The Preparer Penalties of Sec. 6694 and Sec. 6695

By Cynthia E. Bolt, CPA, M.Tax, and Elizabeth Plummer, CPA, Ph.D.

 IMAGE BY MOJOJE/ISTOCK
IMAGE BY MOJOJE/ISTOCK
 

EXECUTIVE
SUMMARY

 
  • Individuals who prepare a tax return or refund claim for compensation or who hire others to prepare returns for compensation are tax return preparers. Preparation of a "substantial portion" of a return or claim for refund is treated as preparation of that return or claim for refund. Tax return preparers can be signing or nonsigning preparers.
  • Tax return preparers are subject to penalties under Sec. 6694 for understatements due to unreasonable positions and due to willful, reckless, or intentional conduct and Sec. 6695 for failing to perform certain duties or for engaging in prohibited conduct (e.g., failing to provide a copy of a return to the taxpayer or negotiating a tax refund check).
  • Both a tax preparer and the firm that employs the preparer, or of which he or she is a partner, member, shareholder, or other equity holder, may be subject to a Sec. 6694 penalty for a position giving rise to an understatement.
  • The Sec. 6694 penalties and most of the Sec. 6695 penalties are subject to a reasonable-cause exception.
  • A number of other serious civil and criminal penalties may also apply to tax return preparers.

Tax preparers have a duty to uphold the federal tax law and abide by professional standards in all client dealings. Failure to do so can result in ­penalties and sanctions, as has been the case for almost 100 years.

The first preparer penalties, which were enacted by the Treasury Department in 1921, could be amended or modified without notice to the public.1 Preparers were known as representatives of claimants, and applications to practice included a sworn statement describing education, training, and experience; two character certifications (for nonlawyers); and a pledge to support and defend the Constitution.2 The statute authorizing Treasury to regulate taxpayer representativesrequired representatives to be "of good character and in good repute," with "necessary qualifications to enable them to render such claimants valuable service."3 The statute allowed Treasury to sanction persons who were "incompetent, disreputable, or who refuse[d] to comply" and those who defrauded, misled, deceived, or threatened claimants.4 Penalties included suspension or disbarment from practice.

Tax preparer penalties have grown progressively complicated. Since 2007, penalties can apply to both signing and nonsigning individuals, as well as individuals who never see the taxpayer's return. An examination of these penalties starts with the definition of a tax return preparer. Two broad penalty areas apply to preparers. Sec. 6694 delineates penalties for paid preparers who take unreasonable positions on tax returns or refund claims that result in an understatement of a taxpayer's liability. Sec. 6694 provides specific details regarding who has responsibility for a position on a return, what is considered an unreasonable position, information verification requirements, and the basis for penalty assessment. Sec. 6695 provides for further assessable penalties when a preparer fails to complete specific responsibilities such as failing to retain a copy of the return, to sign the return, or to furnish a copy to the taxpayer.

Who Is a Tax Preparer?

Individuals who prepare a tax return or refund claim for compensation, or who hire others to prepare returns for compensation, are considered tax preparers.5 For this purpose, the preparation of a substantial portion of a return or claim for refund is considered the preparation of that return or claim for refund. Professional designation, education, nationality, or residence are not considered. Because full return preparation is not required to be a tax return preparer, preparation of a schedule, such as a depreciation calculation or allocation of income or expenses, could potentially "qualify" an individual as a tax preparer. And importantly, tax preparers include preparers of all returns, not just income tax returns.

The definition of a tax return preparer in Regs. Sec. 301.7701-15 includes both signing and nonsigning preparers. Signing preparers have primary responsibility, while nonsigning preparers do not sign the return but could potentially have the same level of responsibility as signing preparers.

Nonsigning preparers are tax return preparers who are not signing tax return preparers but who prepare all or a substantial portion of a return or claim for refund. They include individuals who provide advice (oral or written) to either the taxpayer or another tax adviser that led to a position that constitutes a substantial portion of the return.6 Advice provided by a nonsigning tax preparer before the transaction that leads to the position on the return is not necessarily subject to preparer penalties. Moreover, no preparer penalties apply if, after the transaction occurs, less than 5% of the aggregate tax advisory time on the transaction is provided by the nonsigning preparer.

