Changes ... again: putting tax return preparer penalties in perspective.

• Author: Dellinger, Kip
• Position: Preparerpenalties

tax preparers have endured an interesting roller coaster ride over the past 17 months regarding their responsibilities for recommending tax positions when preparing tax returns, or advising clients in the preparation of tax returns.

When the ride coasted to a rather gentle stop with passage of the Emergency Economic Stabilization Act of 2008, tax practitioners were back in familiar territory. In addition, the revised preparer standards for recommending tax positions are generally retroactive and thus replace the initial changes that were effective May 25, 2007, contained in the Small Business and Work Opportunity Tax Act of 2007.

Before the May 2007 legislation, a preparer was subject to a penalty for recommending or taking a nondisclosed income tax return tax position, of which the preparer had, or should have, knowledge where there was not a realistic possibility of success that the position would be sustained on the merits if challenged by the IRS. If a position was disclosed in the return, either as set forth in an annual revenue procedure or on a Form 8275 or 8275-R, the preparer was not subject to penalty if the position was not frivolous.

The taxpayer's standard was a little higher: for a nondisclosed income tax return position--to avoid an accuracy-related penalty--the taxpayer was required to have substantial authority for the tax treatment of the item; if a position was disclosed, the taxpayer was required to have a reasonable basis for the treatment. Authorities to support tax positions are set forth in Treas. Reg. Sec. 1.6662-4 and have remained unchanged for nearly 20 years.

The initial May 2007 change required that a tax preparer have a reasonable belief that a nondisclosed tax position would more likely than not be sustained on the merits if challenged--a higher standard than the taxpayer's substantial authority standard. For disclosed the positions, the tax preparer was required to have a reasonable basis for the position--essentially the same as for the taxpayer.

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The higher tax preparer standard for nondisclosed positions placed the tax preparer in basically untenable conflict with the taxpayer as the preparer might be required to disclose a tax position that the taxpayer would not otherwise have to disclose. Temporary rules in Notice 2008-13 permitted the preparer to make required disclosure for income tax positions to the taxpayer rather than in the tax return (see "A Closer Look". California CPA, March/April 2008).

Proposed regulations under Code Sec. 6694 released in June 2008 continued to permit the disclosure to the client, and not in the return, for income tax positions for which substantial authority existed but where the tax preparer did not believe the more likely than not threshold was met.

The penalty for a violation of the penalty provision was increased from $250 to $ 1,000 or, if greater, 50 percent of the income derived with respect to the return (or amended return). Also, the penalty for a willful...