IRS Issues Interim Relief on More-Likely-Than-Not Penalties

Introduction

On December 31, 2007, the IRS issued Notice 2008-13 offering interim guidance regarding the implementation of the May 2007 changes to the section 6694 preparer penalty provisions and Notice 2008-11 clarifying prior transitional relief granted with respect to those changes. In addition, it issued Notice 2008-12 providing interim guidance regarding section 6695 return preparer signature requirements. The guidance in these notices alleviates certain tax return preparer issues about the filing season.

We are pleased to see that the notices address a number of the concerns the AICPA has expressed in letters to, and in discussions with, members of Congress, Treasury and the IRS since section 6694 was amended in May 2007.  (See the June 7 letter requesting transitional relief; the July 10 and 12 letters requesting legislative relief; and the September 14 and November 7 letters requesting regulatory guidance, which were highlighted to Tax Section members in June and July Tax E-Alerts.)

Background

In May, the section 6694 tax return reporting standard applicable to preparers for undisclosed positions was raised from the “realistic possibility” standard to a “reasonable belief that the position would more likely than not be sustained on its merits” (MLTN) standard. The preparer standard for disclosed positions was raised from "not frivolous" to "reasonable basis." Further, section 6694 was amended to (1) apply the preparer penalty and related standards to all tax returns, not just income tax returns; and (2) increase the amount of the penalties. In addition, section 6695 was amended to expand the return preparer signature requirements beyond income tax returns. As enacted, these changes were generally effective for returns prepared after May 25, 2007. On June 11, 2007, transitional relief for the changes to the section 6694 preparer penalty provisions was granted in Notice 2007-54.

The MLTN standard for undisclosed positions creates several problems for return preparers. One of the most significant problems is the potential for a conflict of interest between a preparer and a taxpayer/client, which would arise if a return were to contain a position that satisfies the taxpayer standard (“substantial authority”) under section 6662(d), but not the higher preparer standard (MLTN) under section 6694. In such a situation, the taxpayer would not be required to disclose the position to avoid a penalty; the preparer, however, would be protected from the section 6694 penalty only if the taxpayer were to make the disclosure.

Another significant problem is that, given the complexity of the tax law, the lack of guidance on many issues, and the factual nature of many issues, it often may be very difficult to determine whether or not the MLTN standard is satisfied with respect to a position. Further, clients may not be willing to pay for the additional research and analysis that may be needed to make a MLTN determination.

Notice 2008-11: Clarification of the Notice 2007-54 Transitional Period

In Notice 2007-54, Treasury and the IRS provided transitional relief, in recognition of the many practical problems that would have been encountered by an immediate implementation of the May 2007 changes to section 6694. Nonetheless, some uncertainty existed regarding the returns covered by that relief.

Notice 2008-11 clarifies that the transitional relief provided in Notice 2007-54 applies to:

·          any timely filed original or amended return (other than a 2007 employment or excise tax return) that is filed on or before December 31, 2007;

·          any timely filed original or amended employment or excise tax return filed on or before January 31, 2008; and

·          advice provided on or before December 31, 2007 by a nonsigning preparer.

Notice 2008-12: Preparer Signature Requirement

Notice 2008-12 provides interim guidance regarding the tax return preparer signature requirement to take into account the May 2007 expansion of that requirement beyond income tax returns. In general, the notice provides that a preparer will not be subject to a penalty under section 6695(b) with respect to non-income tax returns or refund claims filed during 2008. See the text of Notice 2008-12 for the specific listing of forms for which a signature will be required in 2008.

Notice 2008-13: Section 6694 Interim Guidance

I. Reporting Standard and Disclosure Requirements

The interim guidance in Notice 2008-13 addresses the concerns regarding both: (1) the potential for a conflict of interest between a preparer and a taxpayer/client; and (2) the difficulty in determining if the MLTN standard is satisfied.

A. Signing Preparer

A preparer will be deemed to satisfy the section 6694 requirements with respect to a position with a “reasonable basis,” but for which the preparer does not have a reasonable belief that the position would more likely than not be sustained on its merits, provided one of the following requirements is met.

