TaxPractice
&Procedures
New Rules for Disclosure and Use of Tax Return Information by Tax Return Preparers • Partnership Returns: Late Filing Penalties Increase • Preaching Tax Compliance • Closing Agreement Inapplicable to Successor in Interest
Editor:
John L. Miller, CPA
Faculty Instructor
Metropolitan Community College
Omaha, NE
Mr. Miller is a member of the AICPA Tax Division’s IRS Practice and Procedures Committee. Mr. Dolan is chair of that committee, and Messrs. Keenan, Snow, and Starkman are committee members. For further information about this column, contact Mr. Miller at johnmillercpa@cox.net.
New Rules for Disclosure and Use of Tax Return Information by Tax Return Preparers
Sec. 7216 imposes criminal penalties on tax return preparers who knowingly or recklessly make unauthorized disclosures or uses of information furnished to them in connection with the preparation of an income tax return. Return preparers can also be subject to civil penalties under Sec. 6713 for disclosures or uses of information unless an exception under Sec. 7216(b) applies. Newly finalized regulations should prompt all return preparers to evaluate their processes to ensure that they conform to the new requirements (TD 9375). The new regulations apply to disclosures or uses of tax return information occurring on or after January 1, 2009.
History
Sec. 7216 was originally enacted by the Revenue Act of 1971, P.L. 92-178. In 1988, Congress modified the section by limiting the criminal sanctions to knowing or reckless unauthorized disclosures (P.L. 100-647) and enacted the civil penalty now found at Sec. 6713.
The IRS published proposed regulations under Sec. 7216 in 1972 and final regulations in 1974 (TD 7310). For the next 31 years only minimal amendments were made to that portion of the regulations that authorized return preparer disclosures without requiring explicit consent from the taxpayer.
In December 2005, the IRS published proposed regulations (REG-137243-02) and a proposed revenue procedure (Notice 2005-93) designed to provide guidance to preparers about the form and content of required disclosures. A public hearing took place in April 2006, during which numerous comments were received from a wide range of constituencies.
On January 7, 2008, the IRS published final regulations (TD 9375) and a related revenue procedure (Rev. Proc. 2008-12) concerning the disclosure and use of tax return information by return preparers. On that same day, the IRS also published an advance notice of proposed rulemaking (REG-136596-07), inviting comments on the rules that ought to apply to refund anticipation loans and similar instruments.
Significance of Sec. 7216 Changes
The final regulations are organized into three primary sections. The first deals with overall rules and definitions (Regs. Sec. 301.7216-1). A second section addresses those disclosures and uses that may be authorized without the taxpayer’s explicit consent (Regs. Sec. 301.7216-2). The third major section outlines those circumstances in which explicit consent must be made for particular types of disclosure and use (Regs. Sec. 301.7216-3).
General rules: The changes to Regs. Sec. 301.7216-1 relate primarily to the modernization of the regulations’ definitions to account for the roles, relationships, and activities that relate to electronic filing. For example, the new definition of tax return information—subject to the disclosure and use restrictions—includes information that:
- The preparer derives or generates from the tax return information in connection with preparation of a return;
- The preparer receives from the IRS in connection with processing returns; or
- Is a statistical compilation of tax return information, even in a form that cannot be associated with, or otherwise identify, a particular taxpayer.
Information furnished by the taxpayer for purposes of engaging a tax preparer to prepare a tax return is also considered return information and is therefore subject to the limitations imposed by the regulations (Regs. Sec. 301.7216-1(b)(3)). The regulations define disclosure as the act of making tax return information known to any person in any manner whatever and includes as an example the instance in which a taxpayer’s use of a hyperlink results in the transmission of tax return information (Regs. Sec. 301.7216-1(b)(5)).
Permissible disclosures: In general, permissible disclosures are identified under Regs. Sec. 301.7216-2. Several of these provisions are changed significantly from the old regulations.
- In recognition of the increased use and reliance on software for return preparation, a tax return preparer is permitted to use return information to update the taxpayer’s software to address changes in IRS forms and e-file specifications (Regs. Sec. 301.7216-2(c)(1)).
