Sec. 6694 tax preparer penalties: a look at Chapter 11 of the Consolidated Penalty Handbook.

• Author: Gardner, John C.

Since 1976, Congress has enacted a number of preparer, promoter and protester penalties designed both to increase voluntary compliance with the nation's revenue laws and to enable the IRS to better monitor the preparation of income tax returns. These penalties, which are applicable to all return preparers (including CPAs in tax practice), may lead to fines, injunctions, license revocations, and/or referrals to the IRS Director of Practice (the Director), who has the authority to suspend or disbar preparers entitled to practice before the Service. To promote greater consistency in penalty administration, the IRS has consolidated its procedures for penalty enforcement in Chapter 11 of the Consolidated Penalty Handbook, in Part XX of the Internal Revenue Manual (IRM).(1)

The Service has been particularly concerned with violations of Sec. 6694, which prohibits the understatement of tax liability due to an unrealistic return position or to willful, reckless or intentional disregard of the tax laws. In 1993, for example, the IRS Office of Penalty Administration imposed 2,392 preparer penalties under Sec. 6694.(2)

This article examines the return preparer penalty program outlined in the IRM, analyzes the preparer penalty guidelines for Sec. 6694 that appear in the IRM(3) and the regulations, and suggests prudent defensive strategies to enable CPAs and other tax preparers to avoid a Sec. 6694 penalty, or, if one is asserted, to contest it administratively or judicially.

The Return Preparer Penalty Program

The IRM's new penalty chapter attempts to coordinate responsibility for penalty enforcement. IRM (20)(11)11(4) provides that Return Preparer Coordinators (RPCs) at IRS Service Centers, as well as the district, regional and national offices, have been designated to administer and monitor return preparers' activity. IRM (20)(11)16 states that penalty enforcement at Service Centers is limited to screening and processing claims to verify that assessed penalties have been paid; that claims have been properly and timely filed, forwarded to the appropriate district and processed to final determination; and that preparers are notified that their claims have either been abated or disallowed.

IRM (20)(11)12(4) provides that, at the district level, RPCs order and screen returns, accumulate all preparer penalty referrals, summarize these referrals for presentation to a district Penalty Screening Committee,(4) and prepare referrals to the Director. Since the imposition of penalties may also affect the suitability of preparers as electronic filers,(5) under IRM (20)(11)1(12), district RPCs are to notify the Electronic Filing Coordinator of all asserted preparer penalties.

IRM (20)(11)12(4) charges the Penalty Screening Committee with reviewing RPC case files to ensure that penalties are asserted appropriately and accurately. In addition, under IRM (20)(11)17(2) and (6), this committee reviews RPC recommendations to open "program action cases" after identifying a pattern of noncompliance by a particular preparer. If the Director approves the initiation of program action, the district RPC then coordinates the examination of that preparer's returns and/or refund claims.

Under IRM (20)(11)12(2)(d), at the regional level, the RPC monitors the return preparer penalty program, developing procedures and guidelines to ensure "uniformity in the application of the return preparer provisions throughout the region." (Emphasis added.) Although the Assistant Commissioner for Examination may designate a staff member to "functionally" supervise the "examination aspects of the program," this individual is not explicitly charged under IRM (20)(11)12(1) with responsibility for ensuring that preparer penalties are asserted, assessed and abated consistently and uniformly at the national level. This may result in inconsistent administration of the preparer penalty program among the regions.(6)

Role of the Examiner

Tax examinations are typically conducted by revenue agents or office auditors.(7) Whenever an examination is undertaken, examiners are required to make an initial determination whether the preparer has violated any of the return preparer penalty provisions. IRM (20)(11)13(1) provides that, only after determining that "sanctions against the preparer are warranted," based on the facts and circumstances of the examination, are examiners to open preparer penalty cases. Examiners may also recommend that the district RPC initiate program action against preparers whose returns indicate a pattern of noncompliance.

