In last year’s Small Business and Work Opportunity Tax Act, Congress enacted several recommendations by the Treasury Department and the IRS that had the effect of redefining the responsibilities of tax professionals, implementing new penalty provisions, and modifying standards of conduct expected of professionals with regard to tax positions. The professional tax community was quick to voice its concern regarding the new regulations, in part because of ambiguity in due diligence and disclosure processes, as well as the potential vulnerability to multiple preparers at a firm.
Due to be enacted by the end of this calendar year are several additional proposals that, when combined with the changes enacted by the tax act, will have notable effects on tax professionals. Key among them are:
Elimination of the “one pre-parer per firm” rule regarding pro-fessional responsibility for the accuracy of an income tax return. Under the new rules, each professional within a firm that participates in preparation of a return (non-signing preparers) can be considered the responsible person for positions they advise on.
The proposed regulation establishes definitions for “signing tax return pre-parers”, and “non-signing tax return preparers.” Please note the not-so-subtle removal of the word “income” from these definitions, which expands penalties under these provisions to all types of federal tax returns, such as non-profit reporting, estate and gift returns.
According to the IRS, this change was due to “the evolution in existing business practices and the … increased need for specialization.” Each position set forth in the return is then scrutinized individually, and each person responsible for a partic-ular position can be considered a respon-sible non-signing preparer and, therefore, is subject to penalties.
The signing preparer is still considered primarily responsible for the overall return and its positions and, given the complexi-ties in larger, multi-specialty practices, the signer is still the preparer most likely to be held directly responsible.
Raised due-diligence standards for the preparer’s assumptions as to the validity of a position from a “reasonable possibility of success on the merits” (RPSM), to a “more likely than not” standard, or MLTN, which states that the preparers must, following analysis of “pertinent facts and authorities,” have a reasonable belief that an undisclosed tax position taken on the return would have a better than 50-50 likelihood of being sustained on its merits.
For disclosed tax positions, the standard has changed from the preparer believing the position is “not frivolous,” to having a “reasonable basis.” When assessing a preparer’s due diligence, the IRS weighs several factors, including preparer experi-ence, underlying facts and the complexity of the issue. Section 301 contains a safe harbor provision for advice given post transaction, thus enabling professionals to offer follow-up advice without being considered a return preparer.
With regard to non-signing preparers, a proposal is also included to change the definition of “substantial portion” in the “20% Safe Harbor Rule.” It would change from being “less than $2,000, or less than $100,000 and also less than 20% of the adjusted gross income” shown on the return, to “less than $10,000, or less than $400,000, and less than 20%.”
The purported reasoning behind these provisions is to diminish blatantly fraudulent shelters and other tax scams by creating a more tangible threshold of confidence and increasing the penalties for advising clients into such positions.
Increased penalties are already in place for an underpayment of tax resulting from a position determined to be unsupported. While the above change in terms of art from RPSM to MLTN may seem at first glance to be semantics, the changes are actually significant. At stake are new penalties of $1,000 or 50% of the preparer’s income derived from the preparation of the return.
While these new and proposed regulations address a wide range of issues, the most effective method of preventing penalties is to ensure that there is a reasonable basis for each position, and to adequately disclose them.
Overall, the new and proposed regulatory changes have been met with moderated skepticism as to how effective they will be at closing the “tax gap,” but some specific concerns have been voiced, most notably from the National Taxpayer Advocate. In her annual report, Nina Olsen noted that her office is concerned that these penalties may create a significant disparity between the standards applied to preparers and to taxpayers.
The crux of this concern is that it may place a preparer in the position of being ethically bound to advise a client that their interests may best be served by filing themselves, since their level of responsibility for a tax position is only a “real-istic possibility of success,” and that as such, their disclosure requirements, and potential penalties might also be lower, and they may be less likely to face an audit.