IRS Issues Rules on New Preparer Penalties

On the last day of 2007, the IRS issued Notice 2008-13, which implements the expanded tax return preparer penalties and increased standards of return preparer conduct enacted by the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28 (SBWOTA). The Service also announced that it intends to revise the regulatory scheme governing tax return preparer penalties by the end of 2008, and Notice 2008-13 asks for tax return preparer feedback on that planned overhaul.

The notice’s interim rules emphasize the importance of understanding the legal basis for positions taken on tax returns, the requirement for taxpayers to disclose certain positions, and the need for preparers to advise taxpayers on the various penalties that can apply when a position is taken on a return that may not be supported by existing law.

For undisclosed positions on a tax return, SBWOTA replaced the “realistic possibility” standard with a requirement that there be a reasonable belief that the position’s tax treatment would more likely than not be sustained on its merits (Sec. 6694(a)). Under Notice 2008-13, a return preparer is considered to reasonably believe that the tax treatment of an item is more likely than not the proper tax treatment if the tax return preparer analyzes the pertinent facts and authorities in the manner described in Regs. Sec. 1.6662-4(d)(3)(ii) and, relying on that analysis, reasonably concludes in good faith that there is a greater than 50% likelihood that the tax treatment of the item will be upheld if challenged by the IRS.

For purposes of determining whether a preparer has a “reasonable basis” for a position, the notice says a tax return preparer may rely in good faith—without verification—on information furnished by the taxpayer or by another tax return preparer or other third party and need not independently verify the information. (However, the return preparer cannot ignore the implications of information he or she actually knows or information furnished to him or her, and the preparer must make reasonable inquiries if the information furnished by another return preparer or a third party appears to be incorrect or incomplete.)

SBWOTA also expanded the return preparer penalty to cover all tax return preparers, not just income tax return preparers (SBWOTA Section 8246(a)). The notice states that the definitions of “tax return preparer” in Regs. Secs. 1.6694-1, 1.6694-3, and 301.7701-15 will be modified to eliminate the word “income” to conform to the changes made by SBWOTA.

The notice also provides interim guidance on penalty compliance rules for both signing and nonsigning return preparers. The interim rules will remain in effect until the overhaul of the current return preparer penalty regulations is complete.

Under the notice, preparers of many information returns will not be subject to the new penalty provision unless they willfully understate tax or act in reckless or intentional disregard of the law. The exempted information returns listed in the notice include the W-2 and 1099 series of forms, Forms 990, 990-EZ, and 990-N for exempt organizations, Form 1040-ES, Estimated Tax for Individuals, Form 1120-W, Estimated Tax for Corporations, and Form 2350, Application for Extension of Time to File U.S. Income Tax Return, as well as several others. The notice includes examples illustrating how the new standards would apply.

The notice also clarifies that the date a return or claim for refund is prepared is deemed to be the date shown on the preparer’s signature line on the return. For nonsigning preparers, the relevant date will be the date the person provided the advice, which will be determined by looking at all the facts and circumstances. (The rules in the notice supersede the rules of Regs. Sec.1.6694-2(b)(5), which establish when a realistic possibility is determined.)