Treasury Regulations section 301.7701-15(b) identifies the person who prepares all or a substantial portion of a return or claim for refund as the preparer. Determining a substantial portion may be subjective in some cases, but guidance in the regulations points to a comparison of the length and complexity of the portion, the tax liability or refund involved in the portion, and the tax liability or refund in the return or claim as a whole. The regulations contain two safe harbor rules for determining nonsubstantial preparation: If the part of the return or claim prepared involves amounts of gross income, deductions, or basis for credits that are either less than $2,000 or less than $100,000 and also less than 20% of gross income (AGI for an individual taxpayer).

The issue of who prepared the substantial portion of a tax return has arisen twice in case law. In both cases, the preparer of a partnership return was also deemed to have prepared a substantial portion of the individual partners’ returns when the partners’ shares of flow-through items from the partnership constituted a substantial portion of the individual return [Goulding (CA-7, 1992), 92-1 USTC 50,174; Adler & Drobny, Ltd. (CA-7, 1993)].

The substantial portion issue also arose when an accountant who prepared a corporate tax return for a fee also prepared the corporate shareholders’ returns free of charge. As the preparer, the accountant was required to sign the individual returns. The compensation received for preparing the corporate return was deemed to cover the entire package of individual and corporate returns [Papermaster (DC, 1981), 81-1 USTC 9217].

Return Preparation Standards

Tax return preparers are required to maintain certain standards in preparing income tax returns. The degree to which they fall below the standards may range from not exercising due diligence in applying tax law to fraudulent disregard for rules and regulations.

Due diligence. IRC section 6695(g) requires an income tax return preparer to be diligent in determining whether a client is eligible for the earned income credit. The penalty is $100 for each failure to exercise due diligence. Temporary Regulations section 1.6695-2T, effective for tax years beginning after December 31, 1996, lists four due diligence requirements:

The penalty will not be applied if a return preparer can satisfy the IRS that a failure to meet the due diligence requirement was an isolated and inadvertent act given the facts and circumstances of the preparer’s normal compliance procedures.

Unrealistic position. IRC section 6694(a) provides for a $250 penalty if the preparer knew or reasonably should have known that an understatement on an income tax return or claim for refund was due to a position that had no realistic possibility of being sustained on its merits. The penalty can be avoided if the position was not frivolous and was disclosed on the return, or if the return preparer can show that he acted in good faith and there was reasonable cause for the understatement. Treasury Regulations section 1.6694-2(c) defines a frivolous position as one that is patently improper. The burden of proof is on the preparer to show that the realistic possibility standard was met or that an exception applies.

The realistic possibility standard in Regulations section 1.6694-2(b) parallels the AICPA’s Statement on Standards for Tax Services (SSTS) No. 1. Both provide that a position has a realistic possibility of being sustained on its merits if, after making a reasonable and well informed analysis, a person knowledgeable in tax law would conclude that the position has at least a one in three chance of being sustained on its merits. The regulations provide a number of examples of situations in which the realistic possibility standard is or is not met. In one such example, committee reports for a new provision in the law direct the Treasury to issue regulations interpreting the provision. If the regulations have not been written and no other authorities exist, return preparers that recommend the position supported by the committee reports will satisfy the realistic possibility standard.

Treasury Regulations section 1.6694-1(e) parallels SSTS No. 3, allowing preparers to rely in good faith, without verification, on the information furnished by their clients as long as they make reasonable inquiries where inconsistencies appear. When the IRC or regulations require the existence of specific facts and circumstances, return preparers must inquire as to the existence of the facts and circumstances (e.g., travel and entertainment expense records). If preparers are reasonably satisfied that the records exist, they are not required to examine them before taking a deduction.

The unrealistic position standard became effective for tax years beginning after December 31, 1989, and replaced the earlier, less restrictive negligent behavior standard. Congress adopted the stricter standard of behavior that generally reflects the professional conduct standards applicable to lawyers and CPAs and encompasses negligent behavior in its definition. Existing case law relates to the former IRC section 6694(a) penalty for negligent disregard of the rules and regulations.

