New rules define a tax return preparer
By Vicki Meyer, CPA
Most tax professionals are aware of the new penalty regime under Section 6694 as enacted by the Small Business and Work Opportunity Tax Act of 2007.
Under the new regime, preparer penalties were extended to all federal returns, not just income tax returns. The nonwillful penalty amounts were increased to $1,000, or 50 percent of the fees charged by the preparer. And Section 6694 as originally drafted required preparers to meet a "more-likely-than-not" standard with regard to tax return positions to avoid disclosure on tax returns. Taxpayers, however, were held to the lesser standard of substantial authority. This disparity in treatment and the difficulty of meeting a more-likely-than-not standard created an outcry in the practitioner community.
Congress responded to the outcry by making changes to Section 6694 as part of the Emergency Economic Stimulus Act (EESA) of 2008. The more-likely-than-not standard was dropped and replaced with a substantial authority standard, thereby putting the taxpayer and the preparer on equal footing with regard to what standards have to be met for a return position.
There should no longer be a need for a conversation with the client to make sure that they understand the differing standards.
Many issues still remain, including the definition of a tax return preparer.
The U.S. Treasury and the IRS recently issued proposed regulations under Section 6694. The proposed regulations will require modifications to reflect the changes made to Section 6694 for EESA. However, it is anticipated that the portion of the proposed regulations dealing with the definition of a preparer will be issued as proposed.
New approach to who is a preparer
Practitioners are familiar with the existing general rule defining a preparer as a person who physically prepares and signs income tax returns. This approach is commonly referred to as "one preparer per firm." The proposed regulations use a "one preparer per tax position" approach.
Defining the preparer within a firm
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One preparer per firm is now a preparer per position.
Primarily responsible
Under Proposed Regulation 1.6694-1(b)(1), an individual is a tax return preparer subject to Section 6694 if he is primarily responsible for the position on the return giving rise to an understatement.
There can be only one individual within a firm who is primarily responsible for each position. However, based upon information received from the signing tax return preparer (or other relevant source), it may be concluded that some other person was primarily responsible. This person will be considered a nonsigning preparer.
Two common examples of non-signing preparers are (1) where a preparer relies on the expert advice of someone within their own firm, or (2) where a preparer relies on an opinion from tax legal counsel.
Additionally, there can be more than one tax return preparer if multiple tax return preparers are employed by, or associated with, different firms on the same tax position (only one preparer per firm, but several firms can have a preparer).
Nonsigning tax return preparers
Because nonsigning preparers can be within or outside of the firm that actually prepares the return, the rules for nonsigning preparers parallel the signing tax return preparer rules.
There can be one or more nonsigning preparers and no signing preparer within a firm. If so, then the individual within the firm with overall supervisory responsibility for the positions giving rise to the understatement is the tax return preparer for purposes of Section 6694.
Firms as preparers
A firm that employs a tax return preparer subject to a penalty under 6694(a) is also subject to the penalty, if and only if:
- One or more members of the principal management (or principal officers) of the firm knew of the conduct
- The firm failed to provide reasonable and appropriate procedures for review of the position
- Such review procedures were disregarded by the firm through willfulness, recklessness or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain)
These rules may spur greater documentation standards for review within firms.
Exceptions
There are several exceptions to the definition of a preparer.
The first major exception is that a preparer generally does not include someone who has given advice for events that have not occurred, unless that advice is reconfirmed or reissued after the events have taken place.
The second exception is for de minimis advice. Advice that is given with respect to events that have occurred, which is less than 5 percent of the aggregate time incurred by the person with respect to the positions giving rise to the understatement, will not be taken into account in determining whether an individual is a nonsigning tax return preparer. This rule encourages individuals who principally render advice regarding events that have not yet occurred to provide follow-up advice without having to be concerned about becoming the preparer.
Pass-through entities
Consistent with the existing regulations, a preparer (signing or nonsigning) of a pass-through entity tax return may also be considered the preparer of the principal owner's individual return. A common example would be a nonsigning preparer giving relied-upon advice with regard to a significant transaction of the pass-through entity – for example, a like-kind exchange.
IRS enforcement options
Given the nature of the preparer rules, it seems logical that the IRS will start with the signing tax return preparer as the person primarily responsible for the tax return position.
Other actions by the IRS may include assessing penalties against the nonsigning tax return preparer with overall supervisory responsibility for the position giving rise to the understatement. When it is unclear which individual is responsible, the IRS may assess penalties against the overall supervisory person with responsibility with respect to the position.
The preamble to the proposed regulations states that referral to the Office of Professional Responsibility by a revenue agent will not be automatic when penalties are assessed under Code Section 6694(a).
It is also anticipated that IRS and Treasury will change the Circular 230 rules so that the Code Section 6694 penalty and the monetary penalties under Circular 230 will typically not be stacked.
Examples
The proposed regulations offer several examples to explain the definition of a preparer.
Example 1:
- Attorney A provides advice to client and also signs the return.
- A seeks advice from Attorney B within the same firm.
- B provides advice on which A relies.
- B's advice is reflected in the client's income tax return and creates an understatement to which Code Section 6694(a) or (b) applies.
Under the above example, the IRS advises A that A may be subject to penalty with respect to the client's return. However, based on information provided by A or another source, it may be concluded that B had primary responsibility for the position on the return because B had overall supervisory responsibility for the position giving rise to the understatement.
Example 2:
Same as Example 1, except that neither A nor another attorney with A's firm signs client's return as a tax return preparer. Attorney B is the nonsigning tax return preparer within the firm with overall supervisory responsibility for the position giving rise to the understatement and is therefore subject to penalty under Section 6694.
Example 3:
Same as Example 1, except Attorney D, who works for a different firm than A, also provides advice on the same position upon which A relies. It may be concluded that D is also primarily responsible for the position on the return.
Conclusion
It appears that the genesis for the new rules for defining a tax return preparer started in the tax shelter enforcement era, where the IRS had limited tools under the existing statutory framework to go against the designers and promoters of tax shelters.
The current rules reflect the reality of today’s tax practice, where experts within a firm advise on their area of expertise, and others rely upon that advice. Whether or not a position meets a more-likely-than-not standard or substantial authority, practitioners will need to be familiar with the definition of a tax return preparer.
Vicki Meyer, CPA, is of counsel for Thomas Howell Ferguson PA in Tallahassee. She is a member of the FICPA's Federal Taxation Committee.
This article was reprinted with permission from Florida CPA Today, a publication of the Florida Institute of Certified Public Accountants and is not to be considered an endorsement by the FICPA.
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