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How preparer penalties apply where return not filed, not signed, or filed late

Chief Counsel Advice 201519029

In Chief Counsel Advice (CCA), IRS has provided guidance on whether preparer penalties apply under various scenarios including where a return was signed by the preparer and never filed, where it was filed but IRS couldn’t find a copy with the preparer’s signature, and where a refund claim was filed after the statute of limitations had expired.

Background. Under Code Sec. 6694(a), a penalty is imposed on a tax return preparer who prepares a return or refund claim reflecting an understatement of liability due to an “unreasonable position,” if he knew (or reasonably should have known) of the position.

The penalty is increased under Code Sec. 6694(b) if any part of the understatement is due to a willful attempt in any manner to understate the liability for tax on the return or claim, or a reckless or intentional disregard of rules or regs.

Reg. § 1.6694-1(a)(2) provides that, for purposes of the penalties under Code Sec. 6694, a return or claim for refund is deemed prepared on the date it is signed by the tax return preparer. If a signing tax return preparer (as defined in Reg. § 301.7701-15(b)(1)) fails to sign the return, the return or claim for refund is deemed prepared on the date the return or claim is filed.

Code Sec. 6701 penalizes preparers or promoters who aid, assist in, procure, or advise with respect to the preparation or presentation of any portion of a return or other document if (1) the person knows or has reason to believe that the return or other document will be used in connection with any material matter arising under the tax laws, and (2) the person knows that if the portion of the return or other document were so used, an understatement of the tax liability of another person would result.

Scenario 1. Return preparer made amended returns for three consecutive years which contained an understatement of liability due to willful or reckless conduct. The taxpayer filed the Year 1 amended return but not the subsequent Years amended returns, waiting to see if the amended return was accepted. The refund claimed on the Year 1 amended return was not allowed. IRS has a copy of the amended returns for all three years from the taxpayer. Each has the return preparer’s signature on them. IRS also has copies of the amended returns for all three Years from the return preparer obtained during the investigation which do not have his signature on them but have a watermark stating “Preparer Copy.”

Scenario 2. Return preparer made an amended return that contained an understatement of liability due to willful or reckless conduct. The refund claimed on the amended return was disallowed by IRS, but IRS has only secured a copy of the amended return from the return preparer that is not signed by him.

Scenario 3. Return preparer made an amended return that contained an understatement of liability due to willful or reckless conduct. The amended return was not filed, and IRS has only secured copies of an unsigned copy from the return preparer.

IRS guidance on application of preparer penalties. IRS issued guidance with respect to the following issues and the above scenarios:

Issue 1. May the Code Sec. 6694(b) preparer penalty for understatement of liability due to willful or reckless conduct be assessed if the return preparer made an amended return which was never filed?

IRS said that the Code suggests that if an amended return made by a return preparer contained an understatement of liability due to willful or reckless conduct, the penalty under Code Sec. 6694(b) applies if the amended return is either signed by the return preparer, or if it not signed by the return preparer, if the amended return is filed.

Accordingly, in Scenario 1, the Code Sec. 6694(b) penalty may be assessed for all three years because, for each of those years, the return preparer made an amended return that he signed that contained an understatement due to willful or reckless conduct.

In Scenario 2, the Code Sec. 6694(b) penalty may be assessed because the return preparer made an amended return that contained an understatement of liability due to willful or reckless conduct and that was filed.

In Scenario 3, the Code Sec. 6694(b) penalty should not be assessed because, although the return preparer made an amended return that he may have signed, and that contained an understatement due to willful or reckless conduct, the amended return was not filed and there is no evidence the return preparer signed the amended return.

Issue 2. May the Code Sec. 6694(b) penalty be assessed if amended returns were filed but IRS disallowed the refund?

Yes. Under the language of Code Sec. 6694(b), the return preparer penalty may be assessed if a tax return preparer “”prepares any return or claim of refund with respect to which any part of an understatement of liability is due to” willful or reckless conduct. There is no requirement that IRS allow the amounts claimed on an amended return before the Code Sec. 6694(b) penalty may be assessed. IRS cited cases, e.g., Schneider, (DC IN 2003) 91 AFTR 2d 2003-145391 AFTR 2d 2003-1453, that held that the penalty applied notwithstanding the court’s disallowance of the claimed tax benefit.

…Issue 3. May the Code Sec. 6694(a), Code Sec. 6694(b) or Code Sec. 6701 penalty be assessed if the return preparer made and filed an amended return after the period of limitations for refund claims had expired?

No. Those penalties should not be assessed where the return preparer made and filed a claim for refund after the period of limitations for refunds had expired, because an “understatement of liability,” as defined Code Sec. 6694(e), does not include refund claims that are barred by the period of limitations.

When a refund is denied because the period of limitations had lapsed, it is not denied because there is, under Code Sec. 6694(e), an “understatement of the net amount payable with respect to any tax imposed by this title or any overstatement of the net amount creditable or refundable with respect to any such tax.” The refund is barred merely because the claim was made too late.

Accordingly, the penalties under Code Sec. 6694(a) and Code Sec. 6694(b) do not apply because a time-barred claim does not fall under the definition of an understatement of liability as defined in Code Sec. 6694(e).

For that same reason, the penalty under Code Sec. 6701 should not be asserted for time barred claims. Although Code Sec. 6694(e) applies for “purposes of this section,” that is, Code Sec. 6694, IRS said, citing Gustafson v. Alloyd Co., Inc., (S Ct 1995) 513 U.S. 561, that identical words in the same piece of legislation usually have the same meaning.

RIA observation: While contrary to Chief Counsel Advice 201519029’s claim, Code Sec. 6694(e) was actually enacted in ’76, and Code Sec. 6701 was enacted in ’82, the conclusion that Code Sec. 6701 shouldn’t be assessed here wouldn’t seem to be affected by IRS’s error in implying that the relevant language in those two sections was enacted in the same piece of legislation.

References: For return preparer penalties, see FTC 2d/FIN ¶  V-2631  et seq.; United States Tax Reporter ¶  66,944  et seq.; TaxDesk ¶  867,019  et seq.; TG ¶  71769  et seq.