Willful conduct. When an understatement of income tax on a client’s return or claim for refund is due to the return preparer’s willful attempt to understate the tax liability or reckless or intentional disregard of the rules and regulations, the preparer may be subject to a penalty of $1,000 under IRC section 6694(b). The willful conduct penalty is reduced by any penalty assessed for an unrealistic position under IRC section 6694(a) for the same return or claim. The IRS bears the burden of proof to show willfulness.

Regulations section 1.6694-3(b) identifies a willful attempt to understate tax liability as a preparer’s deliberate disregard of information furnished by the taxpayer or another person in an attempt to reduce the taxpayer’s liability. In the example given in the regulations, a preparer lists six dependents on a return after the taxpayer tells the preparer she has only two dependents. Under Regulations section 1.6694-3(c), a preparer has recklessly or intentionally disregarded a rule or regulation when he knowingly (or would be reckless in unknowingly) takes a position on a return or claim that is contrary to a rule or regulation. Of course, a return preparer cannot act recklessly or intentionally if the position taken has a realistic possibility of being sustained on its merits or is not frivolous and is adequately disclosed.

As with other preparer penalties, case law involving IRC section 6694(b) is scant. In Pickering [(CA-8, 1982), 82-2 USTC 9653, affg 82-1 USTC 9375 (DC, 1982)], the Eighth Circuit upheld the trial court in finding a return preparer guilty of willfully understating the tax liability of a corporate client. The corporation’s bookkeeper advised the return preparer of the corporate practice of paying many of its shareholders’ personal expenses. The preparer ignored the information and prepared the return from the corporate books, which included many deductions for shareholders’ personal expenses. The district court acknowledged that a return preparer may rely on information furnished by a client but cannot ignore other information called to his attention or inferences that are plainly available. The return preparer’s failure to investigate the bookkeeper’s statements constituted willfulness. In affirming the trial court, the appeals court noted that willfulness does not require fraudulent intent or evil motive; it merely requires a conscious act or omission made with the knowledge that a duty is not being met.

Civil fraud. IRC section 6701 imposes a civil fraud penalty for aiding and abetting understatements of the tax liability of another person. The penalty applies not only to return preparers, but to all persons that aid, assist, or advise in the preparation or presentation of a tax return, claim, or other document and that believe their assistance will be used in a material tax matter which will result in an understatement of the tax liability of another person. The penalty extends to persons that either order a subordinate to commit the act or do not attempt to prevent a subordinate from knowingly committing the act. IRC section 6703 places the burden of proof for civil tax fraud on the IRS. Generally, the penalty is $1,000; however, if the taxpayer is a corporation, the penalty is $10,000. The section 6694(a) unrealistic position penalty and the section 6694(b) willful conduct penalty cannot be assessed in addition to the aiding and abetting penalty.

More case law exists for this civil penalty than for any other civil return preparer penalty, and much of it relates to promoters of abusive tax shelters. Several cases involving CPAs and the imposition of the civil fraud penalty for aiding and abetting understatements have been heard. In a particularly significant case, the tax issue was whether a client’s stock loss was eligible for IRC section 1244 treatment [Golletz (DC, 1991), 91-1 USTC 50,233]. During a conference with an appeals officer, a return preparer presented photocopies of a page from the corporation’s minute book and a stock certificate that differed from the copies given during the audit. While the documents given during the audit did not support the taxpayers’ position that their worthless stock was section 1244 stock, the clearly altered copies did. The accountant, who pleaded guilty to a criminal charge of conspiring to make false statements to the IRS, was assessed the civil fraud penalty.

The significant issue in the case involved the third requirement of IRC section 6701: A person who aids or abets in the understatement of tax must know that the document, if so used, will result in an understatement of tax of another person. The return preparer argued that there was no evidence that his client’s tax liability was understated, thus rendering IRC section 6701 inapplicable. The court said section 6701 does not require an actual understatement of tax as a prerequisite to the penalty. The phrase “if so used” implies that conduct intended to violate the tax code can be punished under IRC section 6701 even if the violation never actually occurs.

