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Larry Jacobson

Are You Sure You’re Not a Tax Preparer?

The Treasury Department just promulgated Proposed Regulations that would expand the definition of who is a tax preparer.

September 11, 2008
by Larry Jacobson, CPA/JD

In June, the Treasury Department issued Proposed Regulations regarding the standard of conduct that must be met to avoid imposition of the tax return penalty under IRC 6694. The Small Business and Work Opportunity Act of 2007, Public Law 110-28 (the "2007 Act") revised IRC 6694 completely and expanded greatly the potential penalties to be imposed on tax preparers for failure to act in a professionally proscribed manner. Under IRC 6694(a), a preparer who prepares any return with respect to which any part of an understatement is due to an unreasonable position, shall pay a penalty equal to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return. In my last column, I revealed the required standard of conduct needed to avoid preparer penalties under the Proposed Regulations.

What Makes a Tax Preparer?

Here we look at who is a tax preparer under the Proposed Regulations. In broad terms, a tax preparer is any person who prepares for compensation, or employs one or more persons to prepare for compensation, all or a "substantial portion" of any return or tax or any claim for refund. The Proposed Regulations break out the concept of tax preparers into the category of "signing tax preparer" and "non-signing tax preparer". A signing tax return preparer is any tax return preparer who signs or who is required to sign a return or claim for refund pursuant to IRC 6695.

So far so good. Everyone who prepares tax returns knows whether he or she is a signing tax preparer. The trick is that penalties can now be imposed on persons who fall within the ambit of tax advisors, rather than tax preparers.

Under the Proposed Regulations, a "non-signing tax preparer" is subject to the preparer penalties. A non-signing preparer is someone who gives advice regarding all or a substantial portion of a return or refund claim, with respect to events that have occurred prior to the time the advice is given. Examples of non-signing return preparers are persons who provide advice (written or oral) to a taxpayer (or to another tax-return preparer) when that advice constitutes a substantial portion of a return. However, advice given by a person prior to the consummation of the transaction or event that gives rise to the entry on the tax return does not turn the advisor into a non-signing tax preparer with respect to such advice. In addition, time spent on advice that is given after events have occurred that represents less than five percent of the aggregate time spent by the tax advisor on the entire transaction shall not be taken into account in determining whether the tax advisor is a non-signing tax preparer.

With one limited safe harbor test set forth below, there is no hard test as to when something is a "substantial portion of a return" for purposes of determining whether the tax advisor is a non-signing tax preparer. The Proposed Regulations determines a schedule, entry or other portion of a return is as a substantial portion by whether the person knows or reasonably should know that the tax attributable to the schedule, entry or other portion of the return is a substantial portion of the tax required to be shown on the return. Moreover, the size and complexity of the item relative to the taxpayer's gross income and the size of the understatement attributable to the item compared to the taxpayer's reported tax liability are important factors in applying the substantial portion test. Importantly, a single entry might be viewed as a substantial portion of the tax required to be shown on the return. Nonetheless, an item is not deemed to constitute a substantial portion of a return if (1) it constitutes less than $10,000 or (2) less than $400,000 and also less than 20 percent of the gross income on the return.

S Corporation Tax Preparers

Perhaps the most troubling part of the Proposed Regulations is when a preparer (whether as signing or non-signing preparer) of a partnership or S corporation tax return is responsible for an entry on the partnership or S corporation tax return. This person can be treated as a preparer for a partner or S corporation shareholder if the flow-through of the entry constitutes a substantial portion of the partner's or shareholder's return. Thus, a person who gives advice to a flow-through entity with respect to a consummated transaction may be treated as tax preparer of a partner or S corporation shareholder return even though they:

  1. Know nothing of the tax situation of the partner or shareholder or

  2. Don't even know the name or existence of any of the partners or shareholders.

So what does this all mean? Can a person who is not a tax preparer in the traditional sense, i.e., a person who does not do accounting work in connection with a client's tax return, be a tax preparer and be subject to the enhanced IRC 6694 penalties?

The answer is absolutely yes. Any person who gives tax advice on a completed transaction of any type that will be reported on a tax return ought to consider themselves a tax preparer. Although there are exceptions under the five percent of time spent rule or the $10,000/$400,000 tests, any person who gives tax advice with respect to a completed transaction ought to assume that they are tax preparers.

Penalties

Any tax advisor who is deemed to be a tax preparer with respect to an item is subject to the penalty provisions of IRC 6694. What that means is that a tax advisor who might potentially be a tax preparer with respect to a tax return better either (1) have an informed belief that the position will, if challenged, be more likely than not sustained (without regard to the likelihood of any IRS audit) or (2) have a reasonable belief that the position is correct and have the position disclosed on the tax return. Otherwise, the tax advisor might be subject to the harsh IRC 6694 penalties.

Conclusion

The moral of this story is that any person who gives tax advice on a completed matter should assume that they are presumptively tax preparers and must make it clear, in writing, to a client whether the position to be taken on a tax return meets the "more likely than not" standard or should be disclosed in the tax return. The IRS will expect the presumptive tax preparer to have written documentation regarding the advice given to the taxpayer. It is up to the potential tax preparer to protect their hides; don't expect the client or the IRS to be terribly helpful in this regard.

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Larry Jacobson, an attorney and CPA, is a senior partner in the Chicago office of the law firm of Schiff Hardin LLP. He holds a BA from Washington University, an MBA from the University of Chicago, an MSOD from the University of Pennsylvania and a JD from the Georgetown University Law Center.