Circular 230 Penalty

Editor: Lesli S. Laffie, J.D., LL.M.

Notice 2007-39 contains guidance on the imposition of monetary penalties for prohibited conduct under Section 10.52 of Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, and Appraisers Before the Internal Revenue Service. The American Jobs Creation Act of 2004 (AJCA) amended 31 USC Section 330 (which authorizes the regulation of practice before the Service) to allow monetary penalties to be imposed on a practitioner who (1) is incompetent, (2) is disreputable, (3) violates regulations under 31 USC Section 330 or (4) willfully and knowingly misleads or threatens represented parties or a prospective party with an intent to defraud. (The regulations under that section are known as Circular 230.) Guidance and examples are provided as to the amount of the penalty and its imposition on a practitioner’s employer or firm.

Penalty amount: Under the AJCA amendments, the maximum amount of the penalty will be the income derived by engaging in the prohibited conduct. The IRS has clarified that, if the prohibited conduct is a single part of a larger engagement, the maximum penalty will be the income derived from the entire engagement. If the entire engagement commenced before Oct. 23, 2004, the maximum penalty will be determined on a pro-rata basis to exclude amounts attributable to activities before the AJCA effective date. The Service may impose separate penalties against a practitioner and any employer or firm; they cannot exceed the income received by the sanctioned party. Further, the IRS may impose a penalty that is less than the statutory maximum based on (1) the culpability of the violating practitioner or the practitioner’s employer or firm or (2) whether there was a duty owed a client, the actual harm done to a client or other mitigating factors. “Mitigating factors” will include whether the practitioner, employer or firm took prompt action to correct the noncompliance, promptly ceased to engage in the prohibited conduct, attempted to rectify any harm done by the conduct or undertook measures to ensure the conduct would not be repeated.

Generally, the Service will not impose a penalty when there have been minor technical violations with little or no injury to a client, the public or tax administration, and with little likelihood of repeated misconduct.

Separate penalty: Guidance has also been provided as to when separate penalties may be imposed on a practitioner’s employer or firm. Under the AJCA amendments, penalties may be imposed on an employer or firm when the violating practitioner acts on behalf of the employer or firm and the latter knew, or should have known, of the prohibited conduct.

A practitioner is deemed to have acted on behalf of an employer or firm if:

• An agency relationship existed between the practitioner and the employer or firm;
• The purpose of the relationship was to provide services in connection with practice before the IRS; and
• The prohibited conduct arose in connection with the agency relationship.

An employer or firm is deemed to know or should have known about misconduct if:

• One or more of the principal management or officers of the employer or firm, or a branch office of either, knew or had information that would lead a person of similar experience and background reasonably to have known of the prohibited conduct; or
• The employer or firm, either through willfulness, recklessness or gross indifference, did not take reasonable steps to ensure compliance with Circular 230, and a practitioner of that employer or firm engaged in prohibited conduct that harmed a client, the public or tax administration.

The IRS, when determining whether to impose a penalty on an employer or firm, will also consider the gravity of the misconduct, any history of noncompliance, the presence of measures meant to prevent noncompliance and corrective measures taken after discovery of noncompliance. Future guidance may be issued as to other factors that may be considered in determining whether a penalty should be imposed.