- Tax return preparers within the same firm in the United States may use or disclose information within the firm to assist in the preparation of, or the provision of auxiliary services in connection with, return preparation. Note, however, that any disclosure or use of tax return information outside the country requires the specific consents as defined under Regs. Sec. 301.7216-3. The restrictions on movement of information outside the United States that are embodied here and elsewhere in the regulations are among the most notable substantive changes in the new rules (Regs. Sec. 301.7216-2(c)(2)).
- Disclosure may be made to another preparer located within the United States as long as the services provided are not substantive determinations or advice affecting the tax liability reported by the taxpayer. In response to a commentator’s request for clarification, the regulations define a substantive determination as one that “involves an analysis, interpretation, or application of the law” (Regs. Sec. 301.7216-2(d)).
- Generally a tax return preparer who is lawfully engaged in the practice of law or accountancy and prepares a tax return may use the taxpayer’s information or disclose it to another officer, employee, or member of his or her firm in order to provide other legal or accounting services to the taxpayer. Note, however, that the new rule applies only to disclosures and uses within the United States and that for purposes of the rule, a tax return preparer’s law or accounting firm does not include any related or affiliated firms (Regs. Sec. 301.7216-2(h)(1)(ii)).
- A list of names, addresses, e-mail addresses, and phone numbers of the return preparer’s clients may be compiled and maintained by the preparer for the sole purpose of offering tax information or additional tax return preparation ser-vices to such taxpayers (Regs. Sec. 301.7216-2(n)). Similarly, certain statistical compilations may be produced by return preparers as long as such information relates directly to the preparers’ return preparation business (Regs. Sec. 301.7216-2(o)).
Disclosure and uses permitted only with taxpayer’s consent: Unless disclosure or use is specifically authorized in some other section of the regulations, a tax return preparer may not disclose or use a taxpayer’s tax return information prior to obtaining a written consent from the taxpayer in the method described in Regs. Sec. 301.7216-3.
The form and content of taxpayer consents is specified within the regulation. Rev. Proc. 2008-12 prescribes additional requirements for taxpayer consents that relate to Form 1040 series filers. Treasury and the IRS received many comments related to the disclosure of information outside the United States. Lawyers and accountants advanced the view that no special consents should be required, especially in the case of their multinational clients, because, in the view of the commentators, those clients expect their tax information to be disclosed and used wherever and whenever necessary to fulfill the tax engagement. While the final regulation acknowledges this reality to some extent, it basically creates two unique consent regimes—one for Form 1040 series filers and another for all other types of returns.
When required to obtain consent for disclosure or use of tax return information from a Form 1040 series filer, the consent must comply with the specifications set out in Rev. Proc. 2008-12. In general those requirements include:
- A taxpayer’s consent to each separate disclosure or use of tax return information must be contained on a separate written document that can be furnished on paper or electronically.
- A consent furnished to the taxpayer on paper must be of a size specified in the revenue procedure, and all the text of such consent must pertain solely to the disclosure or use for which consent is being granted. Similar rules are included for consents secured electronically.
- The specific purpose of a disclosure as well as the specific recipients of all disclosures must be identified (see Regs. Sec. 301.7216-3(a)(3)(i)(B)).
- Rev. Proc. 2008-12 also includes significant sections of mandatory language that must be included in all Form 1040 series consents. This language makes clear that nothing can be disclosed without the consent and that the taxpayer is not required to complete the consent. All consents must require the taxpayer’s affirmative consent to a disclosure or use of tax return information—“opt-out” type provisions are not permissible.
The provisions applicable to consents for disclosure and use of return information from all other types of returns are less prescriptive. Such consents may generally be in any format, including an engagement letter to a client. In lieu of the requirement to identify specific recipients of intended disclosures, a consent related to a non-1040 series return may allow disclosure to a descriptive class of entities engaged by a taxpayer or the taxpayer’s affiliate for services in connection with the preparation of tax re-turns, audited financial statements, or other financial statements or financial information as required by a government authority, municipality, or regulatory body (Regs. Sec. 301.7216-3(a)(3)(iii)).