As noted above, an individual preparing a "substantial portion" of a return or claim for refund is considered a tax preparer subject to penalty. The portion of the return or claim for refund prepared by an individual includes any schedules, entries, or other portions of the return prepared by the individual. An individual 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 is treated as having prepared that entry.

Whether a schedule, entry, or other portion of a return or claim for refund prepared by an individual is a substantial portion depends on the individual's knowledge about the return or claim for refund. If the individual knows or reasonably should know that the tax attributable to the portion of the return or claim for refund he or she prepared is a substantial portion of the tax required to be shown on the return or claim for refund, the portion prepared by the individual is a substantial portion of the return or claim for refund.7

For all preparers, the factors considered for determining whether a portion of a return is a substantial portion of the return include, but are not limited to:

  • The taxpayer's reported tax liability in relation to the understatement attributable to that portion of the return;
  • The size and technical complexity of that portion of the return relative to the taxpayer's gross income.8

For nonsigning preparers only, two de minimis rules apply in determining whether a portion of the return is a substantial portion of the return. If the gross income, deduction, or basis for a credit is less than $10,000; or less than $400,000 and also less than 20% of the gross income on the return (or adjusted gross income (AGI) in the case of an individual), a nonsigning preparer will not be considered potentially liable for penalties under Sec. 6694. If the portion of the return prepared by the nonsigning preparer consists of more than one schedule, entry, or other portion, all of these are aggregated in applying the rules.

According to Sec. 7701(a)(36)(B) and Regs. Sec. 301.7701-15(f), the individuals who are not considered tax preparers include:

  • IRS employees performing official duties;
  • Individuals working under the IRS's Volunteer Income Tax Assistance (VITA) program;
  • Volunteers in a Low-Income Taxpayer Clinic;
  • Individuals who provide typing, copying, or printing assistance;
  • Individuals who prepare a return or refund claim of the employer (or of an officer or employee of the employer) for whom they are regularly and continuously employed; and
  • Preparers of fiduciary returns or refund claims when the preparer is either a fiduciary or an officer, general partner, or employee of the fiduciary.

Circular 230's current definition of a preparer no longer refers to representatives of claimants but instead addresses the definitions under Sec. 7701(a)(36) and Regs. Sec. 301.7701-15. The AICPA's Statements on Standards for Tax Services (SSTSs) apply to AICPA members who prepare or sign returns or recommend tax return positions.9

Understatement of a Taxpayer's Liability by a Tax Return Preparer

Sec. 6694 imposes penalties on paid preparers who take unreasonable positions, or who engage in willful or reckless conduct, resulting in an understatement of a taxpayer's liability. Penalties apply to preparers who are considered primarily responsible for the understatement. The Protecting Americans From Tax Hikes (PATH) Act10 increased the Sec. 6694 penalties effective for tax years ending after Dec. 18, 2015. Defining the components of the law provides insight into how the penalty applies.

Understated Tax Liability

Penalties are imposed when an understatement of a tax liability results from specifically disallowed actions of the preparer. The definition of understatement includes overstated deductions, credits, or exemptions, as well as understated income. Returns affected range from income tax returns to excise tax returns. The PATH Act expands the definition to include understatements of tax liability attributable to overstated refundable credits, such as the earned income tax credit (EITC) or the additional child tax credit.

Unreasonable Positions

An understatement caused by an unreasonable position will result in a fine of the greater of $1,000 or half of the income earned by the preparer related to the engagement. Unreasonable positions are generally those that lack substantial authority, meaning that the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting a contrary treatment. This standard is less stringent than the more-likely-than-not standard (a greater than 50% likelihood of being upheld) but more stringent than the reasonable-basis standard.11

A 1999 Joint Committee on Taxation Staff Report describes substantial authority as at least a 40% likelihood of success if challenged, which it described as "a general consensus of scholars and practitioners based on a survey of the literature."12 This same report describes reasonable basis as at least a 20% likelihood of success if challenged.13 In the case of a tax shelter or reportable transaction, the position must meet the "more likely than not" (MLTN) standard (a greater than 50% possibility that the position would be sustainable if examined by the tax authorities) to avoid penalties.

