Preparer Penalties: The Thin Line Between Tax Advisor and Return Preparer.

• Author: Amand, Scott St.,

The IRS has issued over 1.8 million preparer tax identification numbers (PTINs) since September 2010. Of these, nearly 700,000 remain active. (1) This number, however, paints only a small portion of the picture, rather like a friendly little bush in the corner of a Bob Ross painting, because anyone can prepare a return. As with many things in life, however, once money is on the table, things get more complicated. If someone is paid to prepare a return or claim for refund, or someone employs a person who is paid to prepare the same, we have crossed the threshold into the regulated world of "tax return preparers." (2) You may be sitting at your desk, diplomas on the wall and leather-bound volumes of the 1939 version of the code on your bookshelf, (3) peering at the title of this article, and musing to yourself that you have never prepared your own tax return, much less anyone else's. You would, more than likely, be wrong. When an attorney renders substantive legal advice or opines on a position that is later adopted by the taxpayer on a tax return or claim for refund or credit, the attorney inadvertently crosses a line of demarcation between attorney and preparer.

Before you append "preparer" to your title on the firm's business cards, "preparer" is not really an honorific, as the IRS does not care about fancy degrees or certifications, (4) nor whether a preparer is not a U.S. person, nor whether the return was prepared outside the United States. (5) Thus, when your cousin Bijou--who left school in Quebec the summer after ninth grade to tour with the Grateful Dead, and serving as the band's bookkeeper for 20 years (a long, strange trip, indeed)--prepares your Uncle Bill's income tax return in exchange for $50 and a case of Molson, Bijou is a preparer. As a preparer, Bijou is subject to substantial responsibilities and rather unpleasant penalties, as we discuss below.

Who is a Tax Return Preparer?

A "tax return preparer" is any person that prepares (for compensation, or who employs one or more persons to prepare for compensation) any "return of tax" under the code or any claim for refund of such tax. (6) As noted in the introduction, anyone may be a preparer. When someone prepares or advises a taxpayer as to a "substantial portion" of the return, he will be considered to have prepared the entire return. (7) Take pause and reread that last sentence. Even if you, as an attorney, do not physically enter numbers on the face of a return, once you render an opinion regarding a "substantial portion" of a return, you have likely branded yourself as a preparer, as weighty label as the scarlet letter that Hester Prynne wore as a mark of her ignominy. (8) What's more, you may have brought your firm with you.

Not everyone will bear this burden. The code provides that someone, who merely provides mechanical or clerical assistance, is not a preparer, (9) nor is someone who prepares a return for his regular employer. (10) If a person prepares a return in their capacity as a fiduciary (11) or in response to a notice of deficiency or an audit, (12) then he, too, will not be considered a preparer. The regulations provide a much longer list of persons who are not preparers. (13)

Preparers are divided into two general categories, "signing" and "nonsigning" preparers. (14) A signing preparer is the person having the primary responsibility for the overall substantive accuracy of the return, (15) whereas a nonsigning preparer is anyone else that prepares all or a "substantial portion" of a return. (16) In general, therefore, only a person who prepares all or a substantial portion of a return will earn the "preparer" moniker. (17) A portion of a return--whether a schedule, entry, or other part--is considered "substantial" if the tax attributable to that portion is substantial in comparison to the total tax required to be shown on the return. The regulations provide a nonexhaustive list of factors, including the size and complexity of the item relative to the taxpayer's gross income. (18)

Critically, a person who renders tax advice relevant to the "existence, characterization, or amount of an entry on a return," as tax attorneys often do, will be considered to have prepared the entry. (19) When that advice leads to a position or entry that constitutes a substantial portion of the return, the advisor rises to the level of preparer. (20)

If Bijou prepared a return for Uncle Bill's emu conservancy (a partnership) in 2020, and Bill prepared his personal return in 2020, Bijou will not be considered the preparer of Bill's individual return unless an item reported on the conservancy's return is directly reflected on the individual return and constitutes a substantial portion of the individual return. (21) Thus, when Bijou reported an incorrect loss on the conservancy's return, and such loss flowed through to Bill's return, Bijou is the preparer of Bill's return. What happens if Bijou took an unreasonable position or was as reckless with Bill's return as he has been known to be while trying to peel off a corner guard when curling under the influence?

Penalty for Understatement Due to an Unreasonable Position

The code imposes a penalty when a preparer adopts an "unreasonable position" or engages in "willful or reckless conduct" in preparing a return, but only if such untoward tax behavior results in an understatement of tax liability. (22) Thus, no matter how badly Bijou bungles Bill's return, if there is no understatement, no preparer penalty can be asserted. (23) If there is an understatement, but it is based on an isolated mathematical or transcription error, a preparer penalty is unwarranted. (24)

When a preparer assumes an unreasonable position, and he or she knew (or should have known) that the position was unreasonable, the preparer will be liable for the greater of $1,000 or 50% of the income earned preparing the return. (25) Tax shelters are an IRS hot button; so, it should come as no surprise that preparers will be liable for taking a position related to tax shelters. (26)

If a preparer takes a position regarding a reportable transaction, he or she must reasonably believe that there is over a 50% possibility that the position would succeed on its merits if examined by the tax authorities, which is to say that it is more likely than not to be sustained. (27) To form this belief, the preparer must examine all pertinent facts and authorities. (28) One "fact" a preparer may not consider when determining the position's chance of success is the possibility that the IRS will never challenge the position. (29)

A preparer also may be liable if the position is not disclosed on the return without substantial authority for adopting it, (30) and he or she may be liable if the...