An Unexpected Challenge
A provision not in the original proposed version of the regulations is spurring considerable anxiety within the return preparation industry. Under the final regulations, preparers may not obtain a taxpayer’s consent to disclose his or her Social Security number (SSN) to a tax return preparer located outside the United States (Regs. Sec. 301.7216-3(b)(4)). Consequently, many return preparers who have operations offsite or who prepare expatriate returns will be required to fundamentally alter their current work processes and systems. Most income, credit, and deduction data that routinely flow to taxpayers—and to their preparers—are identified both by name and SSN, and many return preparation control systems rely on the SSN. Data and documents are typically organized under the client/taxpayer’s SSN. Treasury and the IRS have invited comment on the regulations during the period prior to their January 1, 2009, effective date, and it is expected that preparers will raise questions and concerns on the extent to which the SSN provision complicates effective business and data security processes.
From Michael P. Dolan, J.D., KPMG, Washington, DC
Partnership Returns: Late Filing Penalties Increase
Late 2007 legislation brought changes to Sec. 6698, which provides for penalties against a partnership for filing a late or incomplete return. The civil penalty under Sec. 6698 applies when a partnership fails to file a complete Form 1065, U.S. Return of Partnership Income, by the due date of the return, including extensions. The penalty may be assessed on a timely filed return if the IRS determines that the return fails to show the information required under Sec. 6031 (related to gross income, deductions, and credits).
Under prior law, the penalty was calculated by multiplying $50 times the number of partners in the partnership during the year for each month, including fractional months, the return was late or incomplete. However, the coverage period was limited to five months. For example, if a partnership consisting of three partners for the entire year failed to file an extension request for the 2005 tax year and ultimately filed Form 1065 on October 15, 2006, the maximum penalty under Sec. 6698 would be $750 ($50 3 3 3 5) because the total number of months considered was limited to five.
Mortgage Forgiveness Debt Relief Act of 2007
The Mortgage Forgiveness Debt Relief Act of 2007, P.L. 110-142 (MRA), increased the per-partner penalty amount from $50 to $85. The coverage period was also increased from 5 months to a maximum of 12 months. Thus, ignoring the provisions of the Virginia Tech Victim’s Relief Act discussed below, the new maximum penalty for a late filed Form 1065 using the same number of months and partners as in the above example would be $1,785 ($85 3 3 3 7). This is an increase of 238% over the above example resulting from both the in-creased penalty amount and two additional months of consideration. Expanding on this, if the return was filed beyond the new 12-month consideration period, the maximum penalty would be $3,060 ($85 3 3 3 12). This is a significant increase over the previous maximum penalty (for a three-partner partnership) of $750.
These two changes to Sec. 6698 under the MRA apply to returns required to be filed after December 20, 2007, the enactment date of the act.
The legislation also adds a penalty for late filed S corporation returns that is essentially equivalent to the increased partnership penalty (see below). Prior to the MRA, no statutory penalty existed for late filed S corporation returns.
Virginia Tech Victim’s Relief Act
The Virginia Tech Victim’s Relief Act, P.L. 110-141 (VTVR), increased the dollar amount under Sec. 6698(b)(1) by $1. However, this increase is limited to returns filed for years beginning in 2008. Thus, for tax years beginning in 2008, the per-partner penalty for filing a late or incomplete partnership return will be $86 per partner for a maximum of 12 months. The provisions of the VTVR are effective for and limited to returns for tax years beginning in 2008.
Reasonable Cause Relief
If a partnership is able to show that the failure to timely file a complete return is due to “reasonable cause,” then the provisions of Sec. 6698 will not apply. The Internal Revenue Manual states that a “taxpayer may establish reasonable cause by providing facts and circumstances showing the taxpayer exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless was unable to comply with the law” (IRM Section 20.1.1.3.1.2).
Section 20.1.1.3 of the IRM provides guidance on what may constitute reasonable cause, which may include but is not limited to:
- Death or serious illness of the taxpayer;
- Fire, casualty, or natural disaster;
- Inability to obtain necessary records;
- Reliance on a competent tax ad-viser; and
- Erroneous advice from the IRS.
Rev. Proc. 84-35
Rev. Proc. 84-35 provides a reasonable-cause safe harbor for certain small partnerships. Under this procedure, a domestic partnership composed of 10 or fewer partners, each of whom is a natural person (other than a nonresident alien) and each of whom has fully reported his or her share of the income, deductions, and credits of the partnership on timely filed income tax returns, is considered to have met the reasonable cause test and is not subject to the penalty under Sec. 6698.
If a partnership of 10 or fewer partners fails to qualify for relief under Rev. Proc. 84-35, the partnership may still show reasonable cause for failure to file a timely and complete return (Rev. Proc. 84-35, §3.03).
It should be noted that in 2005, the Treasury Inspector General for Tax Administration (TIGTA) called for stronger penalties for late filed or incomplete partnership returns. Among the recommendations was the repeal of Rev. Proc. 84-35. Citing congressional intent, the Service disagreed, so small partnerships may still avail themselves of the safe-harbor provisions of Rev. Proc. 84-35. However, many of the recommendations in the 2005 TIGTA report were, at least partially, addressed in the MRA.
S Corporations
The MRA added Sec. 6699, which imposes a monthly penalty for any failure to timely file a complete S corporation return. The provisions of Sec. 6699 mirror those of Sec. 6698 as to the amount ($85) per shareholder and coverage period (12 months). The new penalty is effective for returns required to be filed after December 20, 2007. However, the additional $1 per partner for 2008 partnership returns does not apply to the shareholders included on Form 1120S, U.S. Income Tax Return for an S Corporation.
Because Rev. Proc. 84-35 was issued prior to any statutory penalty for the late or incomplete filing of Form 1120S, practitioners must wait to see if the Service provides the same automatic relief to small S corporations.
Summary
While partnerships, and now S corporations, may still avoid penalties for the late or incomplete filing of returns by demonstrating reasonable cause, failure to do so may result in an increase in assessed penalties. Practitioners should take due care to ensure that extension requests are timely filed and should maintain evidence of their timely filing. Due to the increased penalty rate, practitioners should also advise their clients to maintain evidence of the timely filed (including extension) complete returns.
From Danny Snow, CPA, Thompson Dunavant PLC, Memphis, TN
Preaching Tax Compliance
Sec. 501(c)(3) restricts charities from influencing legislation or intervening in any political campaign or from benefiting insiders through private inurement. Ministers must tread carefully to prevent their preaching from crossing into politics. This issue defined a recent tax conflict involving All Saints Episcopal Church in Pasadena, California.
The conflict highlighted the vagueness of the rules governing what is acceptable, the cost that a church may have to incur in defending itself, and the possible element of political persecution.
The safest course for a minister is to not preach about anything political. However, drawing a line against political speech is difficult, especially when the organization feels its primary mission is at stake.
Facts
All Saints Episcopal Church in Pasadena is one of Southern California’s largest and most liberal churches, with 3,500 members. On October 31, 2004, the Rev’d George F. Regas delivered a sermon titled, “If Jesus Debated Senator Kerry and President Bush.” In the sermon, he depicted Jesus taking both candidates to task for their positions on war, poverty, and abortion. It appeared to be a typical All Saints antiwar, anti-poverty, and pro-choice sermon. But it came just two days before the presidential election. Though it castigated both candidates and endorsed neither, it was interpreted by some as being a bit harder on President Bush. An IRS employee read about the sermon the following day in the Los Angeles Times, and by June 2005, a probe had been initiated.
Sec. 7611 Restrictions
Church inquiries and examinations are restricted by Sec. 7611, which requires a reasonable belief by “an appropriate high-level Treasury official,” based on “facts and circumstances recorded in writing,” that the church may be carrying on an unrelated trade or business or may not be tax exempt as a church. The items identified as potential offenses must be explained in a notice to the church of IRS concerns. Such an inquiry would provide the church with an opportunity for a conference with regional counsel at which it might dispel IRS concerns.
Only after meeting these requirements can a formal IRS examination begin. Such an examination can only review records germane to determining whether the organization has an unrelated business income tax liability or is entitled to tax exemption as a church. The examination must be completed within two years, and, absent special circumstances, a church cannot be examined again for five years (Secs. 7611(c), (f)).
Otherwise, churches are subject to the same restrictions as any other tax-exempt organization. If violations are found, Sec. 4955 specifies penalties against both the organization and its management. Auditing a church is a serious matter, and unless there is unrelated business income, real or imagined political persecution is sometimes inferred.
