Preparer Penalties • Tax Gap

Editor and Author:
Jeffrey R. Hoops, CPA
Partner
Ernst & Young LLP
New York, NY

Mr. Hoops chairs the AICPA Tax Division’s Tax Executive Committee. DC Currents heightens awareness of the Tax Division’s activities and apprises readers of tax policy, technical issues and other practice support matters.

The Small Business and Work Opportunity Act of 2007 (SBWOA ’07) was enacted on May 25, 2007. (It was passed as part of the package that extended funding for the war in Iraq.) SBWOA ’07 changes the rules for imposing a return preparer penalty and increases the penalty amount. Under the new rules, the IRS can impose a penalty on a preparer if an undisclosed position on a tax return does not meet the “more likely than not” standard. Further, the penalty can be imposed with respect to a disclosed position for which there is no reasonable basis. It now applies to preparers of estate and gift tax, employment tax, and excise tax returns, as well as returns of exempt organizations, not just income tax returns. In addition, the penalty is increased to the greater of $1,000 ($5,000 if the failure is due to willfulness or intentional disregard of the rules and regulations) or 50% of the return-preparation fee. These changes were effective for returns prepared after the date of enactment.

It is important for AICPA members to understand these changes. For the first time, the standards are higher for preparers than for taxpayers. For taxpayers, the penalty standard remains at “substantial authority” for undisclosed positions and “reasonable basis” for disclosed positions.

Attempts at Change

The AICPA worked to get Congress to change these proposals before they were enacted. When Tax Division members learned of the proposals, they had numerous meetings and phone calls with the staffs of the House Ways and Means Committee, the Senate Finance Committee and the Joint Committee on Taxation. The AICPA outlined objections to the proposals and suggested workable changes. Those comments were summarized in a letter sent to the Joint Committee on Taxation on May 18, 2007.

While these proposals were under consideration by Congress, the AICPA Council was meeting in Washington, DC. As a result, AICPA staff and Council members were able to jointly meet with the leadership of both the Senate Finance Committee and the House Ways and Means Committee to discuss the proposed changes to the preparer penalties.

Unfortunately, the bill passed without any changes to the proposals. After enactment, even some members of Treasury and the Service expressed surprise at passage of the preparer penalty changes and the new rules’ scope and effective date. It became clear that complying with the new law would be very difficult for tax return preparers and taxpayers. Further, implementing and enforcing the new rules would be just as difficult for Treasury and the IRS.

Shortly after enactment, the AICPA began conversations with Treasury and the Service to encourage the issuance of reasonable transition rules. It sent a letter to each outlining its concerns and suggesting ways to deal with some of the issues (see http://tax.aicpa.org/
NR/rdonlyres/3DA9D834-80E2-4FF8-B3B1-F227EF2D417F/0/MLTN_letter_ 06070Final.doc). Within a few days, Treasury issued Notice 2007-54, providing much-needed transition rules. Generally, during the transition period, for income tax returns, amended returns and claims for refund, the IRS will apply the preparer standards under the law immediately prior to the change. For other returns, the IRS will apply the reasonable basis standard under the Sec. 6662 regulations, without regard to the disclosure requirements. In general, the transition relief is provided for income tax returns due before 2008, estimated tax returns due no later than Jan. 15, 2008, and employment and excise tax returns due no later than Jan. 31, 2008. Tax advisers should become familiar with those transition rules.

The AICPA will continue to work with Treasury and the Service as they write additional guidance. The organization is also working hard to get Congress to change the law to make it more workable for both taxpayers and preparers. The AICPA has already issued e-alerts on these new penalty provisions (e-alerts available at http://tax.aicpa.org/Resources/
Publications/Tax+E-Alert+June+12+2007.htm) and will keep members posted as the situation develops.

The Tax Gap

Because the AICPA is the national professional organization of CPAs, comprising approximately 330,000 members, when it comments on regulatory and legislative proposals, it speaks from a broad base of experience. Members advise clients on Federal, state and international tax matters and prepare income and other tax returns for millions of Americans. They provide services to individuals, nonprofit organizations, small and medium-sized businesses and America’s largest companies. This “broad base of experience” can be used to develop practical suggestions for closing a tax gap estimated to be around $300 billion.

Earlier this year, AICPA members received and responded to a tax gap questionnaire. The results are now being compiled and will soon be shared with members of Congress and the Administration, and will also be published in a future issue of The Tax Adviser.