Exclusive Member Benefits
Preparer Penalties under Circular 230 and IRC § 6694
Richard Kellner, CPA
Over the years, legislation has expanded the definition
for who or what is considered practice before the IRS and
subject to preparer penalties. The preparer penalties have
increased substantially and the tax forms that are subject
to preparer penalties have also increased. Now anyone who
prepares a tax return for compensation is required to be
registered with the IRS.
Federal tax return preparers must be able to identify
and review these changes in order to be aware of their
exposure related to assisting taxpayers with the preparation
of federal tax returns.
Practice Before the IRS
Before the changes
230, "practice before
the IRS" was defined in Circular
230 section 10.2(d),
which stated, “Practice before the IRS comprehends
all matters connected with a presentation to the Internal
Revenue Service or any of its officers or employees relating
to a taxpayer’s rights, privileges, or liabilities
under laws or regulations administered by the Internal
Revenue Service…” but did not include the preparation
of a tax return. It allowed individuals with certain designations,
including attorneys, CPAs and EAs, to represent and advocate
for taxpayers before the IRS. After Aug. 2, 2011, however,
230 section 10.8 included preparation of a tax
return as practice before the IRS. To prepare a tax return
for compensation, the preparer must have a preparer identification
number (PTIN). A new license category of tax return preparer,
known as the registered tax return preparer (RTRP) was
established. In a transitional period, provisional PTINs
will be issued to this new category of preparers in order
to give them time to comply with the requirements of becoming
a RTRP, including passing the competency exam. The newly
licensed preparers are granted limited authority to advocate
for taxpayers before the IRS.
Practice before the IRS (including the new PTIN requirement
and the new category of RTRP) is governed by Circular 230.
The Office of Professional Responsibility (OPR) is responsible
for monitoring compliance with the regulations of Circular
230,and the Return Preparer Office is responsible for PTINs
and the RTRP competency test.
Preparer Penalties and Avoiding Sanctions
Along with increasing the forms that subject a preparer
to penalties, the preparer penalties under IRC section
6694 have dramatically increased over the past few years.
For example, in section 6694 (a), understatement due to
unreasonable position, the $250 penalty was increased to
$1,000 and in section 6694 (b), understatement due to willful
or reckless conduct, the $500 penalty was increased to
$5,000. Sanctions under Circular 230 and section 6694 include
prison as well as monitory actions.
Some of the changes affecting regulation are already in
place. For example, Circular
230 section 10.33 (b) requires
the responsible party to ensure that proper procedures
are in place to meet the requirements of Circular 230.
This means that now each tax preparation firm must provide
proper procedures to ensure accurate and timely preparation
of tax returns.
There are also other significant changes, including revisions
of Circular 230 sections 10.34, 10.35, and 10.36 that directly
impact how tax preparation businesses conduct themselves.
Now, more than ever, paid tax return preparers must understand
and educate themselves to avoid sanctions by the IRS or
Before we discuss the three categories of preparers identified
in Circular 230, we must:
the levels of confidence in a tax position.
whether or not the issue involves tax shelter or
the overall materiality of the tax issue or position.
we must determine the level of confidence that we have
in order to uphold a position, should that
position ever be challenged by the appropriate authority.
We must also know what primary and secondary sources for
tax research are allowed to be used and how much weighting
we are allowed to place on the different sources. As professionals,
we must apply the appropriate weighting to each source.
A lower court decision in the taxpayer’s district,
for example, can carry a greater weight that the same level
court in another jurisdiction. Also, appeals courts can
be weighted higher than lower court rulings. Our weighting,
however, should be consistent between cases and we should
not base the weighting on how it will enhance the desired
tax position. We then must provide these weightings to
the applicable cases to determine the levels of confidence
in a tax position.
The following are levels of confidence in tax positions
based on the Tax Advisor, May 2012, Interpretations of
SSTS No. 1, Tax Return Positions:
More Likely Than Not (MLTN) standard is normally satisfied
if one can reasonably conclude that there is
a greater than 50 percent likelihood the position will
be upheld on its merits.
Authority (SA) is an objective reporting standard
and is satisfied if the weighted authorities supporting
a particular position are substantial in relation
to the authorities supporting a contrary position.
SA normally requires at least about a 40 percent
likelihood that the position will be upheld on its
federal tax purposes and those of many other jurisdictions, any
transaction classified as a tax shelter or reportable
transaction must satisfy the subjective MLTN standard as well as the
objective SA standard.
Possibility of Success (RPOS) normally requires a one-third
the position will be
sustained on its merits.