Regs. Sec. 1.6662-4(d)(3)(iii) provides a list of authorities that are acceptable for determining whether there is substantial authority for a position. The possibility that a return will not be audited, or that an item will not be raised on audit, is not relevant in determining whether a standard is met.14

A preparer can take a position on a tax return and avoid preparer penalties when the position meets the reasonable-basis standard but does not have substantial authority, as long as there is adequate and appropriate disclosure. Reasonable basis is generally defined as a position that has a greater than 20% possibility of success but does not have substantial authority. Reasonable basis is the lowest standard for any position that can be taken on a tax return, and disclosures will not avoid penalties if this standard is not met. The reasonable-basis standard is not applicable to tax shelters and reportable transactions, which must meet the MLTN standard.

Adequate and appropriate disclosure is provided through Form 8275, Disclosure Statement, which allows the preparer to disclose positions that meet the reasonable-basis standard, but that do not have substantial authority, and are not otherwise adequately disclosed on the return. Form 8275-R, Regulation Disclosure Statement, provides adequate disclosure for positions that are contrary to Treasury regulations. Form 8886, Reportable Transaction Disclosure Statement, is used to disclose information for reportable transactions, including prohibited tax shelter transactions. Form 8886 must be filed with the return for each year in which a taxpayer participates in a reportable transaction, regardless of the level of support for the position.

Definition of Tax Return Preparer Compensation

Compensation received by tax preparers provides the basis for Sec. 6694 penalties. Tax returns prepared free of charge are not subject to these penalties. Generally, compensation relates to income received or expected to be received for preparing the return that contained the unreasonable position causing the understatement. Proper allocation may be required if the preparer charges one fee for several services; however, payments for research, consultation, and compliance are all considered to be compensation for purposes of the penalty. If the preparer can specifically determine compensation associated with the advice that resulted in the disallowed position, the penalty will be reduced to the apportioned amount. Preparers who issue a refund to the taxpayer for any or all of their preparer fees must still include the refund amount in determining compensation for purposes of this penalty.

Willful or Reckless Conduct

Penalties are increased to the greater of $5,000 or 75% (50% for tax years ending before Dec. 18, 2015) of the compensation earned by the preparer if actions are determined to have been willful or reckless. Preparers attempting to reduce a tax liability by ignoring the taxpayer's information or modifying it to provide an advantage are considered to demonstrate willful conduct. In those cases, the IRS must prove that willful conduct occurred. Preparers who are determined to have recklessly or intentionally disregarded the rules have the burden of proving they did not. Filing a disclosure statement such as those discussed above can help avoid a determination of reckless or willful conduct.

Date Return Is Deemed Prepared

With frequent tax law changes, the preparation date provides an important detail when applying penalties. Standards of support for a tax position (MLTN, substantial authority, realistic possibility of success, reasonable basis) will be applied according to the existing laws on the date the return is prepared. Preparation is determined by the date the return is signed by the preparer or, in the absence of a signature, the date the return is filed. For nonsigning preparers, an analysis of the facts and circumstances determines when tax advice was provided, which will then be used as the date of return preparation.

Signing vs. Nonsigning Tax Return Preparers' Responsibility

For purposes of Sec. 6694, penalties apply to the tax preparer with primary responsibility for each position on the return. Generally, if there is a signing preparer, he or she will be held responsible for all positions on a return. However, where it is determined, based on credible evidence, that the signing preparer is not responsible for a position, a nonsigning preparer within the signing preparer's firm will be considered responsible for the position and, as such, subject to penalties related to the understatement attributable to that position. In this case, the nonsigning preparer with supervisory obligations for the position is considered to have primary responsibility, unless, based on credible evidence, another nonsigning preparer within the firm is found to be responsible for the position.

Complications also arise when more than one individual in a firm has assisted in deciding to take a position on a return that has been challenged. If both a signing and nonsigning preparer are primarily responsible for a position, the IRS may assess the penalty against either individual, but not against both. In some circumstances, the IRS may determine that multiple preparers have primary responsibility for a position giving rise to an understatement if multiple tax return preparers are employed by, or associated with, different firms.

