In 2007, Treasury issued a report indicating that the uncollected tax revenue attributable to tax evasion and noncompliance activities (i.e., the tax gap) was approximately $345 billion for tax year 2001.1 That report included 16 legislative proposals aimed at increasing voluntary compliance and reducing the tax gap.2 One of the proposals contained a provision to increase the penalties associated with preparing a tax return, raise the standard of conduct for preparers, and draw more practitioners into the scope of the tax preparer penalty provisions.
On the heels of Treasury’s tax gap report, Congress substantially revised the tax preparer penalty statute. Under the revised statute, a tax return preparer will be subject to a penalty for unreasonable positions taken on a tax return. The penalty is the greater of $1,000 or 50% of the fee charged for preparing the return.3 For tax return positions associated with willful or reckless conduct, the penalty is the greater of $5,000 or 50% of the fee charged for preparing the return.4 The government will consider good faith and reasonable cause in assessing the penalty, unless the preparer’s conduct is willful or reckless.5
Before these amendments, the tax preparer penalty statute applied only to income tax return preparers. The recent legislation broadened the scope of the statute to include preparers of income, estate, and gift tax returns as well as certain information returns.6
The recent changes to the tax preparer penalty statute are substantial and have already taken effect. Therefore, all tax return preparers should make sure they understand the risks and vicissitudes associated with the revised statute.
Who Is a Tax Return Preparer?
In general, any person or entity who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of any tax return or any claim for refund is a preparer.7 A person may be a preparer without regard to professional status, educational qualifications, nationality, residence, or the location of the person’s place of business.8
Preparers of income, estate, and gift tax returns are subject to the statute (previously only preparers of income tax returns were affected). Preparers of information returns are also included if the data reported on the information return constitute a substantial portion of another taxpayer’s tax return. For example, the preparer of a Form 1065, U.S. Return of Partnership Income, may be deemed to be the preparer of a partner’s individual income tax return if the items on the partnership return constitute a substantial portion of that partner’s income tax return.9
Preparers fall into one of two categories: signing and nonsigning. A signing preparer is the person who has primary responsibility for the overall substantive accuracy of the preparation of a tax return or claim for refund.10 The person who signs the return for the firm will generally carry this responsibility (i.e., primary) and the related liability for the penalty unless, based upon credible information, it is concluded that a nonsigning preparer is primarily responsible for the position taken on the return.11 Only one person in a firm will be deemed a preparer, but both the firm and the person with primary responsibility can be penalized.12
The following example illustrates the above principles for signing preparers.
Example 1: M and J work in the same accounting firm. M is preparing a tax return for a client that received a large damage award for injuries. The taxation of the damage award will substantially affect the tax liability on the return. M is unable to decipher the taxation of the award and consults J about it. J advises M that the award is not taxable. M uses the advice to complete the return and does not report the award.
If M signs the return, she will be presumed to be the tax preparer for all items in the return, including the position associated with the damage award. The presumption can be rebutted for the damage award because J is the person primarily responsible for the position taken on the return. As a consequence, J may be subject to the penalty if the position is unreasonable.
If no one in the firm signed the return, J is the preparer because he is the person primarily responsible for the position taken on the return. Therefore, J could be subject to penalty if the position is unreasonable.
If J can present credible information that M is also responsible for the position taken on the return with respect to the damage award (e.g., M did not rely on J’s advice), the IRS will determine who is primarily responsible for the position and may assess the penalty against either party (i.e., J or M), but not both. The firm could also be assessed the penalty.
A nonsigning 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 with respect to events that have occurred at the time the advice is rendered. This includes a person who provides advice (written or oral) about events that have occurred that leads to a position on a return (or claim for refund), and that position constitutes a substantial portion of the return.13
What constitutes a “substantial portion” is based on the facts and circumstances of each case. Some of the facts and circumstances that a preparer should consider are:
- The size and complexity of the item relative to the taxpayer’s gross income;
- The size of the understatement attributable to the item compared with the taxpayer’s reported tax liability; and
- Whether or not the tax adviser knows or reasonably should have known that the tax attributable to the position or entry on the return is a substantial portion of the tax required to be shown on the return or claim for refund.14
Time spent on advice given after events have occurred that represents less than 5% of the aggregate time incurred by that individual for the position will not be taken into account. Time spent on advice given before the events have occurred (i.e., tax planning) will be taken into account if the position taken on the return is primarily attributable to such advice, the person gave the advice before the events occurred primarily to avoid being treated as a preparer, and the tax planner followed up on the advice after the transaction was completed in order to assist the client or another preparer with the preparation of a return.15
The following examples illustrate the nonsigning preparer principles.
