rendered in connection with the following: (1) the IRS s examination of or challenge to an original tax return or an amended return or claim for refund where the amended return or refund claim is filed within 120 days of the taxpayer s receiving notice of an IRS examination; (2) a refund claim or credit filed solely for the determination of statutory interest or penalties assessed by the IRS; and, (3) any judicial proceeding arising under the Internal Revenue Code. Section 10.27(c) defines a contingent fee as any fee that is based, in whole or in part, on whether or not a position taken on a tax return or other filing avoids challenge by the Internal Revenue Service or is sustained either by the Internal Revenue Service or in litigation. It includes a fee that is based on a percentage of the refund reported on a return, that is based on a percentage of the taxes saved, or that otherwise depends on the specific result attained. In Ridgely, Jr. [7/16/14], the D.C. District Court determined whether the Treasury Department has the authority to bar the charging of contingent fees for the preparation and filing of the so-called Ordinary Refund Claim, a procedure that a taxpayer may undertake if he determines that he has overpaid his taxes. A taxpayer may file this type of claim after he has filed his tax return or during the course of an examination, but prior to filing suit in court for a refund. A tax practitioner may assist a taxpayer in preparing and filing a refund claim and, in doing so, would not be legally representing the taxpayer until the IRS responds to the claim and the tax preparer submits a power-of-attorney form to the IRS. What the taxpayer challenged in this case is the IRS's proclaimed authority to regulate fee arrangements entered into by tax preparers for preparing and filing Ordinary Refund Claims before the commencement of any adversarial proceedings with the IRS or any formal legal representation by the tax preparer. In this case, the taxpayer was a CPA but the findings of the case should extend to all tax preparers. The taxpayer argued that the Treasury s restrictions on contingent fee arrangements have resulted in a loss of clients and significant revenue and that his ability to represent and assist clients in the preparation and filing of Ordinary Refund Claims and to practice before the IRS has been severely restricted. Pursuant to a law enacted in 1884, Section 330(a) of 31 U.S.C. authorizes the Treasury to "regulate the practice of representatives of persons before the Treasury. However, the statute does not define the term practice. The taxpayer argued that the plain text of the statute and its surrounding context reveal that the IRS's authority is limited to regulating "practice," and the preparation and filing of Ordinary Refund Claims does not constitute "practice" because such claims, by definition, precede agency adjudication. The IRS countered that nothing in the term practice suggests that the term excludes the fees charged by representatives for preparing and filing refund claims which, by their very nature, relate to a taxpayer's liabilities. The court first mentioned that the Loving [2/11/14] case, which held that the IRS does not have the statutory authority to regulate tax return preparers, is very relevant to the current case. The IRS argued that since that case involved non-cpa tax return preparers and different provisions of Circular 230 (competency testing and continuing education requirements), it should not be relied upon for determining the issue in the current case. A more complete summary of the Loving case is provided in the 2014 Spring issue of The Elite Quarterly. The court disagreed, noting that Loving expressly addresses two key questions that the current case faces (1) who are representatives, and (2) what is practice under

2 Section 330. The plain text of Section 330(a) limits the regulatory authority of the Secretary of the Treasury to the practice of representatives of persons before the Department of the Treasury. It concluded that Loving is controlling precedent that must guide the court's examination of Section 330's text, context, and history with respect to the claims at issue in this case. The court made the following observations: (1) as to the meaning of representative, Loving is clear that a representative is traditionally one with the authority to bind others; (2) tax return preparers neither possess legal authority to act on the taxpayer's behalf nor can they legally bind the taxpayer by acting on the taxpayer's behalf; (3) CPAs preparing and filing refund claims before possessing any power of attorney possess no legal authority to act on behalf of taxpayers so they merely assist taxpayers rather than represent them; and, (4) Loving holds that practice before the Treasury ordinarily refers to practice during an investigation, adversarial hearing, or other adjudicative proceeding. The court also noted that Section 7701 defines tax return preparer to include individuals who prepare tax returns or tax refund claims and that Congress conceived of tax-return preparation and tax-refund preparation as similar activities that qualitatively differ from the practice of presenting or adjudicating cases. Furthermore, Congress clearly intended to allow the IRS to regulate these two categories of activity differently, and the grant of authority in Section 330 is limited to the latter. The IRS threw one last Hail Mary pass by arguing that it has authority to regulate all actions of CPAs who at some point practice before the IRS regardless of whether they are in a representational or non-representational capacity. This pass went incomplete as the court concluded that simply because CPAs may at times practice before the IRS does not grant authority to the IRS to regulate their conduct without limit. The court went on to grant the taxpayer s request to permanently