Firm Responsibility

While primary responsibility generally lies only with one individual, firms may also be responsible for penalties under Sec. 6694 if one of their employees, partners, members, shareholders, or other equity holders is assessed. If a firm employs a tax preparer who is found liable for a penalty due to an unreasonable position, or due to willful or reckless conduct, the firm can also be subject to the $5,000 or 75% of income penalty in the following instances:

  • One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the unreasonable position that caused the understatement or of the willful, reckless, or intentional conduct;
  • The firm failed to follow or failed to provide appropriate procedures for review of the position for which the penalty is imposed; or
  • The firm disregarded its reasonable and appropriate review procedures through willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.15

Reasonable-Cause and Good-Faith Exception

Penalties can be avoided if it can be shown that there was reasonable cause for the understatement and the preparer acted in good faith.16 Regs. Sec. 1.6694-2(e) provides a list of factors to determine whether the preparer acted in good faith, given an examination of the facts and circumstances:

  • The law giving rise to the understatement is complex, uncommon, or highly technical;
  • The understatement resulted from an isolated and nonrecurring error;
  • The understatement is relatively immaterial;
  • Normal and appropriate office practices were followed, and the error was rare;
  • The tax preparer relied on the advice of others, including information from the taxpayer, and the information was not unreasonable; and/or
  • Generally accepted industry practices were followed.

Information Verification Requirements

Regs. Sec. 1.6694-1(e) provides tax preparers with guidelines regarding their responsibility to verify information furnished by taxpayers or other parties. Good-faith reliance on information furnished by the taxpayer, other advisers, and other preparers means the preparer is not required to audit, review, examine, or verify information beyond reasonable inquiries of facts and circumstances unless conflicting facts are known. Similarly, tax preparers using information from a previously filed return are not required to verify information unless there is reason to believe the information is incorrect or incomplete. Standards of reasonableness and professional judgment apply for all information used to prepare a return.

Other Assessable Penalties

Although the Sec. 6694 penalties generally receive more attention, Sec. 6695 provides for seven distinct penalties that may be assessed on a tax return preparer for actions related to disclosures and client dealings. The first five penalties discussed below contain a statutory maximum penalty of $25,000, adjusted annually for inflation. The 2016 maximum amount per Rev. Proc. 2015-53 is $25,500, which Rev. Proc. 2016-55 did not raise for 2017. The remaining two penalties below, for negotiating checks and failure to meet due-diligence standards for certain tax credits, have no dollar limitation.

Failure to Furnish Copy to Taxpayer

A preparer must furnish the taxpayer with a complete copy of a tax return or refund claim no later than the date the return is presented for the taxpayer's signature. This rule also applies to returns prepared for nontaxable entities such as partnerships.17 The copy can be in any form (e.g., electronic media) that is acceptable to both the taxpayer and the tax preparer. Regulations provide special provisions for electronically filed returns, such as providing the information on a replica of an official IRS form.18 If desired, a preparer can request a receipt or other evidence from the taxpayer that the copy was received.19 If a tax return preparer fails to comply with these provisions, the penalty is $50 for each failure to comply unless the failure was due to reasonable cause and not willful neglect.20 The maximum penalty of $25,000, adjusted for inflation, is for all documents filed by the preparer during a calendar year.

Failure to Sign Return

An individual who is a signing preparer is subject to penalties for each failure to sign any return or refund claim requiring a preparer's signature. For returns that are not signed electronically, the preparer must sign the document after completion but before it is presented to the taxpayer (or nontaxable entity) for the taxpayer's signature. For electronically signed returns, this is not required. However, the signing preparer must furnish the taxpayer the electronically signed tax return contemporaneously with furnishing the Form 8879, IRS e-file Signature Authorization, or other similar IRS e-file signature form. For both electronically and non-electronically signed documents, the preparer must sign the return in the manner prescribed by the IRS in forms, instructions, or other guidance.21 The penalty is $50 for each failure to sign a return or refund claim when required, unless it is shown that the failure was due to reasonable cause and not willful neglect.22 The maximum penalty of $25,000, adjusted for inflation, is based on all documents filed during a calendar year.