Example 2: Attorney Q provides legal advice to taxpayer T about a completed transaction. The advice will affect a substantial portion of the tax due on T ’s return. Q does not prepare any other portion of T ’s return and does not sign the return. Q is considered a nonsigning preparer for the position because she provided advice about events that have occurred, which affects a substantial portion of the tax liability associated with the return.
Example 3: Q provides legal advice to T about the tax consequences of a proposed transaction (i.e., tax planning). Based on this advice, T enters into the transaction. Once the transaction is completed, Q does not render any additional advice. Q is not considered a preparer because she did not provide advice about events that have occurred.
For nonsigning preparers, de minimis rules are available for purposes of determining what constitutes “substantial.”16 These rules are not available for signing preparers.17 If the issue involves gross income or deductions or an amount on which the basis of credits is calculated that are less than $10,000, the impact is not considered substantial. In addition, if the amounts in question are less than $400,000 and are also less than 20% of the gross income as shown on the return (adjusted gross income for individuals), the impact is not considered substantial. If more than one schedule, entry, or other portion is involved, all schedules, entries, or other portions must be aggregated.18
Persons that furnish typing, reproduction, or other administrative assistance in connection with a tax return are not preparers. An official or employee of the IRS performing official duties is not a preparer. A person who provides tax assistance under a Volunteer Income Tax Assistance program established by the IRS is not a preparer to the extent that the return is prepared under the program. A person who prepares a return or a 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, is not a preparer.19
In order to reduce the tax gap, the government wants to improve voluntary compliance. 20 The voluntary compliance rate has been about 85% over the past few decades (i.e., about 85% of taxpayers comply with the law).21 The chair of the Senate Finance Committee set a 90% voluntary compliance goal for 2017.22
One of the strategies for achieving the compliance goal is to make tax return preparers more accountable. The recent changes to the tax preparer penalty statute implement this strategy by exposing signing and nonsigning tax preparers of income, estate, gift, and certain information returns to higher monetary penalties. Therefore, before giving advice, all practitioners should ask, who is the preparer?
Raymond Placid and H. Wayne Cecil are associate professors at Florida Gulf Coast University in Fort Myers, FL. For more information about this article, please contact Prof. Placid at email@example.com.
1 IRS and Department of the Treasury, Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance 1 (IR-2007-137) (August 2, 2007).
2 Id. at 20.
3 Sec. 6694(a).
4 Sec. 6694(b).
5 Sec. 6694(a)(3).
6 Sec. 7701(a)(36).
7 Regs. Sec. 301.7701-15(a).
8 Regs. Secs. 301.7701-15(d) and (e).
9 Regs. Sec. 301.7701-15(b)(3)(iii).
10 Regs. Sec. 301.7701-15(b).
11 Regs. Sec. 1.6694-1(b)(2); Announcement 2009-15, 2009-11 I.R.B. 687.
12 Regs. Secs. 1.6694-1(b)(1) and (5).
13 See Regs. Sec. 301.7701-15(b)(2)(i).
14 Regs. Sec. 301.7701-15(b)(3)(i).
15 Regs. Sec. 301.7701-15(b)(2)(i).
16 Regs. Sec. 301.7701-15(b)(3)(ii).
17 See Regs. Sec. 301.7701-15(b)(3)(ii)(C). Note: It is unclear if the de minimis rule should be available to a nonsigning preparer that is a member of the same firm as the signing preparer.
18 Regs. Sec. 301.7701-15(b)(3).
19 Regs. Sec. 301.7701-15(f).
20 IRS and Department of the Treasury, Reducing the Federal Tax Gap.
21 Id. at 18.