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January, 2010 Tax Tip

Tax Preparers Are Faced With IRS Penalties – How This Will Affect Clients


The Internal Revenue Code proposes penalties on tax return preparers who prepare returns taking positions that may not be fully supported by the tax laws.  A tax preparer is essentially any person who prepares for compensation, or employs others to prepare for compensation, all or a substantial portion of any tax return or claim for refund.  Obviously, I fit within that definition.


Under the law, if a tax preparer takes an unreasonable position on a return that results in an understatement of tax (no matter the amount), he or she can be subject to a penalty equal to the greater of $1,000 or 50 percent of the fee the preparer received for preparing the return.  In other words, the penalty would be at least $1,000.  As with almost every provision in the tax code, there are exceptions to rules.  Such is the case here.


The general rule states that an undisclosed position taken on a return generally does not constitute an unreasonable position if there is “substantial authority” for it.  There are two exceptions.  First, a disclosed position on a return is not unreasonable if there is a “reasonable basis” (usually viewed as a one in three likelihood of being correct) for taking the position.  Second, if the undisclosed position involves a tax shelter (as defined by law), the preparer is subject to the penalty unless the preparer has a reasonable belief that the position is more likely than not to be sustained on its merits.  The foregoing underscored words are vital in determining the potential application of penalties.  Preparers should assess the appropriate authority for taking tax return positions and act accordingly.


We now know the impact of these provisions on the preparer.  Let me now discuss what the very likely ramifications are to you, the client.  While regulations make it clear that a preparer can generally rely on the information provided by a client in preparing a return, without verification of the data provided, and not be subject to the penalty   However, this does not always let the preparer off the hook. 


The preparer must exercise due care in relying on the information.  That includes such procedures as checklists, methods of obtaining necessary information form clients, a review of the prior year’s return, and other review procedures.  Due care also means that the preparer cannot ignore the implications of the information provided or information actually known by the preparer.  The preparer must make reasonable inquiries if the information presented is incomplete or unclear.  Finally, if the IRS requires that certain documentation be maintained in order to take certain deductions (e.g. automobile, travel and entertainment, or charitable contributions), the preparer must make the appropriate inquiries to be satisfied that the proper documentation does in fact exist.


While the IRS does not expect preparers to audit client information, it does expect them to elicit information from taxpayers that is reasonably necessary to prepare an accurate return.  Therefore, in the coming filing season, you should expect that I, or whoever may be your tax preparer, will be as proactive as deemed appropriate in obtaining the information necessary to properly prepare the returns, even if it means spending more time with clients during the interview or preparation processes. 


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