Friday, February 15, 2008

Section 6694 - IRS Chief Counsel Attorney Recognizes Complications In Implementing New Preparer Penalty Rules

The practical application of the interim guidance on Code Sec. 6694 preparer penalties recently issued by the IRS has raised questions that postponement of full application of the rules does not avoid, concluded participants at a February 14 D.C. Bar luncheon program in Washington, D.C. Panel members included Matthew Cooper, attorney, IRS Chief Counsel, and Ronald Buch, former attorney with IRS Chief Counsel.


The Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28) expanded the scope of Code Sec. 6694 to all tax returns, raised the standard of conduct for preparers and increased the dollar amount of the penalty for understatements due to unreasonable positions and willful or reckless conduct. The IRS has issued guidance in the form of several notices (Notice 2008-11, I.R.B. 2008-3, 279; Notice 2008-12, I.R.B. 2008-3, 280; Notice 2008-13, I.R.B. 2008-3, 282.

Reasonable Belief

According to Cooper, under Code Sec. 6694(a) an unreasonable position on a return is one for which the tax return preparer did not have a reasonable belief that the position was more-likely-than-not be sustained on its merits. Although Buch acknowledged that the standard is objective, he also noted that it has a subjective element as well. "Reasonable belief is based, at least in part, on what the preparer believes," Buch explained. "How is the IRS going to determine what the preparer believed?" he questioned.

Mismatched Standards

The new rules require a preparer to advise his or her clients about the preparer's need to disclose a position on the return that the client would not need to disclosed when the client (taxpayer) has substantial authority for the same position. There is an ethical dilemma because the preparer, by suggesting that his or her client make such disclosures, is placing his interest above that of his client in order to avoid penalties, Buch stated. Buch referred to the disparity between the standards as the "disclosure red zone."

Disclosure Complications

Buch pointed out that the new rules place pressure on the attorney-client privilege. It would appear that an attorney is allowed to disclose privileged information obtained from his or her client to avoid preparer penalties, he observed. He specifically referred to the District of Columbia Rules of Professional Conduct, which permit a lawyer to use or reveal client confidences or secrets to the extent necessary to respond to allegations concerning the lawyer's representation of the client.

Input Requested

Cooper urged all interested participants at the luncheon to provide input to the IRS on the tax return preparer penalty regime. He reported that the IRS intends to issue new regulations under Code Sec. 6694 by the end of 2008.

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