Disclosure under the preparer penalty prop. regs.

• Author: Galvin, Karen E.

On June 16, 2008, the IRS issued proposed regulations (REG-129243-07) on tax return preparer penalty standards that it hopes to have finalized by the end of the year. The proposed regulations amend existing regulations to take into account the provisions in the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28 (SBWOTA). A result of increased IRS scrutiny of the number of fraudulent tax returns and tax return preparers engaged in abusive practices, these regulations are relevant to tax return preparers who know or reasonably should know of unreasonable tax return positions.

The proposed regulations address IRS areas of concern to (1) provide for a broader definition of income tax preparer; (2) amend standards of conduct that must be met to avoid tax return preparer penalties; and (3) provide for higher penalty amounts for return positions that result in an understatement of tax. The IRS would like to finalize these regulations by the end of 2008 so that final regulations will apply to returns prepared beginning in 2009. (For an in-depth discussion of the proposed regulations, see Tillinger, "An Analysis of the New Preparer Penalty Proposed Regulations," on p. 576.)

Standards of Conduct

The proposed regulations amend the standards of conduct that must be met to avoid imposition of the tax return preparer penalties for disclosed and undisclosed tax return positions. The standards as discussed below differ depending on whether a return position is disclosed or undisclosed within the tax return.

For a disclosed return position, the tax return preparer may avoid a penalty for understatement of tax if there is a reasonable basis for the disclosed position. For an undisclosed return position, the tax return preparer may avoid penalty only if the preparer has a reasonable belief that the position would more likely than not (MLTN) be sustained on its merits, which translates into a more than 50% chance of being sustained.

The MLTN standard imposed on the tax return preparer for an undisclosed return position is stricter than the standard imposed on the taxpayer (substantial authority). There is the potential for a conflict of interest for the tax return preparer who wishes to advise a client on a return position but does not want to be subject to penalties for a return position that the client ultimately decides to report on the return. However, under the proposed regulations, a tax return preparer can file a return without disclosure...