Prepare yourself; IRS proposes regulations on new prepare penalties

California CPA, August, 2008 by Stuart R. Josephs

The 2007 Small Business and Work Opportunity Tax Act. (P.L. 110-28) expanded and increased preparer penalties. On June 17, 2008, the IRS published proposed regulations (REG-129243-07) to implement that new law. It is proposed that these regulations would apply to returns and refund claims filed, and advice provided, after the date final regulations are published in the Federal Register.

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Caution: Pending legislation could supersede many of these proposed rules. The House of Representatives passed an "extenders bill" (H.R. 6049) providing the same substantial authority standard for non-abusive undisclosed positions for preparer penalties and taxpayer penalties. A similar provision is contained in the House-approved 2008 Taxpayer Assistance Act (H.R. 5719). The fate of this legislation in the Senate is presently unknown.

Nevertheless, selected highlights of these proposed regulations follow.

Reasonable Belief That a Position Would More Likely Than Not Be Sustained on Its Merits

A preparer may have such a belief if the preparer analyzes the pertinent facts and authorities, and relying on that analysis, reasonably concludes in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits. In reaching this conclusion, the possibility that the position will not be challenged by the IRS is not taken into account. The analysis prescribed by Regs. Sec. 1.6662-4(d)(3)(ii), to determine whether substantial authority exists, also applies to determine whether the more likely than not standard is satisfied.

Whether a preparer meets this standard will be determined based on all facts and circumstances, including the preparer's diligence. In determining the level of diligence in a particular situation, the preparer's experience with the area of Federal tax law and familiarity with the taxpayer's affairs, as well as the complexity of the issues and facts, will be considered.

A preparer also may have such a belief, despite the absence of other types of authority, if the position is supported by a well-reasoned construction of the applicable statute.

To determine whether a preparer has such belief, the preparer may rely in good faith without verification upon information furnished by other parties, as provided in Pop. Regs. Sec. 1.6694-1 (e).

A position must not be based on unreasonable factual or legal assumptions, including assumptions as to future events, and must not unreasonably rely on the representations, statements, findings or agreements of the taxpayer or any other person.

The authorities considered in determining whether a position satisfied the more likely than not standard are those types of authorities provided in Regs. Sec. 1.6662-4(d)(3)(iii) regarding the substantial authority standard.

This more likely than not standard must be satisfied on the date the return is deemed prepared, as prescribed by Props. Regs. Sec. 1.6694-1(a)(2).

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Exceptions

The preparer penalty will not be imposed if the position has a reasonable basis and is adequately disclosed.

Reasonable Basis: This term has the same meaning as in Regs. Sec. 1.6662-3(b)(3) concerning the accuracy-related penalty. To determine whether a preparer has a reasonable basis for a position, the preparer may rely in good faith without verification upon information furnished by others as described above.

Adequate Disclosure for Signing Preparers: Signing preparers can disclose in any of these ways:

1. Properly complete and file a disclosure Form 8275 or Form 8275R or disclose in the return in accordance with the annual revenue procedure described in Regs. Sec. 1.6662-4(f)(2).

2. For income tax returns, if the position would not meet the standard for the taxpayer to avoid a penalty without disclosure because of no substantial authority, the preparer provides the taxpayer with the prepared return that includes the disclosure in accordance with Regs. Sec. 1.6662-4(f).

3. For income tax returns, if the position would otherwise meet the standard for nondisclosure by the taxpayer because of substantial authority, the preparer advises the taxpayer of all the penalty standards applicable to the taxpayer under Sec. 6662. The preparer also must contemporaneously document this advice in the preparer's files. The same process applies to returns or refund claims subject to penalties pursuant to Sec. 6662 other than the substantial understatement penalty [under Sec. 6662(b)(2) and (d)].

4. Follow special rules for tax shelters, reportable transactions with a significant purpose of tax avoidance or evasion or listed transactions [Prop. Regs. Sec. 1.6694-2(c)(3)(i)(D)].

Adequate Disclosure for Nonsigning Preparers: Similar rules apply. See Prop. Regs. Sec. 1.6694-2(c)(3)(ii).

Reasonable Cause: The preparer penalty also will not be imposed if, considering all facts and circumstances, the understatement was due to reasonable cause and the preparer acted in good faith. See Prop. Regs. Sec. 1.6694-2(d) for details.

Stuard R. Josephs, CPA has a San Diego-based Tax Assistance Practice that specializes in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcomittee of CalCPA's Committee on Taxation, can be reached at (619) 469-6999 or stuartrjosephs@yahoo.com.