Tax Preparer Penalties: Who, me??
My Client Wouldn’t Listen to My Advice and Now IRS Wants to Penalize Me?!?
I told my client every year when he came in for his tax appointment that his S Corp compensation of $10,000 wasn’t reasonable considering he took over $300,000 in distributions. Well, he finally got audited and now in addition to the taxes he owes, IRS is proposing to penalize me for his mistakes! What!?
How can IRS do that?
Did you ever think that when a taxpayer asks us to take a position on a tax return that we know to be unreasonable, and we agree to prepare the return, we might actually be aiding and abetting the taxpayer? That’s really the issue. The “uneducated” taxpayer relies on the “seasoned professional” to give advice and to prepare his return in full compliance with the law.
What are the potential tax preparer penalties?
Taking an “unreasonable position” is where the potential penalties lie. What’s an “unreasonable position?”
- The preparer knew (or reasonably should have known) of the position;
- There was no reasonable belief that the position would more likely than not be sustained on its merits; and
- The position was not disclosed or there was no reasonable basis for the position.
Think about these three points in relation to our opening example. The preparer knew the compensation was too low; fully expected if audited the client would lose; the preparer’s concern was not disclosed, and he prepared (and presumably signed) the return anyway.
The entire statement at the beginning supports everything the IRS can use against us.
IRC §6694 contains the tax preparer penalties for taking an unreasonable position. The determination can be made by the IRS concluding the tax pro was guilty of the understatement due to taking an “unreasonable position” based on the points we just discussed.
A penalty of the greater of $1,000 or 50% of the income (to be) derived may occur for each error on a return or claim for refund.
However, if the preparer had reasonable cause for the understatement, and he acted in good faith, then IRC 6694(a)(3) exempts these penalties. This might be the time for you to hire an attorney.
If the preparer made an understatement with “willful or reckless conduct,” the penalty on each return (or claim for refund) is the greater of $5,000 or 75% of the income derived.
So what is “willful or reckless conduct”?
It is defined as any willful attempt in any way to understate a tax liability, or a reckless or intentional disregard of the tax law. IRC §6694(b)(2).
In addition to the monetary penalties, the IRS could bar the preparer from preparing returns. If you are referred to the Office of Professional Responsibility (OPR), I predict you’re going to have a very bad day.
Let’s talk about some best practices to protect our livelihoods:
- In these types of situations, it is vital to document your conversations with the taxpayer. Put your concerns in writing and keep records of what you told the client.
- When conveying your thoughts to the client via e-mail, use the receipt request feature so at least you have proof that someone opened the e-mail. If corresponding in writing, I suggest you send the letter certified or return receipt.
- If the individual insists on taking an unreasonable position, you should tell the client why you can’t take this position and then CANCEL THE ENGAGEMENT, or at least tell the client you can’t continue if he will not listen to you.
- If for some strange reason you still end up preparing the return, I would suggest you do so only after gaining the permission of the client to disclose the position on a Form 8275 or 8275R. If the client tells you no, disengage! The disclosure on Form 8275 or 8275R may potentially save you from preparer penalties.
Remember this from Uncle Tom’s School of Cynicism: Regardless of who the client is, or how long you have known him, he will always blame you and throw you under the bus when faced with an IRS inquiry. “I only did what Tom told me to do!”
By the way, my emphasis today was on only one area of compliance issues and potential penalties. I strongly suggest you familiarize yourself with Circular 230 and the myriad of other provisions with which we all need to comply.
“Hey – let’s be careful out there.”
by Tom O’Saben, EA