IRS Investigation
All Saints could probably have negotiated with the IRS to drop its investigation in exchange for an advisory letter rather than risk revocation of its tax-exempt status. Instead, the church decided to challenge the IRS. It hired former IRS Exempt Organizations Director Marcus Owens to represent it and started a publicity campaign. All Saints argued that it had engaged in free speech and had a history of being “boldly political without being partisan.” It complained that the IRS position that the sermon constituted intervention in a political campaign would effectively prohibit the church from preaching its core values in connection with political issues. Marcus Owens asked whether a pastor might discuss “thou shalt not kill” in the context of the present Iraq war without adverse tax consequences (letter to IRS Exempt Organization Specialist Pat Schneiders, December 13, 2005).
An indefinite decision: After a prolonged dispute, the IRS announced in September 2007 that it was dropping the investigation, while at the same time declaring victory. It said that the October 2004 sermon ap-peared to be the only time the church had intervened in a campaign and that the church had policies to prevent partisan political activity. The Service recommended that the church tell future guest speakers about the policy and that it be careful about posting references to political candidates on its website (2007 TNT 186-24, Doc. 2007-21641, September 10, 2007). Fr. Regas’s sermon is still posted at www.allsaints-pas.org/sermons/(10-31-04)%20If%20Jesus%20Debated.pdf.
There is no bright-line guidance from the IRS on this topic, so confusion reigns. How much political speech is allowed? The answer may be, as much as the political atmosphere will tolerate, because no one really knows. IRS Pub. 1828, Tax Guide for Churches and Religious Organizations, notes that church leaders are “[not] prohibited from speaking out about important issues of public policy . . . [but] cannot make partisan comments in official organization publications or at official church functions.” But no clear definition of “partisan comments” is provided, leaving it up to churches to try to conform to an indefinite directive.
Conclusion
The rules about what a church may preach on politics are quite vague. The best advice is caution. When the IRS pursues a church that is alleged to have engaged in political speech, there are audit protections that should be aggressively pursued (see Regs. Sec. 301.7611-1), tempered by the possibility of reaching a settlement through an advisory letter of reprimand. In addition, the cause of the audit should be determined as well as any political angle that might be exploited. The church should also be prepared to pay potentially steep professional fees: All Saints spent $275,000 in successfully challenging the IRS.
From Jay Starkman, CPA, Sole Practitioner, Atlanta, GA
Closing Agreement Inapplicable to Successor in Interest
The Service recently issued a Chief Counsel advice (CCA 200802031) that highlights one of the limitations the Service places on the use of closing agreements and serves as a good reminder for practitioners to be aware of those limitations.
In the CCA, the IRS addressed whether a closing agreement that sought to bind the Service and the taxpayer for taxable periods ending after the date of the agreement was valid. The Service concluded that the IRS appeals officer who executed the closing agreement on behalf of the IRS did not have the proper authority to bind the government for taxable periods ending after the date of the agreement. Therefore, the Service determined that the taxpayer could not take advantage of the tax treatment set forth in the closing agreement for those taxable periods subsequent to the date of the closing agreement.
Facts
Although the facts in the CCA are heavily redacted, it appears that the owners of a property and the IRS reached an agreement as to the deductibility of certain costs associated with the property. The parties executed a Form 906, Closing Agreement on Determination Covering Specific Matters, that set forth a defined amount of deduction that could be taken by each of the owners over certain tax years. The closing agreement covered tax periods before and after the date of the agreement. It was executed by the owners of the property and the local IRS Appeals Office chief. Subsequently, the owners sold the property to the taxpayer, who sought to take the deductions agreed on in the closing agreement as a successor in interest.
Tax Periods Covered by a Closing Agreement
Sec. 7121 authorizes the Service to enter into a closing agreement with any person relating to tax liabilities of that person for any taxable period. Regulations under Sec. 7121 set forth matters that can be addressed in a closing agreement. For tax periods ending prior to the date of the closing agreement, Regs. Sec. 301.7121-1(b)(2) states:
Closing agreements with respect to taxable periods ended prior to the date of the agreement may relate to the total tax liability of the taxpayer or to one or more separate items affecting the tax liability of the taxpayer, as, for example, the amount of gross income, deduction for losses, depreciation, depletion, the year in which an item of income is to be included in gross income, the year in which an item of loss is to be deducted, or the value of property on a specific date.
For taxable periods ended subsequent to the date of the closing agreement, Regs. Sec. 301.7121-1(b)(3) states:
Closing agreements with respect to taxable periods ending subsequent to the date of the agreement may relate to one or more separate items affecting the tax liability of the taxpayer.