Criminal fraud. Tax return preparers may be convicted of a felony under IRC section 7206 if they willfully assist in the preparation or presentation of a return, affidavit, claim, or other document that is fraudulent or false as to any material matter. The maximum fine for a felony conviction is $100,000 ($500,000 for a corporation) or imprisonment for not more than three years together with the costs of prosecution. The determination of willfulness and materiality is subjective, and the burden of proof is on the government. Neither the IRC nor regulations define “willful” or “material.” The Supreme Court in Bishop [93 S.Ct. 2008 (1973)] ruled that willfulness requires more than a careless disregard for the truth. Willfulness requires a bad purpose or evil motive. It is a voluntary, intentional violation of a known legal duty.

The Supreme Court in Gaudin [115 S.Ct. 2310 (1975)] ruled that a jury must decide whether a matter is material. Case law for IRC section 7206 is extensive, and many of the cases involve tax shelters or tax protester schemes.

In 1983, the Ninth Circuit reversed a district court’s convictions against five individuals who promoted and sold a tax shelter program involving foreign trusts [Dahlstrom (CA-9, 1983), 83-2 USTC 9557, revg DC, cert. den. 5-14-84]. Because the legality of such tax shelter programs was unsettled at the time of indictment, the appeals court disagreed with the trial court that the promoters were aware of the illegality of the tax deductions. If the law is debatable, a defendant lacks the requisite intent to violate it. In addition, the promoters did not actually assist in the preparation of any individual tax returns, merely instructing audiences on how to set up tax shelters. The First Amendment allows freedom of speech, and IRC section 7206 requires a person to actually assist in the preparation of a fraudulent return in order to be convicted of criminal fraud.

In Akaoula [(CA-10, 1999), 99-1 USTC 50,262, affg DC], a return preparer was convicted of 31 counts of aiding and assisting in the preparation of false returns. The return preparer had falsified the clients’ returns by claiming exemptions that did not exist and inflating medical and other expenses and did not dispute that the returns were false as to material matters. Instead, she claimed that she was entitled to rely on her clients’ signatures on their returns as verifying the correctness of the return information. The court dismissed her argument, saying that a preparer cannot hide behind her clients’ signatures to absolve her from the false information she placed on the clients’ returns.

Disclosure Requirements

The law requires tax return preparers to disclose certain information on tax returns and retain records concerning the returns prepared. The five civil disclosure penalties found in IRC section 6695(a–e) apply only to income tax returns and claims for refund. The penalty is $50 for each failure to comply with the disclosure standards, with a $25,000 maximum for each of the five penalties. The penalties will be waived if failure is due to reasonable cause rather than willful neglect.

Furnish copy to taxpayer. IRC section 6107(a) requires tax return preparers to furnish copies of completed returns and claims for refund to their clients not later than the time the original documents are presented to clients for signatures. Under section 6695(a), the $25,000 maximum penalty for failure to comply with section 6107(a) applies within a calendar year period. There is no case law related to the penalty to comply with this regulation.

Retain copy or list. IRC section 6107(b) requires preparers to either retain copies for themselves or maintain a list of all returns and claims prepared which includes clients’ names and Social Security numbers. The copies or list must be kept for three years after the close of a return period and must be available for inspection by the IRS. Under section 6695(d), the $25,000 maximum penalty for failure to comply with section 6107(b) applies per return period.

The IRS has issued a number of revenue rulings to help clarify whether certain types of firms are tax return preparers required to retain copies or lists (e.g., Revenue Rulings 78-318, 85-187, 85-188, 85-189, and 86-55). Revenue Ruling 85-188 deals with a cooperative that provides a computerized data processing system to its members. As part of the service, the cooperative prepares a Schedule F for each member. The IRS ruled that the cooperative is a return preparer if the Schedule F is a substantial part of a member’s return as determined by the criteria of Treasury Regulations section 301.7701-15(b).

