Congress Takes Aim at Preparers
Happy New Year! The New Year has arrived, with all of its promises and pitfalls, including one of man’s greatest fears – filing the income tax return. If you use a paid preparer, there are some changes in the law that may affect how aggressive he or she will be in completing your return.
In May 2007, Congress passed the Small Business and Work Opportunity Act of 2007. The Act provided needed tax relief to small businesses, but it also contained a few revenue measures to offset that relief. One of these measures was designed to curb what Congress perceived as abuse of the tax system by paid preparers. Specifically, Congress strengthened penalties against preparers who take aggressive stands on income tax returns. Not only did the new rules increase penalty amounts, they also place higher standards on the preparer; standards that exceed the standards applied to taxpayers.
Prior to the change in the law, a tax preparer could take a position on a tax return if there was a “realistic possibility” the stand would be sustained on its merits upon examination. The preparer could avoid penalty if the tax position was disclosed in the return. This generally meant that the preparer had to believe there was a one-in-three chance that the taxpayer would prevail in the case of an IRS challenge.
The lower standard meant that tax professionals could advise a taxpayer to take a position that was less than certain. This is not to say the position would have been unsupported or wrong, but taxpayers are constantly faced with unusual circumstances, the tax treatment of which requires substantial judgment. As long as the tax treatment was disclosed in the return, and the preparer could show that he or she had a reasonable basis for the position taken, both the preparer and taxpayer could be shielded from certain stiff penalties.
The new rules have heightened the standards to require that a preparer reasonably believe a tax position will “more likely than not” be sustained on its merits. Even disclosure in the tax return will no longer shield a tax professional if she cannot prove she had a reasonable basis for determining it will “more likely than not” be sustained. “More likely than not” means there is a greater than 50% chance the position will be sustained. In other words, the preparer must be fairly certain of prevailing in the event of an IRS challenge.
If the preparer fails to meet his duties under these heightened standards, it will cost him the greater of $1,000 or 50% of the fee for preparation of the income tax return. The prior penalty was $250. There was no change in penalties applicable to taxpayers.
Effectively, Congress has reduced the tax preparer’s ability to be an advocate for his or her client. In the past, a tax professional has been able to take a position on a tax return even if the position was a shade of gray closer to black than white. Not only was the professional allowed to favor the client in the case of uncertainty, it was her duty to resolve any question in favor of the client. The new law whitens the shade of gray upon which a preparer can rely. By requiring a tax position be more likely than not sustained, Congress has moved the tax professional further away from an advocacy role.
Tax preparers have always been required to do their best to make sure questionable positions were properly disclosed, they nonetheless had some latitude in resolving questions in favor of their clients. These heightened standards could, at the very least, cost you more as your tax professional must delve deeper into uncertain transactions and, perhaps, perform more extensive research. If you begin to wonder if your tax preparer is actually working for the IRS instead of you, don’t worry, he or she is still on your side and simply making sure your tax return is right.
Though tax professionals have always sought to make sure clients were aware of potential taxpayer liabilities, the liability the preparers have faced have seldom been a factor in the preparer-client equation. New laws that took effect in 2007 place a higher burden on your preparer than you for the accuracy of your return. If you are faced with providing additional documentation to your preparer or questions you haven’t previously been asked, don’t worry; he or she is simply fulfilling an obligation to you and to the IRS.
Happy New Year!