Tax Return Advice

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					    Tax Advice In The Wake Of The New Return
    Preparer Penalty Standards

    Meredith K. Knueve

Meredith K. Knueve
is an attorney with the law firm of     Giving advice had gotten trickier for tax professionals
Bricker & Eckler LLP. Her practice      anxious to follow the rules.
includes federal tax planning for
corporations, partnerships and in­
dividuals; trust and estate taxation;
estate planning and administration;     In 2009 the treasury released final regulations on the new
business succession planning; non­
                                        tax return preparer standards. As practitioners navigate the new rules,
profit organizations; and charitable
                                        they might find themselves hesitating on return positions they previously
                                        would have recommended. With raised caution ensuing from the new
                                        harsher standards on return preparers, where does that leave practitio-
                                        ners in counseling their clients on positions to be taken on their tax re-
                                        turns? A thorough understanding of the new regulations, issued under
                                        section 6694 of the Internal Revenue Code of 1986, as amended (the
                                        “Code”), is required for practitioners to comply with the return preparer
                                        standards. (Unless otherwise noted, all section references herein are to the
                                        Code or the Treasury regulations promulgated thereunder.) The recent
                                                                                         The Practical Tax Lawyer | 21
22 | The Practical Tax Lawyer                                                                       Winter 2010

amendments to section 6694 have extended the re-        the new 6694(a) taX return PrePar-
turn preparer standards to preparers of many oth-       er PenaltY stanDarDs • Under the 2008
er types of tax returns and documents (including        amendments to section 6694, a return preparer of
estate and gift, employment, and excise tax returns;    positions that are not tax shelters generally will avoid
depreciation schedules; and cost allocations). Thus,    a penalty for an understatement of liability only if:
not only are more practitioners than ever affected      (1) the position is adequately disclosed and has a
by the penalty standards, but other professionals       reasonable basis; or (2) the position, although not
such as appraisers and bookkeepers also may be          disclosed, is supported by “substantial authority.”
affected. Practitioners are well-advised to gain an     However, a penalty also will not apply if it is deter-
understanding of the new standards.                     mined that, under all the facts and circumstances,
                                                        the understatement was due to reasonable cause
General ChanGes to seCtion 6694 •                       and that the preparer acted in good faith. Factors
On May 25, 2007, Congress amended section 6694          which will be considered include: the nature of the
to heighten penalty standards for tax return prepar-    error causing the understatement, the frequency of
ers. See P.L. 110-28 §8246 (2007). The 2007 amend-      errors, the materiality of the errors, and whether
ment, which required preparers to have a reason-        the preparer’s normal office practice indicates that
able belief that a position is more-likely-than-not     such errors would rarely occur. Finally, under sec-
correct, created a higher standard for preparers than   tion 6694 as amended, a tax return preparer may
for taxpayers under section 6662, under which tax-      rely in good faith and without verification on in-
payers generally are required to have substantial       formation furnished by another advisor, return
authority to avoid a penalty with respect to non–tax    preparer, or party if the return preparer does not
shelter transactions. After the amendment, Trea-        ignore the implications of information furnished to
sury issued a series of notices and proposed regula-    the return preparer or actually known by the re-
tions interpreting the new section 6694. Congress       turn preparer, as long as the return preparer makes
then issued another amendment to section 6694 on        reasonable inquiries if the information furnished
October 3, 2008. See P.L. 110-343, 122 Stat. 3765       appears to be incorrect or incomplete.
(2008). The 2008 amendment reduced the return
preparer standard to “substantial authority” for        who Is a tax return Preparer?
positions not related to a “tax shelter” as defined         A tax return preparer is any person who is pri-
under section 6662(d) or a reportable transaction       marily responsible for the positions on a return
under section 6011. (For tax shelters and reportable    giving rise to an understatement. The term also is
transactions, penalties are imposed if the preparer     defined in Treas. Reg. §301.7701-15 as “any person
does not reasonably believe that the position is more   who prepares for compensation or who employs
likely than not correct.) Treasury then promulgated     one or more persons to prepare for compensation,
final Regulations (T.D. 9436, December 22, 2008)        all or a substantial portion of any return of tax
under sections 6694 and 6695 to replace interim         or claim for refund.” Additionally, a person who
guidance and incorporate the changes made in the        signs or gives advice with respect to a substantial
2008 amendments. The Regulations are applicable         portion of an information return may become a
to returns and refund claims (and advice given) af-     preparer of another return if the entries reported
ter December 31, 2008. In addition, newly issued        on the information return are directly reflected on
Rev. Proc. 2009-11 and Notice 2009-5 both pro-          and constitute a portion of the other return. Treas.
vide guidance on the new standards.                     Reg. §301.7701-15(b)(3)(iii). Note that, despite the
                                                                     New Return Preparer Penalty Standards | 23

