The Tax Return Preparer Standard: Policy Developments

By Editor: Greg A. Fairbanks, J.D., LL.M.

Editor: Greg A. Fairbanks, J.D., LL.M.

The tax return preparer standard set forth in Sec. 6694 has been subject to a series of revisions and refinements. Legislation enacted in May 2007 established a new more-likely-than-not (MLTN) return preparer standard, which required preparers to have a greater-than-50% level of confidence in undisclosed positions. Treasury and the IRS have issued guidance to address many practical concerns about the effects of the MLTN standard, including:

  • The difference between the standards that apply to preparers and to taxpayers;
  • Application of the standard to nonsigning preparers who provide post-transaction advice; and
  • Which positions, with adequate disclosure, should be eligible for a standard that is less than MLTN.
In October 2008, Congress again changed the tax return preparer standard, retroactively lowering it to substantial authority (no disclosure required) for most tax positions. Under the new legislation, certain positions will still require a minimum MLTN confidence level to avoid imposition of a return preparer penalty (and effectively enable tax return preparers to sign a return). As the return preparer standard evolves, there is increasing uncertainty among tax professionals about how to provide traditional tax services to clients without being exposed to the Sec. 6694 penalty regime.

Prior Standard

Under prior law enacted in 1989, tax return preparers could prepare tax returns without making any specific disclosures as to positions reported on tax returns as long as a tax position had at least a "realistic possibility" (approximately a one in three chance) of being sustained on its merits. As a practical matter, under the realistic possibility of success standard it was not difficult for return preparers appropriately evaluating relevant authority to conclude that a tax position had a 33% chance of being sustained on its merits.

A key policy behind the increased MLTN standard seems to have been the desire to hold tax return preparers to a greater gatekeeping role in the tax system. It appears that Congress wanted tax return preparers to take on a greater responsibility for ensuring that tax returns reflect sustainable positions at a level of confidence much greater than one in three without issue disclosure and create more confidence and transparency for the IRS. This resulted in the increased MLTN standard and the required disclosure of positions not meeting the MLTN standard. Moreover, Congress apparently believed that, over time, implementation of the MLTN standard would raise the overall accuracy of tax returns being filed.

Implementation of the MLTN Standard

The implementation of the MLTN standard created many obstacles for tax return preparers. The difference between the standards applied to return preparers (MLTN) and taxpayers (substantial authority) placed stress on preparer-client relationships and created a conflict between the parties when clients elected not to disclose against the advice of the preparer. The standard applied to nonsigning preparers was the same as that applied to signing preparers even where the nonsigner did not have the same level of information or involvement in the position at issue, leading to tension between these preparers. Many tax positions, including several related to accounting methods, amended returns, and passthrough entities, could not ordinarily (if ever) meet the MLTN standard because of their nature or complexity.

Guidance issued shortly after the original MLTN legislation (Notices 2007-54 and 2008-13) showed an attempt to balance the increased burden on tax return preparers by permitting reliance on others in certain instances. The guidance clarified that return preparers may continue to rely on taxpayer representations in preparing returns as long as the preparer does not have reason to know (or should know) that the representations are false. Further, preparers may rely in good faith on the advice of an unaffiliated third party who the preparer had reason to believe was competent to render the advice.

This provision, in some instances, actually reduced the due diligence standard for reliance on third-party advice. Many preparers, however, were not comfortable with such reliance and continued to perform levels of investigation they believed to be appropriate in their role as return preparers. Overall, it was clear that the heightened standard had created a difficult environment for preparers and taxpayers and that additional legislation was necessary to resolve the tension between Congress's policy goals and the practical impediments to implementing the new standard.

Current Status and Challenges

Congress recently enacted legislation that attempted to address concerns with the return preparer standard more broadly by relaxing the MLTN requirement for many tax positions. The Emergency Economic Stabilization Act of 2008, P.L. 110- 343, amended Sec. 6694(a)(2) to lower the return preparer standard for nondisclosed tax positions other than those that have a significant purpose of tax avoidance or evasion (or are certain types of reportable transactions) from MLTN to substantial authority. Under the new rules, a tax position that does not meet the substantial authority level of confidence may nonetheless be taken on a return if there is at least a reasonable basis for the position, provided there is adequate disclosure. Tax positions that have a significant purpose of tax avoidance or evasion or are reportable avoidance transactions must continue to meet the MLTN standard; furthermore, the statutory change (Sec. 6694(a)(2)(C)) does not contain a provision allowing a preparer to sign a return containing such transactions at a lower confidence threshold (i.e., there is no adequate disclosure provision for such transactions).

Reducing the standard for many tax positions to a substantial authority level of confidence (or reasonable basis with adequate disclosure), which is the same standard that taxpayers must meet to avoid an accuracy penalty under Sec. 6662, has been received as a welcome change by most preparers. However, tax positions with a significant purpose of tax avoidance or evasion and reportable avoidance transactions remain at the MLTN standard. The absence of an adequate disclosure provision to address such positions remains a significant issue, and return preparers must understand the issue.

A prominent concern is that "significant purpose of tax avoidance or evasion" is a phrase that could be construed generally to include all transactions that provide a significant tax benefit to the taxpayer. "Significant" is an undefined term, so unless some form of test, safe harbor, or other helpful parameters are established to clarify what constitutes a significant purpose, preparers will be challenged to apply the provision.

Another difficult question is how preparers should view their responsibility to communicate to a taxpayer that they have not reached an MLTN level of confidence on a significant purpose or reportable avoidance transaction. It is not difficult to imagine instances in which relationships among preparers, clients, and third-party advisers could be strained due to the new legislation. For instance, when a signing preparer wishes to rely on advice provided by a nonsigning preparer, additional investigation will be required when there is a disagreement about whether a given tax position involves a significant purpose or constitutes a reportable avoidance transaction, where the signing preparer does not have an MLTN level of confidence that such a position would be sustained on its merits. Furthermore, client representations may increasingly be challenged by both signing and nonsigning preparers as a result of the uncertainty surrounding significant purpose transactions.

Responding to concerns about the most recent return preparer legislation, the IRS has released final regulations and guidance. (For more information, see News Notes, p. 68, and Tax Trends, p. 128.)


The increased return preparer standard enacted in 2007 was originally intended to reduce the increasing number of what were perceived to be aggressive positions being taken on a tax return by requiring tax return preparers to serve in a greater gatekeeping role. The implementation of the MLTN standard forced preparers to heighten their scrutiny of client tax positions but also resulted in significant confusion and uncertainty, which has yet to be resolved. Additional legislation and explanatory guidance clarified certain matters, but many important areas have not been addressed.

The recent amendments to Sec. 6694 included in the Emergency Economic Stabilization Act relaxed the return preparer standard for a large number of tax return positions, but they created a new set of issues that require additional guidance. It appears that the tax return preparer standard will continue to be a work in progress as Congress, the IRS, Treasury, and tax professionals work to establish policy and rules that balance the need for increased scrutiny of transactions at the preparer level with the need for a practical tax administration framework that allows preparers to provide tax services to clients where the rules and penalties are clearly understood.
From Greg Jamouneau, J.D., Chicago, IL


Greg A. Fairbanks, J.D., LL.M., is a tax manager with Grant Thornton LLP in Washington, DC.

For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.

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