Editor: Valrie Chambers, Ph.D., CPA
Procedure & Administration
At the request of the IRS Oversight Board, the Treasury Inspector General for Tax Administration (TIGTA) studied how effective the IRS is in using the requirements and penalty regime that apply to tax preparers. The TIGTA study attempted to determine whether controls are in place to ensure that the IRS effectively enforces and applies penalties to paid preparers as required by Sec. 6694 (see Improvements Are Needed in Assessing and Enforcing Internal Revenue Code Section 6694 Paid Preparer Penalties, TIGTA Rep’t No. 2013-30-075).
Paid Preparer Penalty Regime
Sec. 6694 provides penalty standards for paid preparers who take unreasonable positions or intentionally prepare inaccurate tax returns. Specifically, an understatement penalty may be imposed on a tax preparer who prepares a tax return or a claim for refund that shows an understatement of tax liability. The penalty is imposed where any part of an understatement is due to an unreasonable position taken on the return or refund claim and the preparer knew (or reasonably should have known) of the position. The penalty is the greater of $1,000 or 50% of the income earned by the tax return preparer with respect to the return or claim (Sec. 6694(a)(1)). The penalty may also be imposed on the employer of the tax return preparer (Regs. Sec. 1.6694-2(a)(2)).
A position is generally unreasonable if it does not have substantial authority in the tax law. Sec. 6662(d)(2)(B)(ii)(I) requires disclosure of the relevant facts affecting the item’s tax treatment in the return or in a statement attached to the return. However, a position taken with respect to a tax shelter or a reportable transaction must meet the “more likely than not” standard to avoid being classified as unreasonable. This higher standard is met if it is reasonable to believe that the position is more likely than not (greater than 50% chance) to be sustained on its merits if challenged by the IRS. A tax shelter is defined in Sec. 6662(d)(2)(C)(ii). A reportable transaction is one to which Sec. 6662A applies. The possibility that a return will not be audited or, if audited, that an item will not be raised on audit is not relevant in determining whether there is adequate support for a position (Regs. Sec. 1.6694-2(b)).
The understatement penalty is not imposed if there is reasonable cause for the understatement and the tax return preparer acted in good faith (Sec. 6694(a)(3)).
The minimum penalty is increased when a tax return preparer prepares a return or claim for refund with respect to which any part of an understatement of liability is due to (1) a willful attempt in any manner to understate the liability for tax on the return or claim or (2) a reckless or intentional disregard of rules or regulations (Sec. 6694(b)(2)). A preparer willfully attempts to understate liability if he or she disregards information furnished by the taxpayer or other persons in an attempt wrongfully to reduce the tax liability of the taxpayer (Regs. Sec. 1.6694-3(b)). This increased penalty is equal to the greater of (1) $5,000 or (2) 50% of the income derived (or to be derived) by the tax return preparer with respect to the return or claim (Sec. 6694(b)(1)). The penalty described above for an unreasonable position does not apply when the enhanced penalty for willful understatement or reckless conduct applies (Sec. 6694(b)(3)).
The TIGTA Report
TIGTA reviewed a statistically valid sample of 98 closed Sec. 6694 preparer penalty cases from a population of 2,345 cases with penalties totaling $9.35 million that were closed during fiscal years 2009 through 2011. In eight cases, the immediate IRS managers did not properly approve a total of $19,000 in preparer penalty assessments as required. Based on those eight cases, TIGTA estimated that preparers in 191 cases closed for fiscal years 2009 through 2011 may have been improperly assessed $454,643 in penalties.
An additional 31 cases of the 98 reviewed showed only a typewritten manager’s signature on the Form 8278, Assessment and Abatement of Miscellaneous Penalties. Small Business and Self-Employed (SB/SE) Division officials considered this acceptable; however, TITGA said that typed signatures do not meet the intent of Sec. 6751(b), which says that no penalty can be assessed unless the initial determination of the assessment is personally approved in writing by the immediate supervisor. Additionally, TIGTA noted, a typed signature could be challenged in U.S. district court if a case is litigated. The lack of proper approval thus could hinder the IRS’s ability to litigate these penalty assessments successfully if necessary. In response, among other actions, IRS officials issued a memorandum to field offices emphasizing the importance of properly approving in writing the preparer penalty assessment.
TIGTA also looked at the collection of paid preparer penalties in the report. An analysis of the Master File accounts with a Sec. 6694(a) and/or (b) paid preparer penalty assessment through Jan. 14, 2013, identified 2,336 paid preparers with 7,365 penalty assessments that totaled approximately $35.1 million. Those figures included:
- 4,499 assessments of Sec. 6694(b) penalties totaling $32.2 million; and
- 2,866 assessments of Sec. 6694(a) penalties totaling $2.9 million.
The majority of these cases were either paid, being paid, or being actively pursued by the IRS. However, 5% of the total dollar amount, or $1.9 million, had been written off due to the expiration of the collection statute of limitation. An additional 34%, or $11.8 million, assessed in 584 preparer penalty accounts, was marked as currently not collectible. Of those 584 cases, 243 had been suspended because the amounts due were below the IRS thresholds. However, SB/SE Division officials noted that the return preparers in these cases were expected to be current with filing their business and personal returns and paying all new taxes when due.
SB/SE conducted its own review of the collection process and found that, overall, cases were worked properly. The division did, however, identify these issues in the collection process:
- Some revenue officers did not recognize what the preparer penalty represented;
- Revenue officers did not attempt to locate paid preparers who were no longer operating a tax return preparation business;
- A systemic weakness automatically caused tax accounts to suspend;
- There were delays in assigning preparer penalty cases to revenue officers—most cases appeared to take five to seven years between the examination and assignment to a revenue officer;
- Some paid preparers were criminally convicted, released on probation, and unable to pay; and
- Some preparers took their assets and moved out of the country.
In the conclusion of its report, TIGTA said that as Examination and Collection personnel become more familiar with new Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), Section 10.8(c), “Return Preparation and Application of Rules to Other Individuals,” the Office of Professional Responsibility (OPR) should receive more referrals for disciplinary consideration. Examiners now must refer Sec. 6694(b) preparer penalty assessments to OPR. However, to refer a Sec. 6694(a) preparer penalty assessment to OPR, the examiner must show the paid tax return preparer exhibited a pattern of willful intent to understate taxes.
In an issue not directly related to preparer penalties, TIGTA noted that when preparers register for a preparer tax identification number (PTIN), they are subject to suitability tests that include checks on tax compliance and outstanding balances owed, including preparer penalties. Interestingly, the IRS does not have a system in place to check on tax compliance at the time of the PTIN application.
Only 504 PTIN holders had been issued noncompliance notification letters as of November 2012, TIGTA found. These were individuals who owed $100,000 or more, nonfilers who owed more than $50,000, or individuals with three or more nonfiled tax returns. In early 2013, the IRS sent 175 follow-up letters. However, the IRS in April 2013 had verified personal tax compliance of the vast majority of PTIN holders—97% of 929,000 individuals—and was communicating with a sample of the other 3%.
Anecdotal evidence also suggests that the IRS is looking to be more conscientious in assessing preparer penalties, as it has brought up the preparer penalty process in numerous meetings with practitioners across the country in the past year. Perhaps such continuous reminders to paid preparers are the most effective method of enforcing the rules and regulations that govern them.
Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, Texas. Mark A. VanDeveer is with Mark A. VanDeveer PC, Virginia Beach, Va. Mr. VanDeveer is a member of the AICPA IRS Practice & Procedures Committee. For more information about this column, contact Prof. Chambers at email@example.com.