Tax Articles
Good News on Preparer Penalties
By: Terry Myers and Dee DeScherer
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News of the Profession
Recent developments now ease tax preparer penalties. A tax law enacted at the end of 2008 and follow-up guidance from the IRS have made the tax return preparer penalty rules a little less onerous for preparers as they deal with returns for the 2008 tax year. And portions are retroactive back to tax year 2007.
Background: The Way It Was
Higher Penalty, New Description. A 2007 law change raised the penalty for preparing a return with an understatement due to an "unreasonable" position from a modest $250 to the greater of $1,000 or 50% of the income from preparing a return. At the same time, Congress provided that a position would be deemed unreasonable unless either
- The preparer had a reasonable belief the position would "more likely than not" be sustained on its merits.
- There was a reasonable basis for the position and it was adequately disclosed. In other words, absent disclosure, the law required a more than a 50-50 chance that the position would hold up if challenged.
Worse Than Before. By contrast, under prior law, no penalty applied if there was a "realistic possibility" of a position being sustained on its merits, which was interpreted to mean the position had a one-in-three chance of success. For a disclosed position, no penalty applied unless a position was frivolous.
The "more likely than not" standard was controversial, particularly since it held preparers to a higher standard than the "substantial authority" standard that applies to individuals who prepare their own returns [Code Sec. 6662].
Most Recent Do-Over
Reduced Penalty and New Redefinition. Congress apparently had second thoughts about the new penalty regime. In December, Congress included a provision in the Emergency Economic Stabilization Act of 2008, that generally redefines a position as "unreasonable" unless either
- There is or was substantial authority for the position.
- The position was properly disclosed and had a reasonable basis [Code Sec. 6694(a)].
Retroactive Coverage. Moreover, the new definition is retroactive; the new law applies to returns prepared after May 25, 2007, thus effectively repealing the "more likely than not" standard as of the date of enactment.
Up to a Point. However, the new law does not return to the "realistic possibility" standard in effect before the 2007 law change.
Instead, the law change essentially imposes the same substantial authority standard for tax return preparers that applies to taxpayers who prepare their own returns. It is also important to note that the "more likely than not" standard is not entirely relegated to history; that standard continues to apply to undisclosed positions in the case of tax shelters and reportable transactions.
Interim Guidance
In a notice issued subsequent to the December law change, the IRS provided interim guidance on the latest preparer penalty rules, including what constitutes substantial authority for a return position [Notice 2009-5].
The IRS notice states that, until further guidance is issued, substantial authority generally has the same meaning as in the regulations under Code Section 6662 governing the accuracy-related penalty for individual taxpayers. However, there are a few nuances specific to return preparers. For example, the notice makes it clear that conclusions in treatises, legal periodicals, legal opinions, or opinions rendered by tax professionals aren't substantial authority; although, the authorities underlying such opinions may give rise to substantial authority for a position.
Meeting the Substantial Authority Standard Now
On the other hand, in keeping with recently finalized return preparer penalty regulations, a tax return preparer will be considered to have met the substantial authority standard if he or she relied in good faith on the advice of another advisor, another tax return preparer, or another party.
Reliance. While the final regulations do not incorporate the new substantial authority standard, they do make it clear that a return preparer may rely on the advice of another advisor (including another member of his or her own firm) without verification as long as the preparer had reason to believe the advisor was competent to render the advice given.
Limitations. Reliance on another party's advice will not be considered in good faith if the advice is unreasonable on its face, the preparer knew or should have known that the party providing the advice was not aware of all the relevant facts, or the preparer knew or should have known that subsequent developments in the law had rendered the advice unreliable. [Reg. Sec. 1.6694-2(e)(5)] The final regulations apply to returns and claims for refund filed (and advice given) after December 31, 2008.
Terence M. Myers, J.D. and Dorinda D. DeScherer, J.D. are nationally renowned writers on tax topics for such publications as Accountants Tax Weekly, Tax Return Preparer's Letter, Nonprofit Tax and Financial Strategies, and Executive's Tax and Management Report. For many years Myers was Managing Editor and DeScherer Assistant Managing Editor for many Prentice Hall tax newsletters. Myers and DeScherer have published books and other publications with Harcourt Professional Publishing, Aspen Publishers, Prentice Hall, and the AICPA.
Last Updated: 02/06/2009