1. The position is disclosed in accordance with reg. section 1.6662-4(f).

2. The tax return that the preparer provides to the taxpayer includes a disclosure of the position in accordance with reg. section 1.6662-4(f).

3. There is substantial authority for the position (other than a “tax shelter” as defined in section 6662(d)(2)(C)) and the preparer (i)advises the taxpayer of the difference between the penalty standards applicable to the taxpayer under section 6662 (substantial authority) and the penalty standards applicable to the tax return preparer under section 6694 (reasonable belief that the position would more likely than not be sustained on its merits), and (ii) contemporaneously documents in the preparer’s files that this advice regarding differing standards was given to the taxpayer.

4. If the position may be described as a “tax shelter” in section 6662(d)(2)(C) and, therefore, the taxpayer may not avoid the section 6662 penalty by disclosure, the tax return preparer (i) advises the taxpayer of the penalty standards applicable to the taxpayer under section 6662(d)(2)(C) and the difference, if any, between these standards and the standards under section 6694, and (ii) contemporaneously documents in the preparer’s files that this advice was given to the taxpayer.

B. Nonsigning Preparer

The Notice 2008-13 interim guidance indicates that a nonsigning preparer will be deemed to satisfy the section 6694 requirements with respect to advice given to a taxpayer on a position that satisfies the reasonable basis but not the MLTN standard if the nonsigning preparer provides a statement advising the taxpayer of any opportunity for the taxpayer to avoid a section 6662 penalty through disclosure, if relevant, and of the requirements for such disclosure.

If the nonsigning preparer is providing advice on such a position to another preparer instead of to a taxpayer, the nonsigning preparer will be deemed to satisfy the section 6694 requirements if the advice to that preparer includes a statement that disclosure under section 6694(a) may be required.

In both situations, if the advice regarding the position was in writing, the statement must be in writing; if the advice was given orally, the statement may be given orally or in writing. Further, contemporaneous documentation of the statement should be included in the nonsigning preparer’s files.

II. Reliance on Information Received from Taxpayer

Notice 2008-13 indicates the continued application of the rule in reg. section 1.6694-1(e) regarding when a preparer may rely in good faith without verification on information furnished by the taxpayer. In addition, the notice indicates that a preparer may rely in good faith and without verification on information provided by another advisor, tax return preparer, or other third party. It notes that a preparer is not required to verify or review items reported on tax returns, schedules, or other third-party documents to determine if the MLTN standard is met. It warns, however, that a preparer “may not ignore the implications of information furnished to the tax return preparer or actually known to the tax return preparer” and “must make reasonable inquiries if the information furnished by another tax return preparer or a third party appears to be incorrect or incomplete.”

III. Reasonable Cause and Good Faith Exception

Notice 2008-13 indicates that, in determining if the reasonable cause and good faith exception to the section 6694 penalty applies, the IRS will continue to consider the factors in the current regulations, at reg. section 1.6694-2(d)(1) to -2(d)(4). The reg. section 1.6694-2(d)(5) factor regarding reliance on advice of another preparer is modified in the interim guidance to include reliance on the advice of a third party.

IV. Returns Covered by Section 6694

Notice 2008-13 specifies the returns that will be covered by section 6694 during the period of the interim guidance and the definition of “tax return preparer.” See Notice 2008-13, Sections A and B and Exhibits 1 through 3 for a complete discussion of these issues.

V. Examples

Notice 2008-13 provides several examples to illustrate and clarify provisions of the notice. See Section H of the notice for those examples.

Continued Legislative and Regulatory Activity

The AICPA will continue to communicate practitioner concerns and make recommendations to Treasury and the IRS as they develop the final guidance under section 6694. In addition, the AICPA will continue, as a critical priority, its efforts for a legislative remedy to the problem, encouraging support for passage of H.R. 4318, which would equalize the preparer’s standard for undisclosed, non-tax shelter positions with the standard currently applicable to taxpayers – substantial authority. ( Click here for more information on that legislative effort.)