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Tax season is upon us. As such, this post is going to touch on a few key items for tax preparers including (i) who’s considered a tax return preparer; (ii) responsibilities of tax preparers; and (iii) penalties that tax preparers may face as a result of providing tax preparation services.
In this post we will first discuss what constitutes a tax preparer. Second, we will touch on the responsibilities of tax preparers. Third, will be a PDF summary highlighting the key provisions in the tax code for tax preparer penalties and the applicable fees.
Who is considered a tax return preparer?
In general, any person or entity who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of any tax return or any claim for refund is a preparer 1. A person(s) may be a preparer without regard to educational qualifications, professional status, residence, nationality, or the location of the person’s place of business 2 (i.e., action based and not merit based). The statutes apply to the preparation of income, estate, gift, and some information tax returns if the informational return constitutes a substantial portion of a taxpayer’s tax return. For example, think of a partnership return where the return is part of a family business that generates a majority of the partner(s) annual income.
Signing Preparer
The code bifurcates “preparers” into two categories: singing and non-signing. The signer has primary responsibility for the overall accuracy of the prepared tax returns or claim of refund, unless based on credible information, it’s concluded that the non-signing preparer is primarily responsible for the position taken on the return 3. In addition, only one person of a firm will be deemed the preparer, but both the preparer and the firm may be subject to penalties.
Non-signing Preparer
Non-signing preparer is any tax return preparer who is not a signing return preparer but who prepares all or a substantial portion of a return or claim for refund with respect to events 4. The term “substantial portion” is based on facts and circumstances of each case.
Some facts and circumstances that should be considered include, but are not limited to, (i) size and complexity of the item relative to the taxpayer’s gross income; (ii) size of the understatement attributable to the item compared with the taxpayer’s reported tax liability; and (iii) whether or not the adviser knows or reasonably should have known that the tax attributable to the position or entry on the return is a substantial portion of the tax required to be shown on the return or claim of refund 5.
Other factors to consider are the time period in which the advice is provided 6:
- Completed Transaction: If time spent on advice given after a completed transaction is less than 5% of the aggregate time incurred by that individual then the transaction will not be taken into account.
- Tax Planning Before Completed Transaction: Time spent on planning services will be taking into account if (i) the position taken on the return is primarily attributable to the advice provided to the planner; (ii) the planner gave the advice before the events occurred primarily to avoid being treated as a preparer; AND (iii) the planner followed up on the advice after the transaction was completed to assist in preparation of the return.
The following examples illustrate the non-signing preparer principles.
Example 1: Attorney A provides legal advice to taxpayer B about a completed transaction. The advice will affect a substantial portion of the tax due on T’s return. A does not prepare any other portion of B’s return and does not sign the return. A is considered a non-signing preparer for the position because he/she provided advice about events that have occurred, which affects a substantial portion of the tax liability associated with the return.
Example 2: A provides legal advice to B about the tax consequences of a proposed transaction (i.e., tax planning). Based on this advice, B enters into the transaction. Once the transaction is completed, Q does not render any additional advice. Q is not considered a preparer because she did not provide advice about events that have occurred.
De minimis for non-signing preparer
There are de minimis rules available for purposes of determining what constitutes “substantial portion” for non-signing preparers 7. If the issue involves gross income or deduction or an amount on which the basis of credit is calculated are less than $10k, the impact is not considered substantial. In addition, if the amounts in question are less than $400k and are also less than 20% of the gross income as shown on the return (AGI for individuals), the impact is not considered substantial. If more than one schedule, entry, or other portion is involved, all schedules, entries, or other portions must be aggregated 8.
Non-preparers
Persons that furnish typing, reproduction, or other administrative assistance in connection with a tax return are NOT preparers. This is more important now than ever due to the various types of tax software available to taxpayers (TurboTax, TaxAct, TaxSlayer, H&R Block, and etc.) as well as the large number of baby boomers within the US population (~20%). Furthermore, an employee or official of the IRS performing official duties, a VITA participant performing tax preparation under the VITA program, and a person who prepares a return or claim for refund for a taxpayer with no explicit or implicit agreement for compensation, even if the person receives an insubstantial gift, return service, or favor, is not a preparer 9.
Responsibilities of Tax Preparers 10
Tax preparers are not auditors. There is no requirement to audit a clients’ records before filing a return as the ultimate accuracy of a tax return is the responsibility of the taxpayer. However, the IRS has begun to increasingly hold tax preparers responsible for due diligence in preparing returns. Sections 10.22 and 10.34 of circular 230 allow tax preparers to rely on client data in preparing tax returns with the caveat that the tax preparers exercise adequate due diligence and make reasonable inquiries when information furnished by a client appears to be incorrect, inconsistent, or incomplete. Further, teh IRS Office of Professional Responsibility states that “willful blindness” and “don’t ask, don’t tell” approaches are not acceptable.
Tax Preparer Penalties 11
Attached with this post is a link to a PDF providing a summary of preparer penalties included within the internal revenue code. These can be used as a guide for tax preparers as they consider their risk management profile.
Conclusion
Tax preparers need to consider their potential exposure to penalties when providing tax services to clients. If all else fails, always perform additional diligence to assure you, as the preparer, are covered. If clients become too complicated or make you uneasy, make sure to walk away.
1 Regs. Sec. 301.7701-15(a)
2 Regs. Sec. 301.7701-15(d) and (e)
3 Regs. Sec. 1.6694-1(b)(2); Announcement 2009-15, 2009-11 I.R.B. 687.
4 Regs. Sec. 301.7701-15(b)(2)(i)
5 Regs. Sec. 301.7701-15(b)(3)(i)
6 Regs. Sec. 301.7701-15(b)(2)(i)
7 Regs. Sec. 301.7701-15(b)(3)(ii)
8 Regs. Sec. 301.7701-15(b)(3)
9 Regs. Sec. 301.7701-15(f)
11 https://www.irs.gov/tax-professionals/summary-of-preparer-penalties-under-title-26
Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.