Failure to Furnish Identifying Number

Any return or claim for refund prepared by a preparer must include the preparer tax identification number (PTIN), the employer's number, or both.23 This requirement applies to signing preparers, who must furnish the applicable number on the return or refund claim after completion and before presentation to the taxpayer (or nontaxable entity) for signature.24 The penalty is $50 for each failure to comply with this provision, unless it is shown that the failure was due to reasonable cause and not willful neglect.25 A preparer who uses his or her Social Security number or an expired PTIN can also be subject to the penalty.26 The maximum penalty is $25,000 for all documents filed during a calendar year, adjusted for inflation.

Failure to Retain Copy or List

A signing tax return preparer must retain a completed copy of a taxpayer's return or claim for refund, or retain, on a list, the taxpayer's name and identification number, and make the copy or list available for IRS inspection upon request.27 The copy or list must be retained for a three-year period following the close of the return period during which the return or claim was presented for signature to the taxpayer (or nontaxable entity).28 The penalty is $50 for each failure to comply, unless due to reasonable cause, with a maximum penalty of $25,000 (adjusted for inflation) imposed on any return period.29

Failure to File Correct Information Returns

For each return period, a person who employs one or more signing preparers must retain a record of the name, PTIN, and principal workplace of each preparer employed. (A "return period" is the 12-month period beginning on July 1 of each year.) This record must be retained for the three-year period following the close of the return period to which it relates and must be available for IRS inspection upon request. A sole-proprietorship preparer must retain this record with respect to his or her own work, and a partnership must retain this record with respect to its partners and other employees.30 Note that the IRS has opted for a recordkeeping requirement in lieu of an actual filing. There is a $50 penalty for each failure to retain and make available a record, and for each failure to include a requisite item, unless it is shown there is reasonable cause.31 The maximum penalty is limited to $25,000 (adjusted for inflation) for any return period.32

Negotiation of Check

Penalties are assessed when an individual tax preparer endorses or otherwise negotiates a tax refund check issued to a taxpayer if the individual was the return preparer. A preparer who violates this provision is subject to a per-check penalty of $500 adjusted for inflation ($510 in 2017), with no maximum limit on the penalty amount. This prohibition applies to electronic versions of checks, as well as endorsements directly or through an agent. There are exceptions for banks that prepare tax returns, and also when the taxpayer authorizes the preparer to affix the taxpayer's name to a refund check for purposes of depositing the check into the taxpayer's account.33 Tax return preparers who act as their client's business manager, or who have a power of attorney, should take specific steps so as to not violate this provision.

Failure to Be Diligent in Determining Eligibility for Credits

Tax return preparers are likely familiar with the due-diligence requirements to determine eligibility for, or the amount of, the EITC. Preparers must satisfy all four due-diligence requirements, including completing and submitting Form 8867, Paid Preparer's Due Diligence Checklist.34 The 2015 PATH Act extends the tax return preparer's due-diligence requirements to include returns and refunds on which a child tax credit, additional child tax credit, or American opportunity tax credit is claimed (Sec. 6695(g)). The expanded due-diligence requirements are effective for tax years beginning after Dec. 31, 2015. There is a $510 penalty for each failure, with no maximum dollar limitation. The IRS issued temporary and proposed regulations applying the same EITC due-diligence requirements to the other credits and amended Form 8867 to include the child tax credit, the additional child tax credit, and the American opportuntiy tax credit.35

Current Developments

In striking down the IRS's registered return preparer program, one court recently reviewed the existing tax preparer regulations and related penalties and concluded they are comprehensive and unambiguous.36 The most recent increase in penalties under Secs. 6694 and 6695 confirms the continuing enforcement of standards against abusive tax transactions and improper preparer conduct.

Recent prosecutions against individuals and tax preparation firms suggest that the consequences of violating preparer responsibilities are much wider-ranging than just penalties under Secs. 6694 and 6695.37 Sanctions include not only increased liability assessments, but also closing tax practices, selling assets of businesses that violate the regulations, barring individuals from tax practice, imposing monetary fines based on preparation fees, and assessing litigation costs. Sec. 6695 penalties have been assessed against CPAs for failure to include an appropriate identifying number, although preparers often cite concerns with identity theft. Past litigation includes violations for improper deposits of client refund checks, frivolous returns, failure to maintain copies of returns, and determination of the specific preparer subject to penalty. Juries have had to decide issues related to the reasonableness of a preparer's judgment.

