Tax Preparer and Taxpayer Reporting Standards Equalized

By James Beavers, J.D., LL.M., CPA

A provision in the 2008 Tax Extenders and AMT Relief Act sets the standard of conduct for preparers to avoid the penalty for understatement of tax due to an undisclosed return position at "substantial authority," the same standard applied to taxpayers. The controversial "more likely than not" standard has been retroactively repealed.


Prior to May 25, 2007, an income tax return preparer who prepared a tax return for which there was a tax understatement that was due to an undisclosed position was liable for a preparer penalty if there was not a realistic possibility of the position's being sustained on its merits. If the preparer disclosed the position, the preparer was liable for a penalty only if the position was frivolous.

An amendment to Sec. 6694 made by the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28 (SBWOTA), changed the scope of the preparer penalty to apply to all types of tax returns (instead of just income tax returns), increased the amount of the penalties, and heightened the standards of conduct needed for tax return preparers to avoid the imposition of penalties for the preparation of a return for which there is an understatement of tax. Under the SBWOTA version of Sec. 6694, a tax return preparer could be penalized for preparing a return on which there was an understatement of tax liability due to an "unreasonable position" taken on the return. An unreasonable position was defined as a position that a return preparer does not reasonably believe is more likely than not (MLTN) to be sustained on its merits unless the position is disclosed on the return and for which there is a reasonable basis.

The imposition of the MLTN standard by SBWOTA was unexpected by both IRS officials and the tax community and was roundly criticized by both. The chief complaint was that the new standard of conduct was higher than the standard imposed on taxpayers, who have always had a "substantial authority" standard applied to their undisclosed positions. This difference in standards created a potential conflict of interest between preparers and their clients because, in some situations, a preparer could be protected from a penalty only by a position's disclosure by a client who was not required to disclose the position. As Barry Melancon, president and CEO of the AICPA, stated, this conflict "could have chilled the professional advice CPAs might have given taxpayers."

The AICPA's Tax Division immediately went to work with the IRS to come up with a way to work around this problem with the new rules. As a result, the IRS issued guidance (see REG-129243-07 and Notice 2008-13) that softened the impact of the new standard by allowing preparers to avoid application of the standard in some situations where a preparer provided the taxpayer a properly completed Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, for the position or disclosed certain information to the taxpayer about the position. However, the tax community remained dissatisfied with the new standard and very worried about how the IRS might apply it in practice.

New Legislation Equalizes Standards of Conduct

Recognizing the problems caused by the MLTN standard of conduct for tax return preparers, as part of the 2008 Tax Extenders and AMT Relief Act, P.L. 110-343, Congress lowered the return preparers' standard of conduct for undisclosed positions to the same "substantial authority" standard applied to taxpayers. In general, under the substantial authority standard, the position taken must have an approximately 40% chance of being sustained on its merits, as opposed to a 50% or more chance as required under the MLTN standard. However, it is higher than the pre-SBWOTA "realistic possibility of success" standard, which required approximately a 33% chance of a position prevailing on the merits.

For disclosed positions, the "reasonable basis" standard continues to apply. The preparer standard for Sec. 6662A reportable transactions (i.e., listed transactions and reportable transactions with significant avoidance or evasion purposes) was left at the MLTN level, and the MLTN standard is not lowered for Sec. 6662A reportable transactions even if the transactions are disclosed.

The new standard applies to returns prepared after May 25, 2007, the date the standard had been increased to more likely than not by SBWOTA.

Note: While Congress has repealed the MLTN standard, the other SBWOTA changes to the preparer penalty provisions, including the increased penalty amounts and the application to preparers of all return types, remain in force. To the extent that the proposed regulations deal with issues other than the MLTN standard, they presumably also still apply.


While the return preparer standard has not been reduced to its previous "realistic possibility" level, at least the problem of there being a higher standard for preparers than for taxpayers has been eliminated. Given the very real and very obvious problem caused by having a higher standard of conduct for preparers than taxpayers, it was more a question of when a change would be made to equalize the standards rather than if a change would be made.

In the meantime, both the IRS and the tax community have wasted a large amount of time and resources dealing with a changed standard that would have done little to help the Service's enforcement efforts or actually improve tax reporting.

The MLTN standard was inserted into the SBWOTA legislation late in the process and remained there despite intense objections by the AICPA and its members. Hopefully in the future the members of both the House Ways and Means Committee and the Senate Finance Committee will do a better job of vetting potential legislation and consulting with the IRS and the tax community to prevent the passage of obviously flawed tax provisions.

Tax Extenders and Alternative Minimum Tax Relief Act of 2008, P.L. 110-343, §506

The reports of cases, rulings, etc., herein, except for the Reflections, are edited versions of the relevant court opinion, published ruling, etc.

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