Sign return. IRC section 6695(b) imposes a disclosure penalty on an income tax return preparer who does not sign a tax return or claim for refund; the $25,000 maximum penalty per preparer applies to each calendar year period. If more than one preparer is involved in the preparation of a return or claim, the one with primary responsibility for the overall accuracy of the document is the preparer who must sign [Treasury Regulations section 1.6695-1(b)(2)]. Treasury Regulations section 1.6695-1(b)(1) requires the signature to be manual, not stamped, unless the Secretary of the Treasury prescribes another method. Temporary Regulations section 1.6695-1T(b)(4)(I) allows return preparers to file a photocopy of a return that was manually signed if the preparer retains the manually signed original or retains a photocopy or uses an electronic storage system to store and produce a copy of the manually signed return.

The advent of electronically filed returns has created the need for the secretary to prescribe another method for return preparers to comply with the signature requirement. Revenue Procedure 98-50 details the procedure. A Form 8453 must be prepared for each electronically filed return. The taxpayer, the paid preparer, and the e-file provider (if different from the paid preparer) must all sign the Form 8453. The e-file provider submits the signed form to the appropriate IRS service center.

Furnish identifying number. IRC section 6109(a)(4) requires the identifying number of individual tax return preparers, their employers, or both to be placed on income tax returns and claims they prepare. Although the IRC defines the identifying number of the individual return preparer as the Social Security number, the IRS Restructuring and Reform Act of 1998 authorizes the IRS to approve alternatives to Social Security numbers to identify individual return preparers. Temporary Regulations section 1.6109-2T, effective for returns filed after 1999, allows an individual tax return preparer to elect to use an alternative identification number to be issued by the IRS upon filing Form W-7P, Application for Preparer Tax Identification Number.

If the preparer required to sign the return is an employee, the employer’s identification number (found on Form SS-4) must also be included on a return or claim for refund. The street address of the preparer’s place of business must also be listed on a prepared return or claim. A return preparer may include only the postal zip code if the preparer has previously notified each affected IRS office of the intent to do so. The penalty for failure to furnish an identifying number is provided for in IRC section 6695(c), with the $25,000 maximum imposed with respect to any return period.

Employee information. IRC section 6060 requires the filing of a list of return preparers employed during the return period, and section 6695(e) provides the penalty for failure to comply. The information must include each preparer’s Social Security number and place of work. As authorized by the IRC, the secretary in 1979 provided an alternative method of making the information available. Return preparers must retain the information for possible IRS inspection rather than file it annually. There is no case law regarding the section 6060 requirement on employers to maintain employee information.

Conduct Penalties

In addition to the return preparation and disclosure requirements, Congress was concerned about certain conduct of tax return preparers not directly related to tax return preparation. Consequently, Congress enacted a civil penalty for negotiating a refund check, both civil and criminal penalties for disclosing or using client return information, and a criminal penalty for providing fraudulent documents or information to the IRS.

Negotiating a refund check. Income tax return preparers who endorse or negotiate a client’s refund check are subject to a $500 penalty imposed by section 6695(f). In Revenue Rulings 78-220 and 80-35, the IRS has taken a firm stand on a strict interpretation of the statute. Revenue Ruling 78-220 forbids an income tax return preparer who also operates a check cashing business to endorse refund checks for the clients whose returns he prepares.

Improper disclosure of return information. IRC section 6713, which imposes a $250 civil penalty on any return preparer who improperly uses or discloses client information, extends to a broader range of individuals than many of the other preparer penalties. It applies not only to return preparers and their employees, but any person that provides services associated with the preparation of income tax returns. The penalty is assessed for disclosure of information associated with the preparation of a return or for the use of such information for any purpose other than preparing or assisting in preparing a tax return. The total penalty assessed against a person cannot exceed $10,000 for any calendar year, with some exceptions (e.g., the penalty will not apply to disclosures made under court order or other statutory or regulatory provisions). The Treasury has not issued regulations for section 6713, nor is there any case law regarding the penalty.

