Legislation Tightens CPA Responsibility for Tax Returns

Legislation Tightens CPA Responsibility for Tax Returns

By Melissa A. Reinbold, CPA, MST

Recent legislation has amended the Internal Revenue Code (IRC) provisions regarding the liability of income tax return preparers. The Internal Revenue Service (IRS) has since issued guidance on the amended provisions. Author Melissa Reinbold provides an overview of the changes, including the new definition of tax return preparers, the increased penalties, and their implications for taxpayers.

Enacted this past May, the Small Business and Work Opportunity Tax Act of 2007 amends several IRC provisions addressing tax return preparer liability. The act extends the penalties under IRC Section 6694 to all tax return preparers, tightens the standard for avoiding penalties, and increases the penalties. The amendments were to become effective for tax returns prepared after May 25, 2007, but IRS Notice 2007-54 provides some transitional relief.

Defining “Tax Return Preparer”
Previously, IRC Section 6694 applied to “income tax return preparers,” defined as “any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of [income taxes] or any claim for refund of [income taxes].” The amendments extend the provisions' penalties to a broader class of returns.

The amendments apply to all “tax return preparers.” According to the IRS, the term encompasses preparers of all tax returns, amended returns, and claims refunds. Thus, it also covers preparers of estate and gift tax returns, generation-skipping transfer tax returns, exempt organization returns, employment tax returns, and excise tax returns.

Standard of Conduct
Prior to the amendments, the penalty under Section 6694 was triggered by the understatement of tax liability due to an undisclosed tax position for which “there was not a realistic possibility of being sustained on its merits.” Generally, a tax return preparer was required to disclose any tax position with less than a 33-percent possibility of being upheld if audited by the IRS. If such a position was not disclosed or if the position was frivolous, the preparer could be subject to penalty.

The amendments change that standard. A penalty can be imposed for an undisclosed position if “there was not a reasonable belief that the position would more likely than not be sustained on its merits.” To avoid a preparer penalty, the nondisclosed tax positions must meet a more than 50-percent chance of being sustained.

Increased Penalties
Under the previous statutory scheme, a violation of the standard would result in a $250 penalty per return or refund claim. The amendments increase the penalty to the greater of $1,000 or 50 percent of the income derived (or to be derived) from the preparation of the return or claim.

The amendments also increase the penalty for a preparer’s willful attempt to understate liability or reckless or intentional disregard of rules or regulations. The penalty has jumped from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the preparer in connection with the return or claim.

Transitional Relief
The IRS notice provides transitional relief from the first level of penalty changes — the increase from $250 to $1,000 or 50 percent of income earned. The increase will not apply to: 1) all returns, amended returns, and refund claims due on or before Jan. 1, 2008 (determined with regard to any filing extension); 2) 2007 estimated tax returns due on or before Jan. 15, 2008; and 3) 2007 employment and excise tax returns due on or before Jan. 31, 2008. No transitional relief is granted for willful or reckless conduct; the penalty increase became effective immediately.

What to Expect
Under the amendments, tax preparers are now subject to more stringent standards regarding understatement than taxpayers themselves. The disparity could create a conflict over tax positions that fall between the 33-percent and 50-percent standards, with the preparer pushing to disclose such positions.

The amendments also could result in further analysis of tax positions and increased documentation related to tax positions.

Comparison of Section 6694 Provisions
Provision	Previous Rule	New Rule
Preparer threshold for signing tax return without disclosure under Section 6694(a)	Realistic possibility standard (over 33 percent certain position will be sustained)	More-likely-than-not standard (over 50 percent certain position will be sustained)
Unreasonable position penalty under Section 6694(a)	$250 per tax return	Greater of $1,000 or 50 percent of tax return preparation fee
Willful and reckless conduct penalty under Section 6694(b)	$1,000 per tax return	Greater of $5,000 or 50 percent of tax return preparation fee
Type of tax returns subject to the penalties	Income tax returns	Income and nonincome tax returns

Melissa A. Reinbold is an executive specializing in taxation for financial institutions with Crowe Chizek and Company LLC in Oak Brook, Ill. She can be reached at 630.586.5244 or mreinbold@crowechizek.com.

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