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 giving. 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.