In addition to being assessed penalties, a preparer can be referred to the IRS Office of Professional Responsibility (OPR). The OPR is the governing body responsible for interpreting and applying the Circular 230 regulations and operates independently of the IRS's penalty enforcement divisions. The OPR has oversight of practitioner conduct and can impose disciplinary sanctions on preparers, ranging from a public reprimand to disbarment. Several times each year, the OPR releases the names of sanctioned individuals and firms, including city, state, and effective dates of suspension.38 It is important for tax practitioners to remain current and informed on how penalty assessments change and evolve over time. This is especially true as taxpayers and tax preparers increase their use of information technology, e-filing, and cloud computing. For example, revenue rulings have determined that the Sec. 6694 and Sec. 6695 preparer penalties apply to companies that provide computerized tax preparation services to tax practitioners if these services provide substantive tax advice rather than mere mechanical assistance,39 as well as car dealerships preparing returns for purposes of using the tax refund as a down payment for a car.40 These situations require that preparers refer to resources other than the Code and regulations to determine what constitutes a tax preparer under Sec. 7701(a)(36). In a similar vein, preparers can find court opinions useful in better understanding how legal principles apply to practical situations.

The IRS has many educational efforts aimed at improving the accuracy of tax returns by paid preparers and increasing awareness of preparer responsibilities. One such effort is letters to return preparers. Some of these letters are sent to promote general awareness of new reporting items, while others are sent to preparers for whom the IRS has reviewed tax returns they prepared and found evidence of possible errors. The letters remind preparers of their current responsibilities, possible consequences of noncompliance, and new preparer requirements. The IRS also regularly checks whether preparers are in compliance with their own tax filing and payment responsibilities.41

The IRS also publishes revenue procedures each year that provide updated and expanded guidance concerning the circumstances under which the disclosure on a taxpayer's income tax return with respect to an item or position is adequate for purposes of avoiding Sec. 6694 understatement penalties. For example, Rev. Proc. 2016-13 highlights specific changes that have occurred since the prior year's guidance (Rev. Proc. 2015-16). These annually issued revenue procedures also serve as general reminders to the practitioner of the importance of adequate disclosure, stressing the obligation to provide all required information found in IRS forms and instructions, including accurate calculations and clear identification and description of tax return line items.

The IRS also makes efforts to help educate taxpayers on preparer responsibilities. The IRS provides complaint forms for taxpayers to file when they want to register a complaint about paid preparer misconduct (Form 14157, Complaint: Tax Return Preparer). The form's instructions provide an extensive and detailed list that helps inform taxpayers of the professional requirements of a paid preparer—ranging from not providing a copy of the return to embezzlement of a tax refund.

Other Penalties: Civil and Criminal

Tax preparers should also be aware of other possible penalties—both civil and criminal. The provisions related to these penalties are complex and extensive, but a general awareness is important. The three civil penalties discussed below are in addition to any other penalty provided by law, although their imposition can affect the assessment of certain preparer penalties discussed above. For example, if a preparer is assessed with the Sec. 6701 aiding and abetting penalty for any document, then he or she cannot also be assessed the Sec. 6694(a) or (b) penalties discussed earlier for that document.42

Promoting Abusive Tax Shelters (Sec. 6700)

Any promoter of a tax shelter or similar arrangement who makes (or causes another person to make) a false or fraudulent statement, or gross-valuation overstatement, in connection with the organization or sale of the tax shelter, can be subject to penalties. This penalty is assessed on the promoter, not the investor. For gross-valuation overstatements, the penalty is the lesser of $1,000 for each organization or sale, or 100% of the promoter's gross income derived (or to be derived) from that activity. If the penalty involves a false or fraudulent statement, the penalty is equal to 50% of the preparer's gross income from that activity.

Aiding and Abetting Understatement of Tax Liability (Sec. 6701)

There is a $1,000 penalty for aiding or assisting in the understatement of another person's tax liability. The penalty is $10,000 if the understatement relates to a corporation's tax liability. Individuals subject to the aiding and abetting penalty can be penalized only once for documents relating to the same taxpayer for a single tax period or, where there is no tax period, tax event. Note that the aiding and abetting penalty is broader in scope than the Sec. 6694 penalty discussed earlier. It applies to any person—not just tax preparers; and it applies to a wider range of activities and documents—not just the preparation of tax returns and refund claims. It also does not have protections such as adequate disclosure or substantial authority.

