New 6694(a) Standard

Practitioners are bracing for possible conflicts with clients because of the disconnect in their disclosure standards, tax professionals heard at the recent AICPA National Conference on Federal Taxes in Washington, D.C. The new more-likely-than-not standard in Code Sec. 6694(a) could motivate a preparer to disclose a return position that a taxpayer, under the substantial authority standard, might not be inclined to disclose. Ultimately, the client controls the return and practitioners could be put in the unenviable position of deciding not to sign the return.

Not signing a return as its preparer is not itself an airtight solution. A preparer for penalty purposes may be anyone who gives tax advice relating to any line item on a return. If a client disagrees with the tax professional's advice, the practitioner should memorialize that disagreement in writing.


New Standard

The Small Business and Work Opportunity Tax Act of 2007 (2007 Small Business Tax Act) significantly changed Code Sec. 6694. Before the new law, the standard for nonabusive, undisclosed items under Code Sec. 6694(a) was a realistic possibility of success (essentially a one-third likelihood of success). Under the new law, the standard is more-likely-than-not (essentially a 51 percent chance of success).

The new standard was added to the 2007 Small Business Tax Act without any hearings or testimony. "It surprised the IRS, Treasury and every practitioner."


The more-likely-than-not standard sets the stage for conflict with clients. The taxpayer standard remains substantial authority (which traditionally has been understood to mean a 40 percent chance of success). The client, and not the preparer, controls the return. The preparer cannot force the client to disclose a position. If the client does not agree to disclose the position, the preparer may not be able to sign the return. Section 6695 requires the preparer to sign the tax returns.


Anita Soucy, an attorney-advisor in Treasury's Office of Tax Policy acknowledged that the two standards create a "difficult situation" for practitioners. "We are acutely aware of the conflicts that have developed." Soucy told the AICPA that Treasury and the IRS are considering adopting a rule that would "ameliorate and not exacerbate" these conflicts. However, she did not give any details of how a proposed rule would ameliorate these conflicts.


The AICPA and other professional organizations are urging Congress to equalize the paid preparer and the taxpayer standards for nonabusive, undisclosed positions. The taxpayer standard could be changed to more-likely-than-not or the paid preparer standard changed to substantial authority. John Buckley, a senior aide to House Ways and Means Committee Chair Thomas Rangel, D-N.Y., told the AICPA on November 6 that no legislation has yet been introduced in Congress to make either change.


The 2007 Small Business Tax Act also raised the penalties for violations of Code Sec. 6694. The old first tier penalty in Code Sec. 6694(a) increases from $250 to $1,000 or 50 percent of the income to be derived from the preparation of the return, whichever is greater. The penalty in Code Sec. 6694(b) for willful and reckless misconduct jumps from $1,000 to $5,000 or 50 percent of the income to be derived from the preparation of the return, whichever is greater.