Another new tax law; 2007 Small Business & Work Opportunities Tax Act: good and bad news.

• Author: Josephs, Stuart R.
• Position: Federaltax

The following are selected highlights of the 2007 Small Business and Work Opportunity Tax Act (P.L. 110-28), signed into law May 25, 2007.

Preparer Penalties Expanded and Increased

Old Law: An income tax return preparer was defined as any person who prepared for compensation, or who employs other people to prepare for compensation, all or a substantial portion of an income tax return or refund claim. Therefore, this definition excluded non-income tax return preparers, such as gift, estate, excise or employment tax return preparers.

An income tax return preparer who prepared a return or refund claim, with respect to which there was an income tax understatement that was due to an undisclosed position for which there was not a realistic possibility of being sustained on its merits, or was a frivolous position (even if adequately disclosed), was liable for a $250 first-tier penalty--if the preparer knew, or reasonably should have known, of the position.

A preparer who prepared an income tax return or refund claim and engaged in specified willful or reckless conduct in preparing that return or claim was liable for $1,000 second-tier penalty.

Under Regs. Sec. 1.6694-2(b)(1), a position was considered to have a realistic possibility of being sustained on its merits if a reasonable and well-informed analysis by a person knowledgeable in the tax law would lead such a person to conclude that the position had approximately a one in three, or greater, likelihood of being sustained on its merits (realistic possibility standard).

A frivolous position "was one that was patently improper" [Regs. Sec. 1.6694-2(c)(2)].

New Law: The definition of "preparer" is broadened to include preparers of gift, estate, employment, excise and exempt organization returns.

The new law also alters the standards of conduct that must be met to avoid penalties for preparing a return which has a tax understatement. The realistic possibility standard for undisclosed positions is replaced with a requirement that there be a "reasonable belief" that the tax treatment of the position was more likely than not the proper treatment.

Note: Existing Regs. Sec. 1.6662-4(g)(4), pertaining to tax shelter items of noncorporate taxpayers, states that a taxpayer is considered reasonably to believe that an item's tax treatment is more likely than not the proper treatment if:

* The taxpayer analyzes the pertinent facts and authorities in the manner described in Regs. Sec. 1.6662-4(d)(3)(ii), regarding the nature of analysis for determining whether substantial authority is present, and in reliance upon that analysis, reasonably concludes in good faith that there is a greater than 50 percent likelihood that the item's tax treatment will be upheld if challenged by the IRS, or

* The taxpayer reasonably relies in good faith on a professional tax adviser's opinion--if that opinion is based on the adviser's analysis of the pertinent facts and authorities in the manner described in the preceding "bullet" and unambiguously states that the adviser concludes that there is a greater than 50 percent likelihood that the item's tax treatment will be upheld if challenged by the IRS.

The "not-frivolous" standard, accompanied by disclosure, is replaced with the requirement that there must be a "reasonable basis" for the position's tax treatment accompanied by disclosure.

Note: Existing Regs. Sec. 1.6662-3(b)(3), concerning negligence or disregard of rules or regulations, states that reasonable basis is a relatively high standard of tax reporting, that is significantly higher than "not frivolous" or "not patently improper." The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim. If a return position is reasonably based on one or more of the authorities set forth in Regs. Sec. 1.6662-4(d)(3)(iii) (taking into account the relevance and persuasiveness of the authorities and subsequent developments), the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantial authority standard as defined in Regs. Sec. 1.6662-4(d)(2).

In addition, the first-tier penalty is increased from $250 to the greater of $1,000 or 50 percent of the income derived, or to be derived, by the preparer from preparing the return or claim with respect to which the penalty is imposed.

The second-tier penalty also is increased from $1,000 to the greater of $5,000 or 50 percent of the income derived, or to be derived, by the preparer.

Effective Date: Under the 2007 Act's Section 8246(c), these new rules are effective for tax returns prepared after May 25, 2007.

Transitional Relief: IRS Notice 2007-54 (IRB-27, 7/2/07) relaxes this effective date for:

(1) All returns, amended returns, and refund claims due (with extensions) before 2008;

(2) 2007 estimated tax returns (vouchers) due by Jan. 15, 2008; and

(3) 2007 employment and excise tax returns due by Jan. 31, 2008.

Notice 2007-54 states:

* For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current...