Editor: Mary Van Leuven, J.D., LL.M.
The IRS recently issued internal memoranda setting forth procedures for tax return preparer penalties in taxpayer examinations. These include a memorandum by the Large and Mid-Size Business Division (LMSB) on its procedures for tax return preparer penalty cases and two memoranda by the Small Business/Self-Employed Division (SB/SE) on preparer penalty procedures for excise and employment tax examinations. See LMSB-040308-009 (4/13/08), SBSE-04-1208-068 (12/31/08) (excise taxes), and SBSE-040209-008 (2/3/09) (employment taxes).
This item summarizes the guidance and highlights some areas of concern. It then describes some steps preparers can take to reduce their penalty exposure.
Summary of Guidance
The LMSB and SB/SE memoranda address preparer penalties under Secs. 6694 and 6695 in response to 2007 legislation extending these (and other) penalties to preparers of all tax returns, not merely income tax returns. See the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28 (SBWOTA). These memoranda:
- Require examiners to consider the appropriateness of asserting preparer penalties in all taxpayer examinations involving a paid tax return preparer and to document consideration of the issue in the workpapers. The LMSB memorandum explains that “[i]nterviews of the taxpayer should serve a dual purpose: 1) to further the tax examination and 2) to identify violations by a tax return preparer.”
- Emphasize that the taxpayer examination is separate from the potential preparer penalty case and require that files for these matters be maintained separately.
- Provide that a preparer penalty generally cannot be proposed until the taxpayer examination is completed at the group level.
- Permit examiners to decide not to impose preparer penalties on their own, but require a higher level of approval to impose preparer penalties. The LMSB memorandum requires team manager approval prior to initiating a preparer penalty case, and the SB/ SE memoranda for employment and excise tax examinations require manager and group approval prior to initiating such a case, respectively. Unlike the SB/SE memorandum for excise tax examinations, the LMSB memorandum and SB/SE employment tax examination memorandum also provide that a preparer penalty case should not begin until the examiner has contacted the Return Preparer Coordinator.
- Affirm the preparer’s appeal rights—generally, pre-assessment if at least 180 days remain on the statute of limitation and post-assessment otherwise. The memoranda also note that preparer penalties are an Appeals coordinated issue.
- Mandate referral to the Office of Professional Responsibility (OPR) of penalties imposed under Secs. 6694(a), 6694(b), and 6695(f) against a practitioner (i.e., CPA, attorney, enrolled agent, enrolled actuary, or enrolled retirement plan agent) if the preparer penalty case is closed agreed by the examiner or sustained in Appeals, or closed unagreed without Appeals contact.
Practitioners can take steps to reduce their preparer penalty exposure. Of course, the best defense is working closely with clients to produce high-quality work. However, in spite of a practitioner’s best efforts, on occasion there may be difficulties in gathering the facts or differences of opinion between or among the client, the practi-tioner, and the IRS as to which facts are relevant or the merits of a return position.
The recent IRS guidance may help practitioners in focusing on potential issues. For example, the LMSB memorandum includes examples of questions examiners may ask taxpayers in connection with potential preparer penalties, including:
- Are you aware of any errors, omissions, or mistakes on the return under examination?
- Did you disclose this transaction on your tax return? Why or why not?
- Were there any concerns about how the transaction was reported? What sort of process is used to address those concerns, and on what basis are decisions made?
- Was there any discussion regarding potential penalties?
These questions reinforce the importance of preparers:
- Exercising due diligence in gathering and assembling facts that are potentially relevant to a return position and in determining whether Sec. 6694 standards are satisfied. Although a preparer generally may rely in good faith without verification on information furnished by the client, the preparer must inquire further if the information appears inaccurate, inconsistent, or incomplete.
- Clearly communicating with client concerns about potential reporting positions. This would include discussions with clients about the potential taxpayer penalty consequences of a return position and the opportunity to avoid penalties by disclosure, where relevant.
- Contemporaneously documenting discussions with clients in these (and other) areas.
Practitioners also should remain alert to the fact that they may be subject to Sec. 6694 as nonsigning preparers, even if they do not sign returns as preparers. For example, tax advice may be subject to Sec. 6694 standards, even if the advice is not subject to Circular 230’s covered opinion rules.
Areas of Concern
A general area of concern about the new guidance is that it could encourage IRS examiners and their managers to open preparer penalty cases and/or assert preparer penalties when they are not warranted. This concern is reinforced by SBWOTA’s increase in penalty amounts for Sec. 6694 failures (up to 50% of the fees involved) and the shift in rationale for penalties over the past several years. As recently noted (and questioned) by the National Taxpayer Advocate, the philosophy of civil tax penalties has changed from one that had the sole purpose of encouraging voluntary compliance to one that includes a purpose of economic deterrence (National Taxpayer Advocate, 2008 Annual Report to Congress, Vol. II, 11 (12/31/08)).
While the important role of return pre-parers in our voluntary compliance tax system supports imposing preparer penalties when warranted, this role may also be undermined if the IRS imposes preparer penalties routinely or when reasonable people could disagree as to whether a violation has occurred. Accordingly, the IRS should devote additional resources to training its personnel on the specifics of the penalty rules and on monitoring implementation of the LMSB and SB/SE procedures to help ensure that it imposes penalties only in appropriate situations.
In addition, the IRS rules for administering preparer penalties should be transparent and consistent across functions. It is therefore important that the IRS formalize new procedures in the Internal Revenue Manual as soon as possible. Further, the SB/SE memorandum for excise tax examinations should better align with the other memoranda to require contact with the Return Preparer Coordinator before initiating a preparer penalty case.
Further, IRS procedures should be changed so that a Sec. 6694(a) preparer penalty, in particular, does not automatically lead to a referral to the OPR. Indeed, the mandatory referral approach in the LMSB and SB/SE memoranda for Sec. 6694(a) violations is surprising in view of Treasury’s and the IRS’s position in the preamble to the proposed Sec. 6694 regulations (REG-129243-07). The preamble provides that the IRS intends to modify its internal guidance so that a Sec. 6694(a) penalty generally will trigger a referral to the OPR only if the violation is willful or egregious or if there is a pattern of violations. According to the preamble, this intent is “[i]n keeping with a balanced enforcement program for tax return preparers” and is consistent with the legislative history to the 1989 legislation introducing the current framework for the return preparer penalty regime (see H.R. Conf. Rep’t No. 101-386, 101st Cong., 1st Sess., 662 (1989)).
The preamble’s more tempered approach to OPR referrals also makes sense given that Circular 230 disciplines only willful, reckless, or grossly incompetent violations of its return preparation provisions (Circular 230, §§10.34 and 10.52). Moreover, potential referrals should be routed through the applicable Return Preparer Coordinator before they are made to increase consistency and afford an additional opportunity to determine whether the referral is appropriate.
Mary Van Leuven is Senior Manager, Washington National Tax, at KPMG LLP in Washington, DC.
Unless otherwise noted, contributors are members of or associated with KPMG LLP.
This article represents the views of the author or authors only, and does not necessarily rep-resent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
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For additional information about these items, contact Ms. Van Leuven at (202) 533-4750 or firstname.lastname@example.org.