Disclosure or Use of Information by Return Preparers (Sec. 6713)

A $250 penalty applies for each unauthorized disclosure or use of information obtained in connection with the preparation of an income tax return. The maximum penalty that can be imposed on any person in a calendar year is $10,000. This penalty applies to any person engaged in the business of tax preparation, or who provides services in connection with tax return preparation, when that person discloses information furnished to him or her for, or in connection with, the preparation of an income tax return or uses such information for any purpose other than to prepare or assist in preparing the return. Tax professionals should be careful to safeguard their clients' data. The IRS has issued guidance for tax return preparers on ways to safeguard taxpayer data from identity theft. IRS Publication 4557, Safeguarding Taxpayer Data: A Guide for Your Business (October 2015), provides information on putting together an information security program, including detailed checklists of steps and activities, as well as what to do in the case of an information security breach.

Criminal Penalties

A tax preparer can also be subject to criminal penalties, which can bring both monetary fines and imprisonment. These include such penalties as willfully assisting or advising in the preparation of a return or other document that is fraudulent or false with respect to material matters (Sec. 7206); willfully delivering or disclosing false returns or information (Sec. 7207); and knowingly or recklessly disclosing a taxpayer's information (Sec. 7216). The Sec. 7206 penalty is a felony and, if a person is convicted, can result in fines of up to $100,000 ($500,000 in the case of a corporation) and imprisonment of up to three years. These violations can also result in disciplinary action by a preparer's state board of accountancy and the loss of one's CPA license.

Conclusion

The preparer penalties discussed above are federal penalties that apply to returns and documents filed with the IRS. However, preparers can also be subject to state penalties. Penalties vary across states, so preparers should familiarize themselves with the penalties of the states for which they prepare returns. For example, many of the preparer penalties for California are analogous to the Sec. 6694 through Sec. 6701 federal penalties discussed above, and preparers must meet specific due-diligence requirements when preparing California EITC claims.43 New York state has a preparer e-file mandate, which requires e-filing of certain tax documents, with applicable penalties if a preparer is subject to the mandate and fails to meet the requirements. If a tax preparer is assessed civil penalties of more than $1,000 for certain actions or is convicted of a crime related to tax return preparation, the Minnesota Department of Revenue places the preparer's name on a list of "Tax Preparers Subject to Penalties" and posts it on its website. Similarly, the IRS publishes announcements of disciplinary sanctions in the Internal Revenue Bulletin, listing the names of individuals, their city and state, professional designation, and the reason for the sanction.

Tax preparers must remain informed and alert, using their professional judgment to ensure proper compliance with policies and procedures to ensure that research on a position is appropriate and well-documented; firm policies are properly established, communicated, and monitored; and disclosure requirements are met. The IRS has made efforts to communicate important information to tax professionals through websites such as irs.gov/for-tax-pros, which provides links to preparer guidelines, including disclosure rules, credentials, and qualifications, as well as links to notices and other guidance. While not a substitute for thorough tax research, information provided here can provide a useful overview and starting point.

Also, a number of professional resources can help tax preparers remain informed of changes in preparer responsibilities and penalties. The AICPA Tax Section publishes a number of checklists that can be used by preparers to ensure compliance with IRS reporting and documentation rules and can help identify missed reporting issues and potential exam or audit risks on a tax return. Using aids such as checklists can also help a preparer establish evidence of due-diligence and good-faith efforts.

In sum, tax preparers are subject to a number of penalties for conduct that violates professional standards and disclosure requirements. These penalties can be imposed by federal and state tax authorities and can be both civil and criminal. In addition, clients learning that their preparer is being investigated by the tax authorities can damage a tax professional's reputation and business. It is important for preparers to be well-informed of the professional and disclosure requirements at both the federal and state levels, and exercise care in following those requirements. This not only helps ensure that the preparer provides a good work product for clients, but it also helps avoid penalties and sanctions.  

Footnotes

1T.D. 38773.

2Application for Admission to Practice Before the Treasury Department, promulgated in T.D. 38773. See books.google.com.