broad definition of a return preparer, a tax return      ing of a transaction, Treasury created an exception
preparer does not include any person who prepares        for post-transactional advice that is given in small
a return or refund claim for the employer by whom        amounts. Under the exception, where post-trans-
he or she is regularly and continuously employed.        actional advice is less than five percent of the ag-
§7701(a)(36).                                            gregate time spent by the tax planner, such advice
                                                         is not considered in the determination of whether
Signing Preparers vs. Non-Signing                        the planner is a return preparer. However, the ex-
Preparers                                                ception is inapplicable if the planner gave the ad-
     Although a distinction is made under section        vice before the events occurred as part of a plan
6694 between signing and non-signing preparers,          to avoid being classified as a tax return preparer.
section 6694 now applies to both. The preparer           Under this anti-abuse rule, advice provided after
who signs the return has primary responsibility for      events have occurred, even if the time spent on
the overall substantive accuracy of the return. See      such advice is less than five percent of the aggre-
Treas. Reg. §§1.6695-1(b)(2); 301.7701-15(b)(1). A       gate time incurred by the individual with respect
non-signing preparer is one who does not sign the        to the positions giving rise to the understatement,
return, but prepares all or a substantial portion of a   will be taken into account if: (1) the facts and cir-
return by giving written or oral advice with respect     cumstances indicate that the individual is primarily
to events that already have occurred at the time the     responsible for a position taken on the return; (2)
advice is given. Treas. Reg. §301.7701-15(b)(2)(1).      the individual rendered advice on the position be-
A non-signing preparer is deemed to be a “tax re-        fore events occurred primarily to avoid treatment
turn preparer” only if the preparer knew or had          as a return preparer subject to section 6694; and (3)
reason to know that the advice given was related         the individual confirmed the advice after the events
to a portion of a return that constitutes a substan-     occurred for purposes of preparation of the tax re-
tial portion of the tax required to be shown on the      turn. Treas. Reg. §301.7701-15(b)(2)(i).
return. Treas. Reg. §301.7701-15(b)(3)(i). Under
former regulations, only one person could be a tax       Substantial Portion Of The Return
return preparer. However, Treas. Reg. §1.6694-1(b)           Treas. Reg. §301.7701-15 defines a “tax return
now provides that multiple persons per firm may          preparer” as “any person who prepares for com-
be treated as tax return preparers. It is anticipated    pensation or who employs one or more persons to
that the Service will request signing preparers to       prepare for compensation, all or a substantial por-
“name names” of other potential preparers of the         tion of any return of tax or any claim for refund.”
return to ascertain the primary preparer for each        In determining what portions of a return are
position on the return.                                  “substantial,” factors to consider include the size
                                                         and complexity of the portion or item when com-
Tax Planners As Return Preparers                         pared with the total gross income, as well as the
    Under Treas. Reg. §301.7701-15(b), a distinc-        size of the understatement at issue in comparison
tion is made between tax planners (those who ad-         with the taxpayer’s reported liability. Treas. Reg.
vise clients pre-transaction) and non-signing tax        §301.7701-15(b)(3)(i). An amount is considered to
return preparers who advise clients on how to re-        be substantial if it is at least $10,000 or 20 percent
port completed transactions. Noting the concern          of gross income (AGI for individuals). Treas. Reg.
that tax planners under the new standards would          §301.7701-15(b)(3)(ii)(A). Amounts at or above
be hesitant to continue their advice after the clos-     $400,000 are considered per se substantial.

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