Because a preparer penalty case is regarded as independent of the income tax case, the tax examination must usually be completed at the group level before the examiner may propose the assertion of a preparer penalty.(8) Unagreed tax cases must be submitted at the group level before a preparer penalty may be pursued. However, IRM (20)(11)13(3) and (4) indicate that if the preparer case cannot be separated from the tax examination, both may be pursued at the same time. IRM (20)(11)13(2) generally cautions examiners to limit any discussion of preparer penalties during the examination to the development of facts to determine the applicability of a penalty. However, IRM (20)(11)36(1)(b)2 is more explicit when penalties under Secs. 6694 and 6695 may be involved. Examiners are not to propose or discuss conduct penalties per se in the taxpayer's presence.

Limitations Periods, Claims and Appeals

Claims and appeal procedures for preparers assessed penalties under Sec. 6694 are handled differently from those assessed under other sections. In all penalty cases, however, the IRM indicates that examiners will not submit cases to the IRS Appeals Office (Appeals) if there are fewer than 120 days remaining before the statute of limitations expires, without first soliciting an extension of the period.

Sec. 6696(d)(1) provides that, for penalties asserted under Sec. 6694(a), the penalty is to be assessed within three years after the return or refund claim with respect to which the penalty is assessed was filed. The IRM advises obtaining consent to extend the period when there is insufficient time (generally, fewer than 180 days remaining in the period) to complete the examination. However, IRM (20)(11)19 and (20)(11)81-83 caution examiners that extending the statutory period on a taxpayer case using Form 872, Consent to Extend the Time to Assess Tax, does not extend the statute for preparer penalty cases. To extend that period, the IRS can use Form 872-D, Consent to Extend the Time on Assessment of a Tax Return Preparer Penalty; separate consents are needed for each year being considered. Consents are unnecessary when penalties are asserted under Sec. 6694(b), since there is no statute of limitations for this violation. Nor is there a statutory limit on the IRS's ability to initiate an injunction under Sec. 7407 when the preparer's conduct is subject to a Sec. 6694 penalty.

For Sec. 6694, preparers may use Form 6118, Claim of Income Tax Return Preparers, to file a claim for refund of penalty. Under IRM (20)(11)15(2), the preparer has the option of paying 15% of the penalty and filing a claim for refund within 30 days after the date of notice and demand for payment, or paying the entire penalty assessed and filing a claim for refund within three years of the date the penalty is paid.

If the preparer chooses to pay 15% of a Sec. 6694 penalty, under IRM (20)(11)15(2)(d), the IRS will suspend collection of the balance until the earlier of 30 days (1) after the claim for refund has been denied or (2) from the period ending six months after the preparer files the claim. According to IRM (20)(11)15(e), collection can also be suspended until "final resolution of the proceeding" if the preparer files suit in district court for the determination of the penalty within either 30-day period. IRM (20)(11)15(f) provides that all refund claims for penalties entirely paid, or for abatement of penalties assessed but not paid in full, are sent to the RPC at the appropriate Service Center.

Denials of claims for refund or abatement of Sec. 6694 penalties may be appealed administratively to Appeals. Because of the interrelationship between the penalty and the income tax case, unagreed penalty cases will not be sent to Appeals until the unagreed tax deficiency case is submitted. If the two cases are submitted separately, moreover, IRM (20)(11)14(2)(a) provides that the case file for the proposed preparer penalty will include information on the location and current status of the related taxpayer file.

The IRM, citing Regs. Sec. 1.6694-4(a)(1), identifies the stages of its administrative preassessment appeals procedure. Preparers are sent a 30-day letter informing them of their appeal rights; the penalty is assessed if the preparer does not respond. The preparer may request, and will be granted, a preassessment appeal of penalties asserted under Sec. 6694. Under IRM (20)(11)14(b), postassessment appeal procedures will also apply when the District Director has assessed a Sec. 6694(a) penalty to avoid the expiration of the statutory period for assessment.

Referrals to the Director

CPAs, enrolled agents and licensed attorneys are permitted to practice before the Service and are subject to additional standards of conduct and sanctions that generally do not apply to other commercial preparers. Practice before the Service includes "all matters connected with presentation to the IRS relating...