Changing Tax Return Practice: More Likely Than Not

They’re at it again. The Service has issued new proposed regulations to Circular 230 relating to tax return preparation. This comes on the heels of changes in the return preparer penalties that were enacted by the Small Business and Worker Opportunity Tax Act of 2007. Those changes not only extended the application of the income tax return preparer penalties to all tax return preparers, but also altered the standards of conduct that must be met in order to avoid the imposition of the penalties for preparing a return which reflects an understatement of liability. It also increased applicable penalties. The amendments are effective for tax returns prepared after May 25, 2007.

Prior to the Act, a return preparer could be penalized if a tax position for which there was not a realistic possibility of being sustained on its merits resulted in an understatement of liability, so long as it arose from a willful attempt by the return preparer to understate the tax liability or from a reckless or intentional disregard of rules or regulations, but only if the position was either frivolous or was not disclosed. For returns prepared after May 25, 2007, the return preparer may be penalized if the return preparer did not have a reasonable belief that the tax position would more likely than not be sustained on its merits, but only if the position is not disclosed or there is no reasonable basis for the position. In practical terms, a return preparer can avoid disclosing the position without penalty only if he can establish he had a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Also, a return preparer will be penalized for any undisclosed tax position for which there is no reasonable basis. There remains an exception in the case where there is reasonable cause for the understatement and the tax return preparer acted in good faith.

In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Service has announced that for income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under §6694 will be applied in determining whether or not the Service will impose a penalty. This transitional relief will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.

As if the increased penalties for the preparer under the Code weren’t enough, enter the Service’s Office of Professional Responsibility. The Treasury Department and the IRS have determined that the professional standards under §10.34 of Circular 230 should conform to the civil penalty standards for return preparers.

Under §10.34(a) of these proposed regulations, a practitioner may not sign a tax return as a preparer unless the practitioner has a reasonable belief that the tax treatment of each position on the return would more likely than not be sustained on its merits, or there is a reasonable basis for each position, and each position is adequately disclosed to the Internal Revenue Service. A practitioner may not advise a client to take a position on a tax return, or prepare the portion of a tax return on which a position is taken, unless (1) the practitioner has a reasonable belief that the position satisfies the more-likely-than-not standard; or (2) the position has a reasonable basis and is adequately disclosed to the Internal Revenue Service. The definitions of "more likely than not" and "reasonable basis" are also proposed to be amended to reflect these changes in accordance with the well-established definitions of these terms under the §6662 penalty regulations.

These regulations are proposed to apply to returns filed or advice provided on or after the date that final regulations are published in the Federal Register, but no earlier than January 1, 2008.

Check back soon on the Surgent McCoy website, www.cpenow.com, for an upcoming 2-hour self-study course on these new proposed regulations.

You can also find out more at the following course:

How to Beat the IRS Legally: Tax Planning and Strategies for the Closely-Held Business (BILB)