As the above guidance shows, a closing agreement that covers tax years subsequent to the date of the closing agreement is not necessarily invalid.
Separate Items Covered by a Closing Agreement
Administratively, the IRS has placed some limitations on the use of closing agreements. Rev. Proc. 68-16, §3.02, states that with respect to tax periods ending prior to the date of a closing agreement, the closing agreement can determine the taxpayer’s total tax liability for a specific type of tax for such periods, or the closing agreement can determine separate items that make up the tax liability. For tax periods that end after the execution of the closing agreement, the agreement cannot determine the full amount of the tax liability for that period, but it can determine one or more separate items affecting the taxpayer’s tax liability. See also Regs. Secs. 301.7121-1(b)(2) and (b)(3). Included among the “separate items” that can be the subject of a closing agreement are the amount of gross income, deduction for losses, depreciation, depletion, the year in which an item of income is to be included in gross income, the year in which an item of loss is to be deducted, or the value of property on a specific date (Regs. Sec. 301.7121-1(b)(2)).
The following example set forth in Regs. Sec. 301.7121-1(b)(4) illustrates the concept of addressing a separate item in a closing agreement covering future periods:
A owns 500 shares of stock in XYZ Corporation which he purchased before March 1, 1913. A is considering selling 200 shares of such stock but is uncertain as to the basis of the stock for the purpose of computing gain. Either prior or subsequent to the sale, a closing agreement may be entered into determining the market value of such stock as of March 1, 1913, which represents the basis for determining gain if it exceeds the adjusted basis otherwise determined as of such date. Not only may the closing agreement determine the basis for computing gain on the sale of the 200 shares of stock, but such an agreement may also determine the basis (unless or until the law is changed to require the use of some other factor to determine basis) of the remaining 300 shares of stock upon which gain will be computed in a subsequent sale.
The example provides that closing agreements may be used to determine the basis of shares of stock even if a sale is prospective. Thus, this example makes clear that a closing agreement can apply to a future event. It is important to note, however, that the binding determination is made due to the nature of a past transaction, which must be applied to future years, to ensure the accurate determination in the future years. It does not apply to future transactions that have no connection to the past or have not yet occurred.
Delegation of Authority
Because closing agreements are legislatively authorized agreements that bind the government, the person who signs the agreement for the government must have been delegated the authority to do so.
In the CCA, the Service noted that under Delegation Order No. 97, the local Appeals Office chief only has the delegated authority to make an agreement with a taxpayer regarding “a taxable period or periods ended prior to the date of the agreement and related specific items affecting other taxable periods.” Therefore, although a closing agreement may cover tax periods before and after the agreement date, the delegation authority granted under Delegation Order No. 97 does not entirely cover tax periods after the date of agreement. The authority under that order for tax periods after the date of agreement is limited to specific items. As discussed above, those specific items should stem from past transactions whose determination affects the taxpayer’s tax liability in the future.
According to the CCA, the deductions arising from the specific items covered in the closing agreement were not related to past transactions. Instead, the deductions related to activities that were ongoing during the time frame of the agreement. Therefore, because the transactions involved were not in the nature of related specific items and the local Appeals Office chief lacked the authority to expressly bind the Service for future years, the closing agreement did not bind the IRS for taxable periods subsequent to the date of the agreement.
Conclusion
This CCA highlights the need for taxpayers and their representatives to be aware of the limitations on the Service’s use of closing agreements. It is not enough to review the tax periods and the operative provisions of the closing agreement. It is imperative that taxpayers and their advisers ensure that the IRS employee executing the closing agreement has been delegated the authority to execute the agreement and to enter into a closing for the years covered by the agreement. Although the terms of the closing agreement being analyzed in the CCA indicated that the agreement covered tax periods before and after the date of the agreement, the Service determined that the agreement did not bind the IRS for taxable periods subsequent to the date of the agreement because the local Appeals Office chief lacked the appropriate authority to bind the government.
From John Keenan, J.D., and Vibhuti Patel, J.D., Deloitte Tax LLP, Washington, DC
This item does not constitute tax, legal, or other advice from Deloitte Tax LLP, which assumes no responsibility with respectto assessing or advising the reader as to tax, legal, or other consequences arising from the reader’s particular situation.