enjoin the IRS from enforcing Section of Circular 230. Query: Now that the court in Loving has ruled that the Treasury cannot enforce competency testing and CPE requirements on unenrolled tax preparers and the court in Ridgely, Jr. has ruled that the Treasury cannot prohibit contingent fees for preparers who do not practice before the IRS, are other provisions in Circular 230 also at risk of being stripped of their power? Indeed, is the entire body of Circular 230 enforceable against a tax return preparer who does not practice before the IRS? Only time will tell. IRS DISCIPLINE OF APPRAISERS IS A LESSON FOR ENROLLED AGENTS In IR [3/19/14], the IRS announces that its Office of Professional Responsibility (OPR) has entered into a settlement agreement with a group of appraisers from the same firm accused of aiding in the understatement of federal tax liabilities by overvaluing facade easements for charitable donation purposes. The appraisers admitted to violating Circular 230 by failing to exercise due diligence in document preparation (Section 10.22(a)(1)), and failing to determine the correctness of written representations made to the Department of the Treasury (Section 10.22(a)(2)). The appraisers agreed to a five-year suspension of valuing facade easements and undertaking any appraisal services that could subject them to penalties under the Code. Appraisers need to understand that they are subject to Circular 230, and must exercise due diligence in the preparation of documents relating to federal tax matters, said Karen L. Hawkins, Director of OPR. Taxpayers expect advice rendered with competence and diligence that goes beyond the mere mechanical application of a rule of thumb based on conjecture and unsupported conclusions. The appraisers prepared reports valuing facade easements donated over several tax years. On behalf of each donating taxpayer, an appraiser completed Part III, Declaration of Appraiser, of Form 8283, Noncash Charitable Contributions, certifying that the appraiser did not fraudulently or falsely overstate the value of such facade easements. In valuing the facade easements, the appraisers applied a flat percentage diminution, generally 15%, to the fair market values of the underlying properties prior to the easement's donation. TREASURY REVISES CIRCULAR 230 In Treasury Decision 9668 [6/3/14], the IRS issues final regulations that substantially revise parts of Circular 230. The regulations replace former Section with a new Section 10.35, entitled Competence. The IRS requires that the practitioner have the appropriate level of knowledge, skill, thoroughness, and preparation that is necessary for the matter for which he or she is engaged. The practitioner may become competent for the matter for which he or she has been engaged through various methods, for example consulting with experts in the relevant area and studying the relevant law. The IRS states that whether consultation and / or research are adequate to make the practitioner competent in a particular situation depends on the facts and circumstances of the particular situation. The IRS recognizes that a practitioner who is highly experienced in a particular matter may require less preparation than a practitioner who is handling the same matter for the first time. Even though there are various practitioners subject to Circular 230, for example attorneys, CPAs, and enrolled agents, there is only one competency standard. The IRS does not provide examples that show practitioner competence, though it says there are several sources that are generally informative on Circular 230's standard of competency: Rule 1.1 of the Model Rules of Professional Conduct, State Bar opinions that address the competence standard, and the AICPA s competency standard. While the regulations modify the Section Circular 230 provision covering the due diligence provision for tax practitioners for certain other parts of Circular 230, the Section provision Diligence as to Accuracy generally remains unchanged. So, a practitioner may rely on the work product of another person. But, the practitioner must use reasonable care in engaging, supervising, training, and evaluating that other person. In exercising reasonable care, the practitioner must take proper account of the nature of the relationship the practitioner has with the other person. 2

3 The regulations revise Section 10.31, Negotiation of Taxpayer Checks. Section now applies to all individuals who represent the taxpayer before the IRS, not just practitioners who are tax return preparers. Any practitioner may not endorse or negotiate any check issued to a client by the government in respect of a federal tax liability. Negotiation includes directing or accepting payment by any means, electronic or otherwise, into an account that the practitioner owns or controls, or any firm or other entity with whom the practitioner is associated. Section does not apply to an individual who is acting solely in the capacity of a trustee of a trust, nor to the administrator / executor of an estate. The regulations change Section of Circular 230. Section requires a firm to have in place procedures to ensure that it complies with Circular 230. Section is clarified to require both the existence of procedures to ensure compliance and the implementation of adequate procedures to ensure compliance. Circular 230 now places responsibility for procedures to ensure compliance on persons who may not have principal authority and responsibility for overseeing a firm s practice, but who are practitioners under Circular 230. In the absence of persons identified by the firm as having principal authority and responsibility, the IRS may identify one or more individuals in the firm who are subject to Circular 230 who will be held responsible for taking reasonable steps to ensure that the firm has adequate procedures in effect for all firm members for