Basis (RB) is lower than the RPOS, but is significantly
higher than the "frivolous" or
not patently improper and "is not satisfied
by a return position that is merely arguable or that
a colorable claim," according
to the article. A position normally satisfies
the RB standard if it’s reasonably based on
one or more authorities (considering the relevance
authorities). In practice, RB normally requires
about at least a 20 percent likelihood that the position
upheld on its merits.
position, frivolous, abusive, groundless or other,
that delays the IRS
in properly administering
the tax code and that has less than a 20 percent chance of success,
should be scrutinized with these ratings in
Regulations have provided recent guidance on the economic
substance doctrine, which preparers should consider to
avoid penalties. If a transaction does not have a business,
income or other profit motive, other than reduction of
tax, the economic substance doctrine will not allow that
If a position involves a tax shelter or reportable position,
the MLTN position must be met, in order to give favorable
advice on the position Circular 230 (c) (4) (i).
Subject to Sanctions and Corresponding Circular 230 Sections
preparer with overall responsibility for the tax return
and the signing of the tax return is subject to sanctions
under Circular 230 and the IRC, as is the firm that employee
this preparer. A preparer who is not required to sign
the return, however, may also be subject to sanction
Circular 230, if this person is considered to have prepared
a substantial portion of the return. This preparer is
considered a non-signing preparer stated under Treas.
(2). Factors to consider in determining whether a schedule,
entry or other portion of a return or claim for refund
is a substantial portion of the may include, but are
not limited to, the size and complexity of the item relative
to the taxpayer’s gross income and the size of the
understatement attributable to the item compared to the
taxpayer’s reported tax liability (Treas. Reg. 301.7701-15(b)(3)(i)).
For purposes of applying the aforementioned rules to non-signing
preparers, the schedule or other portion of the return
is not considered to be a substantial portion if the schedule,
entry or other portion of the return or claim for refund
involves amounts of gross income, amounts of deductions,
or amounts on basis of which credits are determined that
1. Less than $10,000
2. Less than $400,000 and also less than 20 percent of
gross income as shown on the return or claim for refund
(or, for an individual, the individual’s adjusted
gross income) (Treas. Reg. 301.7701-15(b) (3) (ii) (A)).)
The three categories of preparers subject to sanctions
are the signing preparer (i.e. the responsible paid tax
return preparer, covered in Circular 230 section10.34),
the firm (or employer) of the signing preparer (covered
in Circular 230 section 10.36), and the non-signing preparer
(that does not include the new designation of RTRP, covered
in Circular 230 section 10.35).
Circular 230 section 10.34, standards with respect to
tax returns and documents, affidavits and other papers,
begins with the usage of the terms willfully, reckless,
or through gross incompetence. These terms are not defined
in Circular 230, but rather are subject to interpretation
by the IRS or OPR and the alleged perpetrator has the right
to have these assertions confirmed or dismissed by the
The willful, reckless or through gross negligence position
must lack reasonable basis, be an unreasonable position,
(for example, not meet the substantial authority level
of confidence IRC 6694(a) (2), or be a willful attempt
to understate the tax liability or reckless or intentional
disregard of the regulations.
We can look at some cases to see how the courts have ruled
on specific issues. For example, there are many disciplinary
actions brought on because the preparers did not file their
personal tax returns. The courts have not been very forgiving
in these cases. Generally the courts take a dim view if
the preparer does not provide information requested by
IRS. If this issue, however, is the result of an uncooperative
taxpayer, or a fiduciary relationship between the preparer
and the taxpayer, the courts have been a little more forgiving.
In Circular 230 section 10.36, procedures to ensure compliance,
section (a) relates to covered opinions and section (b)
relates to tax returns. These sections provide sanctions
for the person with principal authority to oversee the
firms practice and are in addition to the sanctions for
There is a responsibility for the firm to take steps to
ensure the firm has adequate procedures in effect for all
members, associates and employees for purposes of complying
with section 10.35.
The Circular 230 section 10.35, request for covered opinions,
includes written advice and provides definitions and specific
requirement reliance opinions, marketed opinions, opinions
subject to conditions of confidentiality and opinions subject
to contractual protection, (e.g., advice on tax shelters).
Generally, to recommend these decisions, a MLTN standard
must be met.
In summary, paid tax return preparers must understand
the new regulations in Circular 230, and IRC sections 6694
and 6695, and must implement procedures and exercise judgment
to avoid the enhanced sanctions provided by these regulations.
Kellner, CPA, who owned and operated a CPA firm with
offices in Massachusetts and Florida for over 20 years,
now works for Drake Software, in Franklin, N.C. He is a
member of the AICPA and has a B.S. in accounting from Bentley
College, an M.B.A. from Babson College and a master's degree
in taxation from Florida International University. He can
be reached at 786.427.1695 or email@example.com.