3Act of July 7, 1884, 23 Stat. 258, as quoted in Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended June 30, 1921, p. 341 (Gov't Printing Office 1922). See books.google.com.

4Act of July 7, 1884, 23 Stat. 258. The current version of this statute is codified at 31 U.S.C. §330.

5Sec. 7701(a)(36).

6Regs. Sec. 301.7701-15(b)(2).

7Regs. Sec. 301.7701-15(b)(3)(i).

8Regs. Secs. 301.7701-15(b)(3)(i)(A) and (B).

9See AICPA Statement on Standards for Tax Services No. 1, Tax Return ­Positions, ¶1.

10Protecting Americans From Tax Hikes (PATH) Act, §210, enacted as part of the Consolidated Appropriations Act, 2016, P.L. 114-113.

11Regs. Secs. 1.6662-4(d)(2) and (3).

12Staff of the Joint Committee on Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Including Provisions Relating to Corporate Tax Shelters), vol. 1, p. 152 (Table 7) (July 22, 1999).

13Id.

14For a detailed discussion on the allowable authorities and evaluation of those authorities when determining substantial authority, see Nash and Parker, "Establishing Substantial Authority for Undisclosed Tax Positions," 40 The Tax Adviser 380 (June 2009).

15Regs. Sec. 1.6694-2(a)(2) and Regs. Sec. 1.6694-3(a)(2).

16Sec. 6694(a)(3).

17Sec. 6107(a) and Regs. Sec. 1.6107-1(a).

18Regs. Sec. 1.6107-1(a)(2).

19Regs. Sec. 1.6107-1(a)(1).

20Sec. 6695(a).

21Regs. Sec. 1.6695-1(b).

22Sec. 6695(b).

23Sec. 6109(a)(4).

24Regs. Sec. 1.6695-1(c).

25Sec. 6695(c).

26See Notice of Proposed Rulemaking (REG-134235-08), 75 Fed. Reg. 14,539, 14,542 (March 26, 2010).

27Sec. 6107(b).

28Regs. Sec. 1.6107-1(b).

29Sec. 6695(d).

30Regs. Sec. 1.6060-1.

31Sec. 6695(e).

32This conflicts with the regulations, which indicate that the maximum penalty is imposed for each calendar year (Regs. Sec. 1.6695-1(e)).

33Sec. 6695(f) and Regs. Sec. 1.6695-1(f).

34See www.eitc.irs.gov/Tax-Preparer-Toolkit/dd/lawandregs.

35T.D. 9799; REG-102952-16.

36Loving, 917 F. Supp. 2d (D.D.C. 2013), aff'd, 742 F.3d 1013 (D.C. Cir. 2014).

37See, e.g., U.S. Dep't of Justice, press releases, "United States Attorney and IRS, Special Agent in Charge, Urge Taxpayers to Beware of Fraudulent Tax Return Preparers and Tax Scheme Promoters" (April 11, 2016), "Federal Court in Florida Bars Former LBS Tax Services Franchisor From Owning Tax Return Preparation Businesses and Preparing Tax Returns For [sic]" (Nov. 16, 2016).

38See IRS, Disciplinary Sanctions—Internal Revenue Bulletin, available at www.irs.gov.

39Rev. Rul. 85-187.

40Rev. Rul. 86-55.

41See irs.gov/tax-professionals/irs-letters-and-visits-to-return-preparers.

42Sec. 6701(f)(2).

43See Franchise Tax Board "Penalty Reference Chart" at ftb.ca.gov/forms/misc/1024.pdf.

 

Contributors

Cynthia Bolt is an associate professor of accounting at the Citadel School of Business in Charleston, S.C., where she teaches introductory accounting, auditing, and tax. Elizabeth Plummer is a professor of accounting at the Neeley School of Business at Texas Christian University in Fort Worth, Texas, where she teaches tax and accounting courses. For more information about this column, contact thetaxadviser@aicpa.org.

 

Newsletter Articles

SPONSORED REPORT

Cybersecurity threats proliferating for midsize and smaller businesses

This report details how SMBs can properly protect private information from breaches, design and implement a cybersecurity policy, and create safeguards for training and education.

PRACTICE MANAGEMENT

2016 Best Article Award

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”