purposes of complying with Circular 230. While the firm is limited in its responsibility for personal tax filings and payment obligations of any member, associate, or employee, the regulations specify that firm management should not ignore noncompliance with those obligations by any practitioner associated with the firm when the noncompliance is known or should be known to the firm. The regulations revise Section that covers written tax advice. Former Sections on covered opinions and on requirements for other written advice essentially have been replaced with new Section 10.37, Requirements for Written Advice. The information / disclosure requirements for covered opinions no longer are in Treasury 230. In that the covered opinion rules have been eliminated from Circular 230, the IRS expects that such elimination also will eliminate the use of Circular 230 disclaimers in s and other writings, though the use of an appropriate statement that describes any reasonable and accurate limitations of the written advice rendered to the client is not prohibited. In giving written advice on a federal tax matter, the practitioner must adhere to six principles. First, he must base the written advice on reasonable factual and legal assumptions. The IRS states that all forms of advice, written or oral, should be based on reasonable assumptions. Second, he must reasonably consider all relevant facts and circumstances that he knows or reasonably should know. Third, he must use reasonable efforts to identify and ascertain the facts relevant to written advice on each federal tax matter. Fourth, he may not rely on representations, statements, findings, or agreements of the taxpayer or any other person if reliance on them would be unreasonable. The IRS provides that reliance on representations, statements, findings, or agreements is unreasonable if the practitioner knows or reasonably should know that one or more representations or assumptions on which any representation is based are incorrect, incomplete, or inconsistent. Fifth, he must relate the applicable law and authorities to the facts. Sixth, in evaluating a federal tax matter, he must not take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit. Audit risk should not be considered by practitioners in the course of advising a client on a federal tax matter, regardless of the form in which the advice is given. Generally, the practitioner may rely on the advice of another person if the advice was reasonable and the reliance is in good faith, considering all the facts and circumstances. Practitioner reliance on another includes reliance on any other person, whether the person is one defined as a practitioner under Circular 230 or not. Federal tax matter generally is any matter concerning the application or interpretation of a Section 6110(i)(1)(B) revenue provision, any provision of the law that impacts a person s obligations under the Internal Revenue Code and Treasury regulations, and any other law or regulation that the IRS administers. This definition of a federal tax matter reflects the broad nature of advice that federal tax practitioners render in today s practice environment. There are two items the IRS states specifically are not written advice on a federal tax matter. One is government submissions on matters of general policy. The other is continuing education presentations provided to an audience solely for the purpose of enhancing practitioners professional knowledge on federal tax matters. Including contact information on a continuing education presentation does not convert an educational presentation into an item of written tax advice governed by the regulations. Presentations marketing or promoting transactions are not continuing education presentations. IRS PROVIDES GUIDANCE ON ELECTRONIC RETURN ORIGINATOR In Chief Counsel Advice , the IRS clarifies e-file rules with respect to electronic return originators (EROs). A participant in the IRS e-file program is referred to as an Authorized IRS e-file Provider and EROs are one category of Providers. An ERO that is also a paid preparer must exercise due diligence in the preparation of returns in accordance with the provisions of the Code, Treasury Regulations (including Circular 230), and Publication 1345, Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns. For example, Section 6695(g) requires paid preparers to exercise due diligence in the preparation of returns involving the earned income tax credit (EITC), as it is a popular target for fraud and abuse. Paid preparers must complete all required worksheets and meet all record keeping requirements associated with preparing returns involving the EITC. More generally, Section of Circular 230 states that a return preparer "must exercise due diligence...[i]n preparing 3

4 or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters." The current Chief Counsel Advice discusses whether certain items are violations of the IRS e-rules. There is a violation if an ERO shares its electronic filing identification number with others although it is okay if an employee of an ERO prepares returns at a location other than the business location provided in the ERO s Form 8633, Application to Participate in the IRS e-file Program. On the other hand, it is a violation for an ERO to electronically originate returns prepared by a subcontractor, regardless of where the returns are prepared. According to Publication 3112, IRS e-file Application and Participation, an ERO must originate the electronic submission of only returns that the ERO either prepared or collected from a taxpayer. An ERO that chooses to originate returns that it has not prepared, but only collected from taxpayers, becomes an income tax return preparer of the returns, and is subject to return preparer due diligence requirements when, as a result of entering data, it discovers errors that require substantive changes, and then corrects the errors before filing the return. EROs also must comply with all of the direct deposit rules provided in Publication 1345, Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns. Whether return preparer penalties may be imposed against an ERO depends on whether the ERO is a return preparer. An ERO does not automatically become a return preparer by sharing its EFIN. Therefore, return preparer penalties may not be imposed against an ERO if the ERO's only violation is sharing its EFIN. A tax return preparer is defined as any person who prepares for compensation, all or a substantial portion of any return of tax or claim for refund of tax. **REVIEW QUESTIONS AND SOLUTIONS** 1. True or False. Under the current provisions of Section 10.27(a) of Circular 230, a tax return preparer may charge a contingent fee related to a judicial proceeding arising under the Internal Revenue Code. 2. Regarding a recent court case challenging the Treasury s regulations dealing with contingent fees related to tax services, which one of the following statements is false? a. Tax return preparers generally neither possess legal authority to act on the taxpayer's behalf nor can they legally bind the taxpayer by acting on the taxpayer's behalf. b. The court noted that the term practice before the Treasury refers to practice during an investigation, adversarial hearing, or other adjudicative proceeding. c. The D.C. District Court dismissed the relevance of the Loving decision since it dealt with competency testing and continuing education requirements rather than fees. 3. True or False. Appraisers are not subject to Circular Which one of the following statements about final regulations on Circular 230 is true? a. A practitioner may accept a client s electronic payment of a federal tax liability into an account that the practitioner controls. b. It is only necessary that the practitioner have procedures in place to ensure compliance with Circular 230. c. Generally, a practitioner may rely on the work product of another person. 5. In a recent IRS ruling dealing with electronic return originators (EROs), which one of the following is not a violation of Circular 230? Solutions a. The ERO electronically originates returns prepared by a subcontractor. b. An employee of the ERO uses the ERO electronic filing identification number to prepare and file returns at a location other than the business location provided in the ERO s Form c. The ERO shares its electronic filing identification number with a tax practitioner in another firm. 1. True is the correct response. Section 10.27(b) provides three situations where contingent fees are allowed. A contingent fee related to a Judicial proceeding arising under the Internal Revenue Code is the third situation. False is the incorrect response. Generally, contingent fees are disallowed under Section with certain exceptions. The contingent fee rules are likely to change as a result of the Ridgely, Jr. case. Section of Circular "C" is the correct response. The Loving case served as the foundation for the court to determine whether tax return preparers practice before the IRS for purposes of Section of Circular 230. A" is an incorrect response. The court noted under Loving that the preparation of tax returns generally does not legally bind the client to take certain action. B" is an incorrect response. Loving holds that practice before the Treasury ordinarily refers to practice during an investigation, adversarial hearing, or other adjudicative proceeding. Ridgely, Jr.. 3. False is the correct response. A group of appraisers recently were suspended by the Office 4

5 of Professional Responsibility from valuing facade easements and undertaking any appraisal services that could subject them to penalties under the Code, because they violated Circular 230. True is the incorrect response. The appraisers were suspended because they violated two parts of Section 10.22, Diligence as to Accuracy, under Circular 230. IR "C" is the correct response. A practitioner may rely on the work product of another person. But, the practitioner must use reasonable care in engaging, supervising, training, and evaluating that other person. A" is an incorrect response. A practitioner may not direct or accept payment by any means, electronic or otherwise, into an account that the practitioner owns or controls, or any firm or other entity with whom the practitioner is associated. B" is an incorrect response. Revised Section requires both the existence of procedures to ensure compliance and the implementation of adequate procedures to ensure compliance. Treasury Decision "B" is the correct response. Employees of an ERO are allowed to use the ERO s electronic filing identification number. A" is an incorrect response. It is a violation for an ERO to electronically originate returns prepared by a subcontractor, regardless of where the returns are prepared. C" is an incorrect response. Generally only the ERO and his or her employees may use the ERO s electronic filing identification number. Chief Counsel Advice PART II RECENT DEVELOPMENTS INVOLVING PENALTIES AFFECTING TAX PREPARERS ELEVENTH CIRCUIT DISAGREES WITH OTHER CIRCUITS BY RULING FRAUD MUST BE PROVEN TO IMPOSE SECTION 6701 PENALTY In Carlson [6/13/14], the taxpayer was employed with a national tax preparation company for five years. Although she had no formal training in taxation or accounting, she prepared between tax returns for both individuals and corporations. She relied primarily on in-house class education and the company s tax software to generate tax returns for her clients. Following the 2006 arrest of the owner of the company for cocaine distribution and money laundering, the IRS began investigating the company s business. IRS auditors determined that 40 of the tax returns which were prepared by the taxpayer claimed deductions which could not be substantiated. 13 of the 40 tax preparer penalties were dropped and the remaining 27 penalties were tried by jury in a district court. Over the taxpayer s objection, the district court instructed the jury that the IRS had the burden of proving its case by a preponderance of the evidence. The taxpayer contended that the correct standard of proof was by clear and convincing evidence. The jury returned a verdict for the IRS and a judgment of over $119,000 in penalties was assessed against the taxpayer. The taxpayer appealed to the Eleventh Circuit. The applicable penalty provision is Section 6701 which assesses a penalty on any person who: (1) aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document; (2) knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws; and, (3) knows that such portion would result in an understatement of the liability for tax of another person. The Eleventh Circuit noted that the third condition embodies a scienter requirement (intent to deceive), which must be proven to establish fraud. The court further argued that under this standard the IRS must prove that the preparer actually knew the return understated tax. The IRS must prove that the preparer deceitfully prepared a return knowing it misrepresented or concealed something that understates the correct tax. This is a classic case of fraudulent conduct. Under the Eleventh Circuit s longstanding precedent, the IRS must prove fraud in civil cases by clear and convincing evidence. This is a higher standard than the preponderance of the evidence. The IRS argued that Section 6701 cannot be a fraud statute because the statute never uses the word fraud. The court countered that the lack of the word fraud is immaterial if the conduct the IRS must prove meets the definition of fraud. Because the IRS presented no evidence that the taxpayer knew that the tax returns understated the correct tax, the Eleventh Circuit reversed the district court ruling by holding that the taxpayer was not subject to the penalties under Section Note: Both the Second and Eighth Circuits have held that the correct standard of proof under Section 6701 is a preponderance of the evidence rather than clear and convincing evidence. Expect an IRS appeal to the Supreme Court. IRC SECTION 6694: PREPARER S UNDERSTATEMENT OF TAXPAYER S LIABILITY Section of Circular 230 contains the rules for the standard that the practitioner must meet before signing or advising with respect to a client s tax return position, advising as to a position on other documents, affidavits, and other papers, and advising clients on potential penalties. Practice before the IRS under Circular 230 includes preparing and filing documents, corresponding with the IRS on the client s behalf, rendering written advice to the client, and representing the client at conferences, hearings, and meetings. A practitioner may be sanctioned for violating Section Sanctions include censure, suspension, and disbarment from practice before the IRS. Under Circular 230, the practitioner who is an income tax preparer may not willfully, recklessly, or through gross incompetence sign a tax return or claim for refund that he knows or reasonably should know contains a position that lacks a reasonable basis, is an unreasonable position as described in Section 6694(a)(2), or is a willful attempt by the practitioner to understate the liability for tax or a reckless or intentional disregard of rules or regulations by the practitioner as described in Section 6694(b)(2). Under the Code, a tax return preparer is any person who prepares for compensation or who employs persons who prepare for compensation 5

6 any tax return or claim for refund. Understatement of liability is the understatement of the net amount payable with respect to any tax, or any overstatement of the net amount creditable or refundable with respect to any such tax. A position is not an unreasonable position under Section 6694(a)(2) if there is substantial authority (about a 40% chance of success) for the position, or there is reasonable basis (about a 20% chance of success) with disclosure of the position taken on the return. Disclosure is done by attaching Form 8275, Disclosure Statement, or 8275-R, Regulation Disclosure Statement, to the return, or disclosing as required by an annual revenue procedure, currently Revenue Procedure For tax shelters and reportable transactions, a position is not unreasonable if it is more likely than not (greater than 50%) to be sustained on its merits. The standards under Section also apply where the practitioner advises a client to take a position on a tax return or claim for refund, or with respect to a position taken on a portion of a tax return or claim for refund. A pattern of conduct is a factor the IRS will take into account in determining whether a practitioner acted willfully, recklessly, or through gross incompetence. The Section 6694(a)(2) penalty with respect to each return or refund claim is the greater of $1,000 or 50% of the income derived by the preparer with respect to the return or refund claim. The preparer also can avoid the penalty for an unreasonable position under Section 6694(a)2) if there is reasonable cause, and the preparer acted in good faith. The IRS identifies six factors to consider when there is reasonable cause. Factor 1 is nature of the error whether the error resulted from a provision that was complex, uncommon, or highly technical, and a competent tax return preparer reasonably could have made the error. Factor 2 is frequency of errors whether the understatement was the result of an isolated error, for example an inadvertent mathematical or clerical error, rather than a number of errors. Factor 3 is materiality of errors. This exception generally applies if the understatement is of a relatively immaterial amount. Factor 4 is preparer s normal office practice whether the preparer s normal office practice indicates that the error in question would rarely occur, and the practice was followed in preparing the return or refund claim. Factor 5 is reliance on the advice of others. A tax return preparer may rely without verification upon advice and information furnished by the taxpayer and information and advice furnished by another tax return preparer or other party. The return preparer also may rely in good faith on the advice of, or schedules or other documents prepared by the taxpayer or another tax return preparer who the tax return preparer had reason to believe was competent to render the advice or other information. The relied upon advice or information may be written or oral. Factor 6 is reliance on generally accepted administrative or industry practice whether the tax return preparer reasonably relied in good faith on generally accepted administrative or industry practice in taking the position that resulted in the understatement. Section 6694(b) contains a penalty if the understatement of liability on the return or refund claim is due to the preparer s willful or reckless conduct. The penalty is the greater of $5,000, or 50% of the income derived by the preparer with respect to the return or refund claim. The negligence penalty is reduced by any penalty imposed on the preparer for an unreasonable position. IRS UPDATES DISCLOSURE REQUIREMENTS TO AVOID PREPARER PENALTY FOR UNDERSTATEMENT DUE TO UNREASONABLE POSITIONS Revenue Procedure [1/23/14] updates existing procedures and circumstances under which the disclosure on a taxpayer's income tax return with respect to an item or a position is adequate for purposes of avoiding the taxpayer accuracy penalty for substantial understatement of tax penalty under Section 6662(d), and the preparer penalty under Section 6694(a). The procedure applies to income tax returns filed for a tax year that begins in 2013, or for returns filed in 2014 on 2013 tax forms for short tax years that begin in If an item is not included in the procedure, disclosure is adequate with respect to that item only if made on a properly completed Form 8275 or Form 8275-R and attached to the return for the year or to a qualified amended return. Form 8275 is used to disclose items or positions generally. Form 8275-R is used to disclose items or positions that are contrary to Treasury regulations. Section 4.02 of the procedure provides five broad categories of items in which it specifies the required forms to be filed and other disclosure requirements. For example, the first category is itemized deductions on Schedule A. For interest expense to be adequately disclosed, lines 10 through 15 must be completed supplying all required information where relevant. If the deduction for investment interest expense is limited, Form 4952, Investment Interest Expense Deduction, must be completed. Amounts disallowed under Section 265 (expenses and interest relating to tax-exempt income) are not covered under this section. Another example on Schedule A is charitable contributions. Lines 16 through 19 must be completed supplying all required information. The amount of the contribution reduced by the value of any substantial benefit (goods or services) provided by the donee organization must be entered. If the contribution s value is not reduced by the value of the benefit received, the disclosure is not considered to be adequate. There are special disclosure rules for contributions of $250 or more, cash of less than $250, and a contribution of property other than cash and the amount claimed as a deduction is more than $500. OTHER PENALTIES ASSOCIATED WITH TAX PREPARERS While Section 6694 (understatement of taxpayer's liability by tax return preparer) may be the most common penalty assessed against a tax preparer, there are several other tax provisions where penalties may be assessed against either a tax preparer or the taxpayer because the preparer failed to follow the rules. Some of these provisions are covered below. Section 6107(a) Non-Compliance Under Section 6107, the tax return preparer must furnish a completed copy of the taxpayer s tax return to the taxpayer no later than the time the return is presented for the taxpayer's signature. If the preparer fails to comply with this provision, Section 6695(a) assesses a penalty of $50 unless the preparer can show that the failure is due to reasonable cause and not due to willful neglect. The maximum penalty imposed under this subsection on any person with respect to documents filed during any calendar year shall not exceed $25,000. 6

7 Sections 6695(b) (g) Other assessable penalties with respect to the preparation of tax returns for other persons Sections 6695(b) - (e) provide other $50 penalties per event up to $25,000 a year if the tax preparer fails to perform the following: (1) sign the client s tax return; (2) provide a preparer identification number on the client s tax return; (3) retain a completed copy of the return, or retain, on a list, the name and taxpayer identification number of the taxpayer for whom such return was prepared, and make such copy or list available for inspection upon request by the IRS; and, (4) file correct information returns. Section 6695(f) imposes a penalty of $500 for each IRS check issued to the preparer s client which is endorsed or negotiated by the tax preparer. Section 6695(g) imposes a $500 penalty for each tax return (no maximum per year) on which the preparer claims an earned income tax credit for the taxpayer where the tax preparer fails to comply with due diligence requirements imposed by Treasury regulations pertaining to the earned income tax credit. Sections 6698 and 6699 (Failure to file partnership return or S Corporation return) Although these penalties are imposed on the owners of the partnership or S Corporation, it may be the tax preparer s lack of knowledge or due diligence in assuring that the client s partnership return or S Corporation return is filed in a timely manner. For untimely filed partnership or S Corporation tax returns, the failure to file penalty can be pretty stiff, especially for small business $195 per owner for each month or fraction of a month the return is not filed after its due date. The maximum penalty is for 12 months. So a small business taxed as a partnership or S Corporation with ten owners that goes a year without timely filing its tax return will be subject to a penalty of $23,400 ($195 x 10 owners x 12 months). Note: For first-time offenses, the IRS typically waives these penalties. Section 6713 (Disclosure or use of information by preparers of returns) Tax practitioners who in connection with preparing a tax return provide services in connection with the preparation of a client s tax return will be subject to a penalty if they disclose any information furnished them for, or in connection with, the preparation of the client s return or use any of the information for any purpose other than to prepare, or assist in preparing, the return. The amount of the penalty is $250 for each disclosure or use with a maximum of $10,000 per calendar year. **REVIEW QUESTIONS AND SOLUTIONS** 6. Regarding a recent court case dealing with the Section 6701 penalty provision for any person who aids in an understatement of tax, which one of the following statements is false? a. The Eleventh Circuit found that the IRS presented no evidence that the taxpayer knew that the tax returns understated the correct tax. b. The Eleventh Circuit decision was consistent with decisions reached by the Second and Eighth Circuits. c. The IRS argued that Section 6701 cannot be a fraud statute because the statute never uses the word fraud. 7. How much is the preparer penalty if the understatement of liability on the client s tax return is due to the preparer s willful or reckless conduct? a. The greater of $1,000 or 50% of the income derived by the preparer with respect to the return or refund claim. b. The greater of $5,000, or 50% of the income derived by the preparer with respect to the return or refund claim. c. $5, Which one of the following is a factor the IRS has stated it will consider in determining whether there is reasonable cause to avoid the penalty for taking an unreasonable position under Section 6694(a)(2)? a. Reliance on generally accepted administrative or industry practice. b. Reliance on Revenue Procedure c. Whether the taxpayer previously has been censured or suspended from practice before the IRS. 9. Under Revenue Procedure , which one of the following is acceptable disclosure of the item? a. Where the taxpayer has no investment interest expense or interest relating to tax-exempt income, the taxpayer completes lines of Schedule A, and supplies all information. b. For interest expense, lines on Schedule A are completed, the taxpayer has investment interest expense that is disallowed under Section 163(d), and Form 4952 is not completed. c. Regarding charitable contributions on Schedule A, the taxpayer completes lines 16-19, makes contributions and receives goods for the contributions, and he reports the contributions values unreduced by the value of the goods that he receives. 10. The ABC 2013 partnership return was due on April 15, 2014, but not filed until June 30, No extension was filed on or before April 15, Assuming there are 20 partners in the ABC partnership, what is the amount of the late-filing penalty? a. $ 585. b. $ 7,800. c. $11,700. 7

8 Solutions 6. "B" is the correct response. The Eleventh Circuit disagrees with the decisions reached by the Second and Eighth Circuit as the latter courts applied the preponderance of evidence standard rather than the clear and convincing evidence standard. A" is an incorrect response. One of the requirements to apply Section 6701is proof that the taxpayer knows that there is an understatement in the client s tax liability. The court ruled that the IRS failed to prove this requirement. C" is an incorrect response. The court dismissed the IRS s assertion that Section 6701 is not a fraud statute because the statute never uses the word fraud. Carlson. 7. "B" is the correct response. The behavior is covered under Section 6694(b), and the penalty is the greater of $5,000, or 50% of the income derived by the preparer with respect to the return or refund claim. A" is an incorrect response. This is the Section 6694(a) penalty for an unreasonable position taken on the tax return or the refund claim. C" is an incorrect response. The penalty is the greater of $5,000, or 50% of the income derived by the preparer with respect to the return or refund claim. IRC Section 6694(b). 8. "A" is the correct response. The IRS has identified several factors. This is factor # 6 in paragraph three of the discussion of IRC Section B" is an incorrect response. Revenue Procedure is the current procedure that identifies items that meet the disclosure requirement to avoid the understatement of income tax liability penalty under Section 6694(a). C" is an incorrect response. This is not one of the 6 factors the IRS has identified that it will consider if there is reasonable cause for a position. IRC Section "A" is the correct response. No special disclosure requirements are required beyond completing lines on Schedule A, and supplying all information. B" is an incorrect response. If the deduction for investment interest expense is limited, Form 4952, Investment Interest Expense Deduction, must be completed. C" is an incorrect response. Entering a contribution s value not reduced by the value of the benefit (goods in this case) received does not constitute adequate disclosure. Revenue Procedure "C" is the correct response. The late filing penalty for partnership returns is $195 per partner for each month or fraction of a month the return is not filed after its due date. In this case, there were two full months plus a partial month and there were 20 partners. Therefore, the penalty equals $11,700 ($195 x 3 months x 20 partners). A" is an incorrect response. $585 would be correct if the penalty was not based on the number of partners and simply was $195 per month. B" is an incorrect response. $7,800 would be the penalty if the partial month was not included in the calculation. That is, $7,800 equals $195 x 2 months x 20 partners. Sections 6698 and All rights reserved. The reproduction or translation of these materials is prohibited without the written permission of CPElite. The material contained in CPElite's courses and newsletters qualifies for CPE credit designed to enhance the professional knowledge of the individual. The material is sold with the understanding that CPElite is not engaged in rendering legal, accounting, tax, or other professional services in a consulting capacity "We have entered into an agreement with the Office of Director of Practice, Internal Revenue Service, to meet the requirements of 31 Code of Federal Regulations, Section 10(g), covering maintenance of attendance records, retention of program outlines, qualifications of instructors and length of class hours. This agreement does not constitute an endorsement by the Director of Practice as to the quality of the program or its contribution to the professional competence of the enrolled individual." CPElite, Inc. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Suite 700, Nashville, TN, Web site:

9 ***** QUIZ QUESTIONS ***** Place your answers to the following10 Multiple Choice Questions on the enclosed answer sheet (page 11). ON-LINE TESTERS GO TO CPELITE.COM. 1. Under the current provisions of Section 10.27(a) of Circular 230, in which case below may a tax preparer not charge a contingent fee for services rendered to a client? a. The preparation and filing of an ordinary refund claim before the commencement of any adversarial proceedings with the IRS. b. The preparation and filing of a refund claim or credit filed solely for the determination of statutory interest or penalties assessed by the IRS. c. The preparation and filing of an amended return or claim for refund where the amended return or refund claim is filed within 120 days of the taxpayer s receiving notice of an IRS examination. 2. Regarding a recent court case challenging the Treasury s regulations dealing with contingent fees related to tax services, which one of the following statements is true? a. The court ruled that the preparation of ordinary refund claims before the commencement of any adversarial proceedings with the IRS represents practice before the IRS. b. Tax return preparers generally meet the definition of representative under Section 330. c. The court permanently enjoined the IRS from enforcing Section of Circular Which one of the following was not a Circular 230 violation that a group of appraisers recently committed, which resulted in their suspension of valuing facade easements? a. Failing to exercise due diligence in document preparation. b. Failing to determine the correctness of written representations made to the Department of the Treasury. c. Failing to complete Part III of Form Which one of the statements about new Section 10.35, Competence, in Circular 230 is false? a. There are three separate competency standards. b. The practitioner may become competent for a matter for which she has been engaged through consulting with experts in the area or studying the law. c. A practitioner who is more experienced in a matter than another practitioner may not require the same amount of preparation than the other practitioner. 5. Which one of the following is not one of the six principles to which the practitioner must adhere in giving written advice on a federal tax matter? a. Use reasonable factual and legal assumptions. b. Never rely on representations or statements of another person. c. Not take into account the possibility that a tax return will not be audited with respect to the federal tax matter the practitioner is evaluating. 6. In a recent ruling dealing with electronic return originators (EROs), which one of the following statements is true? a. EROs may only e-file tax returns prepared by others; they may not prepare returns. b. EROs must also comply with all of the direct deposit rules provided in IRS Publication c. Tax return preparer penalties may never be imposed on EROs. 7. Regarding a recent court case dealing with Section 6701, which standard of evidence did the Eleventh Circuit require for the IRS to prove to impose the Section 6701 penalty? a. The preponderance of evidence standard. b. The clear and convincing evidence standard. c. The substantial authority of evidence standard. 9

10 8. Under Section 6694(a)(2), which one of the following is an unreasonable position? a. Taxpayer has a reasonable basis and attaches a required Form 8275-R. b. Taxpayer has substantial authority and no disclosure. c. Taxpayer has a tax shelter with reasonable basis and attaches a required Form If the taxpayer s return position is against a Treasury regulation, and disclosure is required, what is the appropriate means of disclosure to avoid the Section 6694(a) preparer penalty? a. Disclosure using Form 8275-R. 10. Which one of the following tax return preparer penalty provisions is correct? a. The penalty for failure of the tax return preparer to sign a client s tax return is $50 per return with an annual maximum of $10,000. b. The penalty for the failure of the tax return preparer to comply with the due diligence requirements when claiming an earned income tax credit is $500 per return with an annual maximum of $10,000. c. The penalty for using client information for other than to prepare or assist in preparing a client s return is $250 for each use with an annual maximum of $10,000. b. Disclosure using Form c. Disclosure using both Forms 8275 and 8275-R. 10