2010-2011 revisions to circular 230.

• Author: Gardner, John C.

This article focuses primarily on the Circular 230( 1 ) tax preparer penalties and other sanctions as well as the regulations governing practice before the IRS that were revised by T.D. 9527 effective August 2, 2011. Circular 230 prescribes who may practice before the IRS. Previously, Circular 230 covered practitioners such as attorneys, certified public accountants, enrolled agents, enrolled actuaries, and enrolled retirement plan agents. T.D. 9501 introduced a new category of practitioner: registered tax return preparer.

T.D. 9501 specifies that all individual who for compensation prepare tax returns or refund claims filed after December 31, 2010, must obtain and use a valid preparer tax identification number (PTIN). T.D. 9501 and T.D. 9527 greatly increase in the number of individuals and entities that will be covered by Circular 230. The preamble to T.D. 9501 noted that the IRS expected approximately 1.2 million preparers to apply for a PTIN, and on November 8, 2011, an IRS official reported that the Service had received 745,000 applications.( 2 ) The PTIN requirement applies to all categories of practitioners listed above who are tax return preparers.

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The final regulations issued in T.D. 9527 involve significant revisions of Circular 230 as part of the regulatory regime involving tax preparation. The thrust of these regulations begins with the recognition that a penalty regime already exists under Sec. 6694 (for tax preparers) and Sec. 6662 (for taxpayers). The regulatory changes to Section 10.34 of Circular 230 are significant because, while they generally follow the tax return preparer regulations under Sec. 6694 and related regulations as well as other primary sources, the IRS has modified some of the language in Circular 230.

Tax Practice Standards

During the past 25 years, the U.S. tax system has undergone fundamental changes. The complexity of the Internal Revenue Code has dramatically increased since the tax reforms of 1986, which lowered marginal tax rates and somewhat simplified the Code itself. Subsequent legislation and related regulations have increased the system's complexity by adding overlapping provisions that affect both businesses and individuals.

Efforts to revise the penalty administration for both taxpayers and preparers have increased in the past 25 years. Taxpayers have been subject to heightened penalty exposure under Sec. 6662 and related regulations. A preparer should review the tax return position standards for both undisclosed and disclosed tax return positions under the accuracy-related penalty sections of Sec. 6662. Sec. 6662A extends the accuracy-related penalty to listed and reportable transactions.

Sees. 6662 and 6694 now require the same standards for either an undisclosed or a disclosed tax return position. The phrase "tax return position" is not defined in the Code. However, the AICPA's Statements on Standards for Tax Services provide a definition of tax return position for the Institute's members. SSTS No. 1,( 3 ) paragraph la, states in part that "a tax return position is (i) a position reflected on a tax return on which a member has specifically advised a taxpayer or (ii) a position about which a member has knowledge of all material facts and, on the basis of those facts, has concluded whether the position is appropriate." This definition, while enforceable for AICPA members, may also have legal authority in liability cases and under particular state statutes. CPA tax practitioners who advise a client about a tax return position must follow Sec. 6694 (and related administrative pronouncements) in their recommendations to clients.

An undisclosed tax return position, according to Sec. 6694(a)(2), is considered unreasonable unless there is or was substantial authority for the position. Notice 2009-5( 4 ) states that substantial authority has the same meaning as in Regs. Sec. 1.6662-4(d)(2), which is applicable to taxpayers under the accuracy-related penalty regulations. The analysis outlined in Regs. Sec. 1.6662-4(d)(3)(i) for determining whether substantial authority exists is also applicable to Sec. 6694. Additionally, the list of authorities that may be used for purposes of Sec. 6662 is also applicable to preparers under Sec. 6694(a)(2). A tax return preparer is considered to have met the standards of Sec. 6694(a)(2)(A) if the preparer relies in good faith and without verification on the advice of another tax return preparer, adviser, or other party. Regs. Sec. 1.6694-(2)(e)(5) sets forth the factors used in evaluating a return preparer's good-faith reliance on the advice of another.

Disclosed tax return positions that are reported on Forms 8275 or 8275R (in the case of positions contrary to a regulation) are considered reasonable if there is a reasonable basis for the position as provided under Sec. 6662(d)(2)(B)(ii)(l). According to Regs. Sec. 1.6662-3(b)(3), "[r]easonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper." A disclosed position does not include a tax shelter position as defined under Sec. 6662(d)(2)(C)(ii) or reportable transactions described in Sec. 6662A. Any tax shelter or reportable transactions only will be considered reasonable if the return position would more likely than not be sustained on its merits. Practitioners should also note that Notice 2009-5 does not apply to Sec. 6662A. Sec. 6662A has a two-level penalty provision for understatements arising from reportable transactions: a 20% additional penalty for disclosed positions and a 30% additional penalty for undisclosed positions. CPA tax preparers should review Notice 2009-5 and the regulations cited therein for further details about the return preparer rules. The rules in the notice also have provisions that apply to both signing and nonsigning preparers.

CPA tax practitioners should also review the Statements on Standards for Tax Services Nos. 1-7 (with special emphasis on SSTSs No. 1 and No. 7 for tax return positions and client communications). Members who practice at various jurisdictional levels should be aware that the SSTSs apply to all jurisdictions. According to SSTS No. 1, paragraph 5(a), if a taxing authority does not have any written standards for recommending a tax return position or preparing or signing a tax return, or if the taxing authority's standards are lower than the default position (the realistic-possibility standard), a member should not recommend a tax return position or sign or prepare a return "unless the member has a good-faith belief that the position has at least a realistic possibility of being sustained administratively or judicially on its merits if challenged." (Note that the realistic-possibility standard no longer appears in Circular 230.) Members should thus determine what particular standards are imposed by the applicable taxing authority and comply with them when preparing and signing a tax return or recommending a tax return position if the standards are higher than the realistic possibility standard. Notwithstanding this rule, SSTS No. 1, paragraph 5(b), allows a member to prepare or sign a tax return or recommend a tax return position if he or she concludes that there is a reasonable basis for the position and the position is appropriately disclosed.

CPAs should also review the discussion contained in SSTS No. 1 regarding responsibilities to their clients regarding advice about penalties, not playing the audit lottery, and ways to avoid penalties through disclosure. It is...