Willful or reckless disclosure of return information. If return preparers knowingly or recklessly disclose or use clients’ return information, they may be subject to a criminal penalty under IRC section 7216. The crime is a misdemeanor and carries a fine of $1,000, one year in prison, or both. As with the civil disclosure penalty, the definition of return preparer is broader than the section 7711(a)(36) definition used for other return preparer penalties and includes any person who provides services associated with the preparation of a tax return. Treasury Regulations section 301.7216-1(b)(2) provides examples of return preparers, including a secretary who types a return prepared by the employer and a computerized tax processing service that generates computer returns from information furnished by another person.

A tax return is any income tax return or amended return imposed under IRC Chapter 1, or a declaration or amended declaration of such estimated tax. The IRC allows return information to be disclosed or used under certain circumstances. The regulations for section 7216 are detailed and provide specific examples to help preparers avoid criminal disclosure of return information.

Treasury Regulations section 301.7216-2 provides 16 examples of disclosures that are acceptable without a client’s consent, most of which are based on common sense (e.g., disclosure or use of a taxpayer’s information in preparing the tax return of another taxpayer if the taxpayers are related, the first taxpayer has not expressly prohibited such disclosure or use, and the first taxpayer’s tax interest in the information is not adverse to the second taxpayer’s tax interest).

Moreover, Treasury Regulations section 301.7216-3 allows return information to be disclosed with the formal consent of the taxpayer when the return preparer is—

For example, a bank may prepare tax returns in order to stimulate its loan business. If a client’s return indicates a balance due, the bank return preparer can advise the client that the bank’s loan department may be able to offer a loan to pay the tax due. If the client decides to take advantage of the loan opportunity, she must sign a written consent allowing the bank to use the tax return information in determining whether to make the loan.

IRC Section 7216 became effective for disclosures or uses after December 31, 1988. Although there is little case law to date, one accountant served with an IRS administrative summons for a client’s records argued that he could not comply because he would be subject to the criminal penalties of section 7216 for disclosing client information [Buckner (DC, 1995), 95-1 USTC 50,228]. The court ruled that disclosure without a client’s consent is acceptable if done pursuant to a summons from a federal agency.

Providing fraudulent documents or information to the IRS. IRC section 7207 provides a misdemeanor penalty of a $10,000 fine ($50,000 for corporations) or not more than one year in prison for any person who willfully delivers or discloses to the IRS any such items he knows to be fraudulent or false as to any material matter. In the most significant case, an accountant made unsolicited false statements during a tax audit [Fern (CA-11, 1983), 83-1 USTC 9151]. The accountant claimed his client found a substantial deduction not taken on the tax return as originally filed, and the accountant submitted a canceled check as verification. The check was not, in fact, for a donation, but the tax auditor accepted the evidence and allowed the deduction. The auditor’s supervisor was not satisfied with the evidence and instructed the auditor to secure further verification. When this contradicted the original evidence, the accountant recanted, saying the client decided not to take the deduction after all. In fact, the accountant had not discussed the issue with his client as claimed. The court found the accountant guilty of providing fraudulent documents and information to the IRS. The potential effect on the government need not involve a pecuniary loss; it simply must have the capacity to impair or pervert the functioning of a government agency.

Circular 230

CPAs, attorneys, and enrolled agents that practice before the IRS are subject to the provisions of Circular 230, which establishes practice and conduct standards and prescribes disciplinary actions. These penalties, which are under the authority of the director of practice and are separate from and in addition to all other return preparer penalties, may include suspension or disbarment. Disbarred practitioners must wait five years before applying for reinstatement. Many of the standards parallel the AICPA’s SSTS and the provisions of the return preparer penalties.

Practice standards. All individuals that practice before the IRS must follow the following 16 practice standards:

Conduct standards. In addition to the practice standards, Circular 230 imposes a host of conduct standards on CPAs and others that practice before the IRS. The following list of disreputable conduct is subject to disciplinary action: