Proposed Regulations on section 6694 return preparer penalties
NPRM REG-129243-07 June 17, 2008 DEPARTMENT OF THE TREASURY

Internal Revenue Service (IRS)

26 CFR Parts 1, 20, 25, 26, 31, 40, 41, 44, 53, 54, 55, 56, 156, 157, and 301

[REG-129243-07]

RIN 1545-BG83

Tax Return Preparer Penalties under Sections 6694 and 6695

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations implementing amendments to the tax return preparer penalties under sections 6694 and 6695 of the Internal Revenue Code (Code) and related provisions under sections 6060, 6107, 6109, 6696, and 7701(a)(36) reflecting amendments to the Code made by section 8246 of the Small Business and Work Opportunity Tax Act of 2007. The proposed regulations affect tax return preparers and provide guidance regarding the amended provisions. This document also provides notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by [ INSERT DATE THAT IS 60 DAYS AFTER PUBLICATION OF THIS DOCUMENT IN THE FEDERAL REGISTER]. Outlines of topics to be discussed at the public hearing scheduled for Monday, August 18, 2008, must be received by Monday, August 4, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-129243- 07), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-129243-07), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C., or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov/Regs (IRS REG-129243-07). The public hearing will be held in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, N.W., Washington, D.C.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Michael E. Hara, (202) 622-4910, and Matthew S. Cooper, (202) 622-4940; concerning submissions of comments, the hearing, and/or to be placed on the building access list to attend the hearing, Regina Johnson, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:



Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by [ INSERT DATE THAT IS 60 DAYS AFTER PUBLICATION OF THIS DOCUMENT IN THE FEDERAL REGISTER]. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of information;

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in §§1.6060-1(a)(1), 1.6107-1, 1.6694- 2(c)(3), 20.6060-1(a)(1), 20.6107-1, 25.6060-1(a)(1), 25.6107-1, 26.6060-1(a)(1), 26.6107-1, 31.6060-1(a)(1), 31.6107-1, 40.6060-1(a)(1), 40.6107-1, 41.6060-1(a)(1), 41.6107-1, 44.6060-1(a)(1), 44.6107-1, 53.6060-1(a)(1), 53.6107-1, 54.6060-1(a)(1), 54.6107-1, 55.6060-1(a)(1), 55.6107-1, 56.6060-1(a)(1), 56.6107-1, 156.6060-1(a)(1), 156.6107-1, 157.6060-1(a)(1), and 157.6107-1. This information is necessary to make the record of the name, taxpayer identification number, and principal place of work of each tax return preparer, make each return or claim for refund prepared available for inspection by the Commissioner of Internal Revenue, and to document that the tax return preparer advised the taxpayer of the penalty standards applicable to the taxpayer in order for the tax return preparer to avoid penalties under section 6694. The collection of information is required to comply with the provisions of section 8246 of the Small Business and Work Opportunity Tax Act of 2007. The likely respondents are tax return preparers and their employers.

Estimated total annual reporting burden: 10,679,320 hours.

Estimated average annual burden per respondent: 15.6 hours.

Estimated number of respondents: 684,268.

Estimated frequency of responses: 127,801,426.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.



Background

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1), the Estate Tax Regulations (26 CFR part 20), the Gift Tax Regulations (26 CFR part 25), the Generation-Skipping Transfer Tax Regulations (26 CFR part 26), the Employment Tax and Collection of Income Tax at Source Regulations (26 CFR part 31), the Excise Tax Procedural Regulations (26 CFR part 40), the Highway Use Tax Regulations, (26 CFR part 41), the Wagering Tax Regulations (26 CFR part 44), the Foundation and Similar Excise Tax Regulations (26 CFR part 53), the Pension Excise Tax Regulations (26 CFR part 54), the Excise Tax on Real Estate Investment Trusts and Regulated Investment Companies Regulations (26 CFR part 55), the Public Charity Excise Tax Regulations (26 CFR part 56), the Excise Tax on Greenmail Regulations (26 CFR part 156), the Excise Tax on Structured Settlement Factoring Transactions Regulations (26 CFR part 157), and the Regulations on Procedure and Administration (26 CFR part 301) implementing the amendments to tax return preparer penalties under sections 6694 and 6695 (and the related provisions under sections 6060, 6107, 6109, 6696, and 7701(a)(36)) made by section 8246 of the Small Business and Work Opportunity Tax Act of 2007, Public Law 110-28 (121 Stat. 190) (May 25, 2007) (the 2007 Act).

In accordance with the 2007 Act, these proposed regulations amend existing regulations defining income tax return preparers to broaden the scope of that definition to include preparers of estate, gift, and generation-skipping transfer tax returns, employment tax returns, excise tax returns, and returns of exempt organizations. These proposed regulations also revise current regulations to amend the standards of conduct that must be met to avoid imposition of the tax return preparer penalty under section 6694. In addition, these proposed regulations reflect changes to the computation of the section 6694 tax return preparer penalty made by the 2007 Act. These regulations also amend current regulations under the penalty provisions of section 6695 to conform them with changes made by the 2007 Act expanding the scope of that statute beyond income tax returns. The Treasury Department and the IRS intend to finalize these proposed regulations by the end of 2008, with the expectation that the final regulations will be applicable to returns and claims for refund filed (and advice given) after the date that final regulations are published in the Federal Register, but in no event sooner than December 31, 2008.



History of the Tax Return Preparer Penalty Provisions

The 2007 Act amended section 6694 to expand the definition of tax return preparer, broaden the scope of the tax return preparer penalties to include preparers of returns other than income tax returns, revise the standards of conduct that tax return preparers must meet to avoid imposition of penalties, and change the computation of the tax return preparer penalties. The 2007 Act did not amend a number of other Code sections related to tax return preparer conduct, nor did it directly address the tax regulations, published guidance, and case law that have developed since enactment of the preparer penalty regime as part of the Tax Reform Act of 1976, Public Law 94-455 (90 Stat. 1688) (October 4, 1976) (the 1976 Act).

The Treasury Department and the IRS believe that the recent amendments to the tax return preparer penalty provisions necessitate a comprehensive review and overhaul of all the tax return preparer penalties and related regulatory provisions. These proposed regulations are the first significant step in this process. Because the proposed regulations were drafted with consideration of the existing regulations and the legislative history of the statutory provisions that were amended by the 2007 Act, a brief review of the legislative and regulatory history leading up to the recent amendments is appropriate in order to place the proposed regulatory changes reflecting the 2007 Act amendments in context.



The Tax Reform Act Of 1976

The provisions in section 7701(a)(36) defining income tax return preparers, and the provisions in sections 6694, and 6695, imposing various penalties on income tax return preparers, were first enacted by the 1976 Act. Sections 6107 and 6109, imposing an obligation on return preparers to furnish and maintain copies of returns and include an identifying number on those returns, were also enacted by the 1976 Act.

As originally enacted, section 7701(a)(36)(A) defined the term income tax return preparer to mean any person who prepared for compensation, or who employed one or more persons to prepare for compensation, any income tax return or income tax claim for refund, or a "substantial portion" of such return or claim. Section 7701(a)(36)(B) excluded from the definition of income tax return preparer persons who merely provided mechanical assistance in the preparation of a return or claim for refund, or who prepared returns and claims as an employee of the taxpayer or in a fiduciary capacity. The legislative history to the 1976 Act explained that whether or not a portion of a return constituted a substantial portion of a tax return was to be determined by examining both the length and complexity of that particular portion of the return and the amount of tax liability involved. The legislative history noted, however, that the filling out of a single schedule would generally not be considered a substantial portion of that return unless that particular schedule was the dominant portion of the entire tax return. The legislative history also provided that a person who prepared a return for compensation may be an income tax return preparer even though that person did not actually place figures on a taxpayer's return. See S. Rep. No. 94-938, 94 th Cong., 2 d Sess. 349-359 (1976).

As originally enacted, section 6694(a) imposed a "first tier" penalty of $100 if any part of an understatement was due to the negligent or intentional disregard of rules or regulations by an income tax return preparer. Section 6694(b) imposed a "second tier" penalty of $500 if any part of an understatement was due to a willful attempt in any manner to understate tax liability by an income tax return preparer. Section 6695(b) imposed a penalty of $25 if an income tax return preparer failed to sign a return or claim for refund in the manner prescribed by regulations. Sections 6695(a), (c), (d), and (e) also imposed penalties of $25 if an income tax return preparer failed to comply with the various identification rules in sections 6107(a), 6109(a)(4), 6107(b) and 6060.

The House and Senate Reports to the 1976 Act, H. Rep. No. 94-658, 94 th Cong., 1 st Sess. at 274 (1975) and S. Rep. No. 94-938 at 349-50, and the Joint Committee on Taxation's General Explanation of the Tax Reform Act of 1976, 94 th Cong., 2 d Sess. at 346 (1976), explained the need for the new tax return preparer penalty regime by noting the significant number of fraudulent returns and tax return preparers engaged in abusive practices. The legislative history further explained that, under prior law, it was often difficult for the IRS to detect any individual case of improper return preparation. This was because the IRS generally had no way of knowing whether the return was prepared by the taxpayer or by a tax return preparer who may have engaged in abusive practices involving a number of returns. Further, even when the IRS could trace the improper preparation of tax returns to an individual tax return preparer, the only sanctions available were criminal penalties, which were often considered inappropriate, cumbersome, and ineffective deterrents because of the cost and length of time involved in prosecuting those cases. The legislative history makes clear that Congress intended the tax return preparer penalties to aid the IRS in detecting returns that were incorrectly prepared and to deter tax return preparers from engaging in improper conduct. See S. Rep. No. 94-938, at 350-51 (1976).

Regulations implementing certain of the amendments made by the 1976 Act were published on December 29, 1976, as TD 7451, 41 FR 56631, and later amended on March 31, 1977, by TD 7473, 42 FR 17124. Additional regulations were published on April 1, 1977, as TD 7475, 42 FR 17452, and November 23, 1977, as TD 7519, 42 FR 17452 (the November 1977 final regulations).

The November 1977 final regulations applied the tax return preparer penalty provisions to persons who did not sign the return or claim for refund, or make or control the entries on the return or claim for refund, including tax professionals who rendered advice that was directly related to the determination of the existence, characterization, or amount, of an entry on a return or claim for refund. By including a broad definition of tax return preparer, the Treasury Department and the IRS intended the regulations to increase advisor care and to monitor careless or deceptive members of the profession. The November 1977 final regulations reflected the considered view that excluding nonsigning tax professionals from the reach of section 6694 could result in a lack of accountability for positions taken on a return, as taxpayers could escape penalty liability because they employed tax return preparers, tax return preparers could escape liability because they relied on nonsigning tax professionals' opinions, and nonsigning tax professionals could escape liability because they would not be considered tax return preparers. The November 1977 final regulations also reflected a concern with the possible exemption of tax attorneys and other professionals involved in preparing more complex returns while at the same time subjecting to penalties preparers of less sophisticated returns who did not rely on the work of others.

The November 1977 final regulations also adopted the safe harbor provisions of §301.7701-15(b)(2), which excluded from the definition of a tax return preparer persons providing tax advice (other than those signing the return) if the amounts of gross income, deductions, or credits giving rise to the understatement were less than $2,000; or less than $100,000 and also less than 20 percent of the gross income (or, for an individual, the individual's adjusted gross income) shown on the return or claim for refund.



Omnibus Budget Reconciliation Act of 1989

Sections 6694 and 6695 were amended by the Improved Penalty Administration and Compliance Tax Act of 1989, enacted as title G of the Omnibus Budget Reconciliation Act of 1989 (OBRA 1989), Public Law 101-239 (103 Stat. 2106) (December 19, 1989). The OBRA 1989 amended section 6694(a) to remove the prior link to negligence or intentional disregard of rules or regulations and instead impose a $250 penalty on an income tax return preparer who understated a taxpayer's tax liability on an income tax return or claim for refund if the understatement was due to a position for which there was not a "realistic possibility" of being sustained on its merits, and the tax return preparer knew or reasonably should have known of such position. The revised section 6694(a) penalty did not apply, however, if the position was "not frivolous" and was adequately disclosed, or if there was reasonable cause for the position taken and the tax return preparer acted in good faith. The OBRA 1989 also amended section 6694(b) to impose a $1,000 penalty on a tax return preparer who understated a taxpayer's tax liability on an income tax return or claim for refund if the understatement was due to the tax return preparer's willful attempt to understate tax liability or the tax return preparer's reckless or intentional disregard of rules or regulations.

The OBRA 1989 also made uniform the tax return preparer penalties that apply for each failure by a tax return preparer to: (1) furnish a copy of a return or claim for refund to the taxpayer under section 6695(a); (2) sign the return or claim for refund under section 6695(b); (3) furnish his or her identification number under section 6695(c); or (4) file a correct information return under section 6695(e). The unified penalty amount was $50 for each failure, with a limit of $25,000 for the total amount of penalties that could be imposed for any single type of failure.

The OBRA 1989 also consolidated the negligence, substantial understatement and valuation misstatement penalties applicable to taxpayers. These penalties were consolidated into a single accuracy-related penalty regime under section 6662. The new accuracy-related penalty for a substantial understatement of income tax generally would not be imposed, however, if (1) there was "substantial authority" for the taxpayer's treatment of the item giving rise to the understatement, or (2) relevant facts affecting the tax treatment of the item were adequately disclosed in the return or in a statement attached to the return and there was a "reasonable basis" for the tax treatment of the item.

By adopting the "realistic possibility" standard for tax return preparers, and the higher "substantial authority" standard for taxpayers with respect to undisclosed positions, OBRA 1989 created a disparity between the penalty treatment of tax return preparers and most taxpayers subject to income tax.

Regulations were published on December 31, 1991, as TD 8382, 56 FR 67509, which amended the regulations under section 6694 to conform the income tax return preparer regulations with the statutory changes made by OBRA 1989 and to make other changes.



The Small Business and Work Opportunity Tax Act of 2007

Section 8246 of the 2007 Act amended sections 6694 and 7701(a)(36) and made conforming changes to other Code provisions to make tax return preparer penalties applicable to a broader range of tax returns. The 2007 Act's amendments to section 6694 also changed the standards of conduct that tax return preparers must meet in order to avoid imposition of penalties in the event that a return prepared results in an understatement of tax. For undisclosed positions, the 2007 Act replaced the "realistic possibility" standard with a standard requiring the tax return preparer to "reasonably believe that the tax treatment of the position is more likely than not" the proper treatment. For disclosed positions, the 2007 Act replaced the "not-frivolous" standard with a standard requiring the tax return preparer to have a "reasonable basis" for the tax treatment of the position.

The 2007 Act also increased the first-tier penalty under section 6694(a) from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim for refund with respect to which the penalty was imposed. In addition, the 2007 Act increased the secondtier penalty under section 6694(b) from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the tax return preparer. The amendments made by the 2007 Act are effective for tax returns prepared after the date of enactment, May 25, 2007.



Notice 2008-13

Notice 2008-13 (2008-3 IRB 282) was released on December 31, 2007 and provided interim guidance under the 2007 Act regarding: (1) the relevant categories of tax returns or claims for refund for purposes of applying the penalty under section 6694(a); (2) the definition of "tax return preparer" under sections 6694 and 7701(a)(36); (3) the date a return is deemed prepared; (4) the standards of conduct applicable to tax return preparers for disclosed and undisclosed positions taken on tax returns; and (5) the penalty compliance obligations applicable to tax return preparers. Additional guidance was provided in Notice 2008-12 (2008-3 IRB 280) with respect to the implementation of the tax return preparer signature requirement of section 6695(b), and in Notice 2008-11 (2008-3 IRB 279), which clarified the earlier transition relief provided in Notice 2007-54 (2007-27 IRB 12 (July 2, 2007)). Notice 2008-46 (2008-18 IRB 868) was released on April 16, 2008 and added certain returns and documents to Exhibits 1, 2, and 3 of Notice 2008-13.



Explanation of Provisions

In developing these proposed regulations, the Treasury Department and the IRS recognize that the majority of tax return preparers serve the interests of their clients and the tax system by preparing complete and accurate returns. Tax return preparers are critical to ensuring compliance with the Federal tax laws and are an important component in the IRS's administration of those laws. The proposed regulations intend to balance the interests of the IRS in curtailing the activities of noncompliant tax return preparers against the burden imposed on all tax return preparers in complying with the requirements imposed by the 2007 Act and these proposed regulations.

The Treasury Department and the IRS also recognize that the government has a number of tools to monitor and sanction tax return preparers, and will continue to coordinate the application of penalties under sections 6694, 6695, 6695A, 6700, 6701, 6702, and Circular 230, as well as other applicable penalties and criminal sanctions.

The IRS will assess penalties under section 6694 in appropriate cases. In keeping with a balanced enforcement program for tax return preparers, the IRS intends to modify its internal guidance so that a referral by revenue agents to the IRS Office of Professional Responsibility (OPR) will not be per se mandatory when the IRS assesses a tax return preparer penalty under section 6694(a) against a tax return preparer who is also a practitioner within the meaning of Circular 230. This change is consistent with the general administrative recommendations made in the legislative history of the amendments made by OBRA 1989 to the section 6694 penalty. See H.R. Conf. Rep. 101-386, 101 st Cong., 1 st Sess. at 662 (1989). In matters involving non-willful conduct, the IRS will generally look for a pattern of failing to meet the required penalty standards under section 6694(a) before making a referral to OPR, although any egregious conduct subjecting a tax return preparer to penalty may also form a basis for a referral to OPR.



Proposed Changes

The following is a summary of the proposed changes to the existing regulations affecting tax return preparers. The changes included in these proposed regulations are discussed in order of the Code sections to which they relate. When appropriate, cross-references to definitional sections are included. Significantly, the definition of tax return preparer, which maintains the concepts in the existing regulations of signing and nonsigning tax return preparers, is located at the end of these proposed regulations in §301.7701-15, and that section is crossreferenced in the relevant sections of the regulations under sections 6694 and 6695.



Furnishing of Copy of the Tax Return

Section 1.6107-1(a), which requires signing tax return preparers to furnish the taxpayer a copy of the prepared return, is proposed to be amended to provide that for electronically filed Forms 1040EZ, "Income Tax Return for Single Filers and Joint Filers With No Dependents," and Forms 1040A, "U.S. Individual Income Tax Return," filed for the 2009, 2010 and 2011 taxable years, the return information may be provided on a replica of a Form 1040, "U.S. Individual Income Tax Return," that provides all of the return information. For other electronically filed returns, the information may be provided on a replica of an official form that provides all of the information. This amendment addresses the IRS' transitional issues in implementing the Modernized e-File platform for the Form 1040 series of returns.



Date Return is Prepared

Proposed §1.6694-1(a)(2) defines the date a return or claim for refund is prepared as the date it is signed by the tax return preparer, and also provides that if the tax return preparer fails to sign the return when otherwise required to do so, the date the return is deemed prepared is the date the return is filed. In the case of a nonsigning tax return preparer, the relevant date is the date the person provides the advice on the position that results in the understatement. This date will be determined based on all the facts and circumstances.



Defining the Preparer Within a Firm

Current §1.6694-1(b)(1) provides a "one preparer per firm" rule. Specifically, if a signing tax return preparer is associated with a firm, that individual, and no other individual in the firm, is treated as a tax return preparer with respect to the return or claim for purposes of section 6694. Under the current regulations, if two or more individuals associated with a firm are tax return preparers with respect to a return or claim for refund, and none of them is the signing tax return preparer, only one of the individuals is a nonsigning tax return preparer with respect to that return or claim for purposes of section 6694. In such a case, ordinarily, the individual who is a tax return preparer for purposes of section 6694 is the individual with overall supervisory responsibility for the advice given by the firm with respect to the return or claim. The "one preparer per firm" rule and the corollary rule included in §1.6694-2(d)(5) of the current regulations precluding a tax return preparer from relying on the advice of an individual associated with the tax return preparer's same firm for purposes of penalty protection were intended to eliminate the administrative difficulty of attempting to apply the section 6694 penalty on an intra-firm basis.

The Treasury Department and the IRS believe that the amendments to section 6694 made by the 2007 Act, together with the evolution in existing business practices and the increased complexity of the Federal tax law that has created an increased need for specialization, require reconsideration of the "one preparer per firm" rule. Specifically, the Treasury Department and the IRS believe this evolution requires the adoption of a framework that centers on the return or claim for refund on a position-byposition basis, with the focus of any penalty on the position(s) giving rise to the understatement on the return or claim for refund and any responsible parties with respect to such position(s). Thus the Treasury Department and the IRS believe that the "one preparer per firm" rule is no longer appropriate and have proposed to adopt a framework defining a preparer-per-position within a firm.

Under both the current and the proposed regulations, an individual is a tax return preparer subject to section 6694 if the individual is primarily responsible for the position on the return or claim for refund giving rise to the understatement.

Under proposed §1.6694-1(b)(1), only one person within a firm will be considered primarily responsible for each position giving rise to an understatement and, accordingly, be subject to the penalty. In the course of identifying the individual who is primarily responsible for the position, the IRS may advise multiple individuals within the firm that it may be concluded that they are the individual within the firm who is primarily responsible. In some circumstances, there may be more than one tax return preparer who is primarily responsible for the position(s) giving rise to an understatement if multiple tax return preparers are employed by, or associated with, different firms.

Proposed §1.6694-1(b)(2) provides that the individual who signs the return or claim for refund as the tax return preparer will generally be considered the person that is primarily responsible for all of the positions on the return or claim for refund giving rise to an understatement. The "one preparer per firm" rule, however, is revised by these proposed regulations if it is concluded based upon information received from the signing tax return preparer (or other relevant information from a source other than the signing tax return preparer) that another person within the signing tax return preparer's same firm was primarily responsible for the position(s) giving rise to the understatement. In this situation, the "one preparer per firm" rule in the current regulations could unduly limit the IRS to assessing the penalty against a person who may have overall responsibility in terms of signing the return, but who may lack detailed knowledge of, or responsibility for, a problematic return position, and who reasonably relied on another professional at the same firm with greater knowledge of, and responsibility for, the accuracy of a position giving rise to the understatement.

The Treasury Department and the IRS believe that amending the regulations to better target the person or persons responsible for the position(s) giving rise to the understatement will further compliance and result in more equitable administration of the tax return preparer penalty regime.

Proposed §1.6694-1(b)(3) establishes a similar rule for situations when there are one or more nonsigning tax return preparers at the same firm. If there are one or more nonsigning tax return preparers at the firm and no signing tax return preparer within the firm, the individual within the firm with overall supervisory responsibility for the position(s) giving rise to the understatement is the tax return preparer who is primarily responsible for the position for purposes of section 6694. Additionally, if after the application of proposed §1.6694-1(b)(2) it is concluded that the signer is not primarily responsible for the position or the IRS cannot conclude which individual (as between the signing tax return preparer and other persons within the firm) is primarily responsible for the position, the individual nonsigning tax return preparer within the firm with overall supervisory responsibility for the position(s) is the tax return preparer who is primarily responsible for the position(s) giving rise to the understatement.

This rule in proposed §1.6694-1(b)(3) is intended to address the potential for uncertainty regarding the identification of the primarily responsible tax return preparer prior to the time of the expiration of the period of limitations on making an assessment under section 6694(a). The proposed rule is distinguished from the current "one preparer per firm" rule in the current regulations because under the proposed rule the IRS may assess the penalty against either the signing tax return preparer or the nonsigning tax return preparer with overall supervisory responsibility for the position(s) giving rise to an understatement depending on the facts and circumstances. Specifically, when the facts indicate that the signing tax return preparer is the primarily responsible tax return preparer under proposed §1.6694-1(b)(1) and (b)(2), the IRS may assess the section 6694 penalty against that individual when appropriate under the statute and regulations. In situations when the facts indicate that the nonsigning tax return preparer with overall supervisory responsibility is the primarily responsible tax return preparer under proposed §1.6694-1(b)(1) and (b)(3), the IRS may assess the section 6694 penalty against that individual when appropriate. In situations when it is unclear which individual, as between the signer and other nonsigning tax return preparers at the firm, the IRS may assess the section 6694 penalty against the nonsigning tax return preparer with overall supervisory responsibility with respect to the position giving rise to the understatement when appropriate. The Treasury Department and the IRS specifically request comments regarding the approach taken in these proposed regulations and any recommendations to improve this rule.

As described in this preamble, conforming rules are included in §1.6694-1(f) of the proposed regulations regarding computation of the "income derived (or to be derived)" from the firm and the individual(s) associated with the firm, in order to ensure that the same income is not counted twice in determining the amount of income subject to the section 6694 penalty.



Reliance on Information Provided

Section 1.6694-1(e) of the current regulations allows a tax return preparer generally to rely in good faith without verification upon information furnished by the taxpayer. Proposed §1.6694-1(e) allows similar reliance, but provides that a tax return preparer may not rely on information provided by taxpayers with respect to legal conclusions on Federal tax issues.

The proposed regulations expand on the current regulations to provide that a tax return preparer may rely in good faith and without verification on information furnished by another advisor, another tax return preparer, or other party (even when the advisor or tax return preparer is within the tax return preparer's same firm). Similarly, a tax return preparer may rely in good faith without verification upon a tax return that has been previously prepared by a taxpayer or another tax return preparer and filed with the IRS. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer, and must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. The Treasury Department and the IRS believe that this expansion of the current rules regarding reliance is necessary given the heightened standards imposed on tax return preparers by the 2007 Act and the increased complexity of the tax law, which often requires signing and nonsigning tax return preparers to rely on the work of others in ensuring compliance.



Income Derived Determination in Computing Penalty Amount

Proposed §1.6694-1(f) defines "income derived (or to be derived)" with respect to a return or claim for refund as all compensation the tax return preparer receives or expects to receive with respect to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement. In the situation of a tax return preparer who is not compensated directly by the taxpayer, but rather by a firm that employs the tax return preparer or with whom the tax return preparer is associated, income derived (or to be derived) means all compensation the tax return preparer receives from the firm that can be reasonably allocated to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement. In the situation where a firm that employs the individual tax return preparer (or the firm with which the individual tax return preparer is associated) is subject to a penalty under section 6694(a) or (b), income derived (or to be derived) means all compensation the firm receives or expects to receive with respect to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement.

If the tax return preparer or the tax return preparer's firm has multiple engagements related to the same return or claim for refund, only those engagements relating to the position(s) taken on the return or claim for refund that gave rise to the understatement are considered for purposes of computing the income derived (or to be derived). In the situation of a tax return preparer who is not compensated directly by the taxpayer, but rather by a firm that employs the tax return preparer or with whom the tax return preparer is associated, income derived (or to be derived) means all compensation the tax return preparer receives from the firm that can be reasonably allocated to the relevant firm engagements.

The proposed regulations also provide that only compensation for time spent on tax advice that is given with respect to events that have occurred at the time the advice is rendered and that relates to the position(s) giving rise to the understatement will be taken into account for purposes of calculating the section 6694 penalty. This rule is intended to be consistent with the definition of tax return preparer in §301.7701-15(b)(2)(i).

The proposed regulations provide that it may be concluded, based upon information received from the tax return preparer, that an appropriate allocation of compensation attributable to the position(s) giving rise to the understatement on the return or claim for refund is less than the total amount of compensation associated with the engagement. For example, it may be concluded that the number of hours of the engagement spent on the position(s) giving rise to the understatement may be less than the total hours associated with the engagement. If this is concluded, the amount of the penalty will be calculated based upon the compensation attributable to the position(s) giving rise to the understatement. Otherwise, the total amount of compensation from the engagement will be the amount of income derived for purposes of calculating the penalty under section 6694.

The proposed regulations also clarify that the amount of penalties assessed against the individual and the firm shall not exceed 50 percent of the income derived (or to be derived) by the firm from the relevant engagement(s) relating to the position(s) giving rise to an understatement. The portion of the total amount of penalty assessed against the individual tax return preparer shall not exceed 50 percent of the individual's compensation attributable to the engagement that relates to the position(s) giving rise to an understatement. In other words, the same income will not be taken into consideration more than once in calculating the penalty against an individual tax return preparer and the individual tax return preparer's firm. The Treasury Department and the IRS also anticipate that Circular 230 will be revised to state that the IRS generally will not stack the section 6694 penalty and monetary penalties under 31 U.S.C. section 330 with respect to the same conduct.



Firm Liability

Proposed §§1.6694-2(a)(2) and 1.6694-3(a)(2) are the same as §§1.6694-2(a)(2) and 1.6694-3(a)(2) of the current regulations regarding when a firm is liable for the section 6694(a) or (b) penalty with one exception. Proposed §§1.6694-2(a)(2)(iii) and 1.6694-3(a)(2)(iii) provide that a firm is also subject to the penalty when the firm's review procedures were disregarded by the firm through willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.



Reasonable Belief of More Likely Than Not

Proposed §1.6694-2(b)(1) provides that the "reasonable belief that the position would more likely than not be sustained on its merits" standard will be satisfied if the tax return preparer analyzes the pertinent facts and authorities and, in reliance upon that analysis, reasonably concludes in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits. Whether a tax return preparer meets this standard will be determined based upon all facts and circumstances, including the tax return preparer's due diligence. In determining the level of diligence in a particular case, the IRS will take into account the tax return preparer's experience with the area of tax law and familiarity with the taxpayer's affairs, as well as the complexity of the issues and facts in the case. The proposed regulations also provide that a tax return preparer may meet the "reasonable belief that the position would more likely than not be sustained on its merits" standard if a position is supported by a well-reasoned construction of the applicable statutory provision despite the absence of other types of authority, or if the tax return preparer relies on information or advice furnished by a taxpayer, advisor, another tax return preparer, or other party (even when the advisor or tax return preparer is within the tax return preparer's same firm), as provided in proposed §1.6694-1(e).

Proposed §1.6694-2(b)(2) provides that a tax return preparer may not rely on unreasonable assumptions, while proposed §1.6694-2(b)(3) states that the authorities contained in §1.6662-4(d)(3)(iii) (or any successor provision) are to be considered in determining whether a position satisfies the "more likely than not" standard. Proposed §1.6694-2(b)(4) also provides examples that illustrate positions meeting the "reasonable belief that the position would more likely than not be sustained on its merits" standard.



Reasonable Basis

Proposed §§1.6694-2(c)(1) and (2) establish that the "reasonable basis" standard that must be met for disclosed positions is the same standard as defined in §1.6662-3(b)(3) (or any successor provision). The proposed regulations also provide that, to meet the "reasonable basis" standard, a tax return preparer may rely in good faith, without verification, upon information furnished by a taxpayer, advisor, another tax return preparer, or other party (even when the advisor or tax return preparer is within the tax return preparer's same firm), as provided in proposed §1.6694-1(e).



Adequate Disclosure

Section 1.6694-2(c)(3) builds on the current regulations and the interim guidance provided in Notice 2008-13 and provides the rules for disclosure of a position for which there is a "reasonable basis" but for which the tax return preparer does not have a "reasonable belief that the position would more likely than not be sustained on its merits."

For a signing tax return preparer within the meaning of §301.7701-15(b)(1), the proposed regulations provide that a position may be disclosed in one of five ways. First, the position may be disclosed on a properly completed and filed Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, as appropriate, or on the tax return in accordance with the annual revenue procedure. See Revenue Procedure 2008-14 (2008-7 IRB 435 (February 19, 2008)). Second, for income tax returns, if the position does not meet the "substantial authority" standard described in §1.6662-4(d), disclosure of the position is adequate if the tax return preparer provides the taxpayer with a prepared tax return that includes the appropriate disclosure. Third, for income tax returns, if the position meets the "substantial authority" standard, disclosure of the position is adequate if the tax return preparer advises the taxpayer of all of the penalty standards applicable to the taxpayer under section 6662. Fourth, for income tax returns, if the position may be described as a tax shelter under section 6662(d)(2)(C) or a reportable transaction to which section 6662A applies, disclosure of the position is adequate if the tax return preparer advises the taxpayer that there needs to be at a minimum "substantial authority" for the position, that the taxpayer must possess a "reasonable belief that the tax treatment was more likely than not" the proper treatment, and that disclosure will not protect the taxpayer from assessment of an accuracy-related penalty. Fifth, for tax returns or claims for refund that are subject to penalties other than the accuracy-related penalty for substantial understatements under sections 6662(b)(2) and (d), the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer under section 6662. This fifth rule is intended to address the situation when the penalty standard applicable to the taxpayer is based on compliance with requirements other than disclosure on the return (for example, section 6662(e)). In order to establish that the tax return preparer's disclosure obligation was satisfied, the tax return preparer must document contemporaneously in the tax return preparer's files that the information or advice required by the proposed regulations was provided.

In the case of a nonsigning tax return preparer within the meaning of §301.7701-15(b)(2), the position may be disclosed in one of three ways. First, the position may be disclosed on a properly completed and filed Form 8275, "Disclosure Statement," or Form 8275-R, "Regulation Disclosure Statement," as appropriate, or on the tax return in accordance with the annual revenue procedure. Second, a nonsigning tax return preparer may meet the disclosure standards if the nonsigning tax return preparer advises the taxpayer of all opportunities to avoid penalties under section 6662 that could apply to the position and advises the taxpayer of the standards for disclosure to the extent applicable. Third, disclosure of a position is adequate if a nonsigning tax return preparer advises another tax return preparer that disclosure under section 6694(a) may be required. The nonsigning tax return preparer must document contemporaneously in the tax return preparer's files that this advice required by the proposed regulations was provided.

In order to satisfy the disclosure standards when the position is not disclosed on or with the return, each return position for which there is a "reasonable basis" but for which the tax return preparer does not have a "reasonable belief that the position would more likely than not be sustained on the merits" must be addressed by the tax return preparer. Thus, the advice to the taxpayer with respect to each position must be particular to the taxpayer and tailored to the taxpayer's facts and circumstances. No form of a general boilerplate disclaimer will satisfy these standards. Proposed §1.6694-2(c)(iv) provides that disclosure in the case of items attributable to a passthrough entity is adequate if made at the entity level in accordance with the rules in §1.6662-4(f)(5). For example, a tax return preparer of a partnership tax return need only advise the partnership in order to satisfy any of the above disclosure rules and does not need to advise each individual partner in the partnership of the applicable penalties.



Reasonable Cause

Proposed §1.6694-2(d) maintains the rules in the current regulations regarding reasonable cause and good faith, except that §1.6694-2(d) is proposed to be revised to provide that whether a position is supported by a generally accepted administrative or industry practice is an additional factor to consider in determining whether the tax return preparer acted with reasonable cause and good faith. This provision is intended to address situations in the absence of published guidance when administrative or industry practice has developed that would not reasonably be subject to challenge by the IRS.

The reasonable cause factor regarding reliance on advice of another tax return preparer is also expanded to allow a tax return preparer to reasonably rely on information or advice furnished by a taxpayer, advisor, another tax return preparer, or other party (even when the advisor or tax return preparer is within the tax return preparer's same firm), as provided in proposed §1.6694-1(e).



Electronically Signed Returns

Proposed §1.6695-1(b)(2) provides that, in the case of an electronically signed tax return, a tax return preparer need not sign the return prior to presenting a completed copy of the return to the taxpayer. The tax return preparer, however, must furnish all of the information to the taxpayer contemporaneously with furnishing the Form 8879, IRS e-file Signature Authorization, or similar IRS efile signature form. The information may be furnished on a replica of an official form that provides all of the information.



Due Diligence for Earned Income Credit

Proposed §1.6695-2(b)(3) establishes a reasonableness standard for signing tax return preparers' due diligence requirements with respect to determining eligibility for the earned income credit and adds examples.



Claims for Refund or Credit by Tax Return Preparers or Appraisers

Proposed §1.6696-1, discussing the procedures for filing claims for credit or refund for penalties assessed against tax return preparers under sections 6694 or 6695, is revised to also cover the new appraiser penalty under section 6695A. Section 6695A was enacted by section 1219 of the Pension Protection Act of 2006 (Public Law 109-280 (120 Stat. 780, 1084- 86) (August 17, 2006)), as amended by the Tax Technical Corrections Act of 2007 (Public Law 110-172 (121 Stat. 2473, 2474) December 29, 2007)). A separate regulation project will provide guidance under section 6695A.



Definition of Tax Return Preparer

Proposed §§301.7701-15(b)(1) and (2) add to the section 7701 regulations the definitions of "signing tax return preparer" and "nonsigning tax return preparer" that are included in §1.6694-1 of the current regulations. Proposed §301.7701-15(b)(1) provides that a signing tax return preparer is any tax return preparer who signs or who is required to sign a return or claim for refund as a tax return preparer pursuant to §1.6695-1(b).

Proposed §301.7701-15(b)(2) provides that a nonsigning tax return preparer is any tax return preparer who is not a signing tax return preparer but who prepares all or a substantial portion of a return or claim for refund within the meaning of §301.7701-15(b)(3) with respect to events that have occurred at the time the advice is rendered. In determining whether an individual is a nonsigning tax return preparer, the proposed regulations provide that any time spent on advice that is given with respect to events that have occurred, which is less than 5 percent of the aggregate time incurred by the person with respect to the position(s) giving rise to the understatement will not be taken into account in determining whether an individual is a nonsigning tax return preparer. The Treasury Department and the IRS believe that this less than 5 percent test will encourage tax professionals who principally rendered advice regarding events that had not yet occurred to provide follow-up advice requested by a taxpayer without the concern that, by providing such advice to a taxpayer, the advisor would become a tax return preparer under proposed §301.7701-15(b)(2) and (3).

Consistent with the current regulations and the legislative history of the 1976 Act, proposed §301.7701- 15(b)(3)(i) clarifies that whether a schedule, entry, or other portion of a return or claim for refund is a substantial portion is determined based upon all facts and circumstances, and a single tax entry may constitute a substantial portion of the tax required to be shown on a return. The proposed regulations include additional factors to consider in determining whether a schedule, entry, or other portion of a return or claim for refund is a substantial portion, such as 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.

Proposed §301.7701-15(b)(3)(ii) increases the de minimis exception in determining a substantial portion of a return or claim for refund for nonsigning tax return preparers. Under the proposed regulations, the de minimis exception applies if the item giving rise to the understatement is (i) less than $10,000, or (ii) less than $400,000 if the item is also less than 20 percent of the taxpayer's gross income (or, for an individual, the individual's adjusted gross income). This de minimis rule does not apply for signing tax return preparers within the meaning of §301.7701-15(b)(1). This change to the regulations updates the current de minimis amounts to reflect the passage of time since those amounts were set in 1977. The Treasury Department and the IRS are considering whether other de minimis rules applicable to nonsigning tax return preparers of non-income tax returns are warranted.

Consistent with the interim guidance set forth in Notice 2008-13, §301.7701-15(b)(4) is proposed to be amended by revising the definitions of "return" and "claim for refund" to only include preparers of returns and claims for refund that are specifically identified in published guidance in the Internal Revenue Bulletin. The Treasury Department and the IRS will publish this guidance simultaneously with the publication of final regulations and will likely maintain the three tiered approach used in the exhibits to Notice 2008-13, subject to any appropriate modifications. Under the substantial portion rule in section 7701(a)(36)(A), preparation of a broad range of information returns, schedules, and other documents can subject a person to the section 6694 penalties even though the documents may not themselves give rise to an understatement. Accordingly, the Treasury Department and the IRS believe that including a list of returns or other documents, the preparation of which may subject a tax return preparer to penalties, will further compliance by not unduly increasing the burden on persons preparing information returns and other documents.



Cross-References

Conforming changes are made in §§1.6060-1, 1.6107-1, 1.6109-2, 1.6694-0, 1.6694-1, 1.6694-4, 1.6695-1, 1.6695-2, 1.6696-1, and 301.7701-15 to replace references to income tax return preparers with references to tax return preparers, consistent with the provisions of the 2007 Act. Conforming cross references are also made to Part 20, Estate Tax; Estates of Decedents Dying After August 16, 1954; Part 25, Gift Tax; Gifts Made After December 31, 1954; Part 26, Generation-Skipping Transfer Tax Under the Tax Reform Act of 1986; Part 31, Employment Taxes and Collection of Income Tax at Source; Part 40, Procedural Excise Tax; Part 41, Highway Use Tax; Part 44, Wagering Tax; Part 53, Foundation and Similar Excise Taxes; Part 54, Pension Excise Taxes; Part 55, Excise Tax on Real Estate Investment Trusts and Regulated Investment Company Taxes; Part 56, Public Charity Excise Taxes; Part 156, Excise Tax on Greenmail; and Part 157, Excise Tax on Structured Settlement Factoring Transactions; to conform these parts with the provisions in Parts 1 and 301, consistent with the provisions of the 2007 Act.



Availability of IRS Documents

The IRS notices referred to in this preamble are published in the Internal Revenue Bulletin and are available at http://www.irs.gov.



Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.

When an agency issues a rulemaking proposal, the Regulatory Flexibility Act (5 U.S.C. chapter 6), requires the agency to "prepare and make available for public comment an initial regulatory flexibility analysis" that will "describe the impact of the proposed rule on small entities." (5 U.S.C. 603(a)). Section 605 of the RFA provides an exception to this requirement if the agency certifies that the proposed rulemaking will not have a significant economic impact on a substantial number of small entities.

The proposed rules affect tax return preparers. The IRS estimates there are 38,566 tax return preparation firms and 260,338 self-employed tax return preparers that qualify as small entities. Therefore, the IRS has determined that these proposed rules will have an impact on a substantial number of small entities.

The IRS has determined, however, that the impact on entities affected by the proposed rule will not be significant. The statute and proposed regulations would require entities that employ tax return preparers to retain a record of the name, taxpayer identification number and principal place of work of each tax return preparer employed. The IRS estimates that this would not require purchase of additional software and would take five minutes per tax return preparer employed. The statute and proposed regulations would also require tax return preparers to retain a complete copy of a return (or claim for refund) or a list of the name, taxpayer identification number and taxable year for each return (or claim for refund) and the name of the tax return preparer required to sign the return or claim for refund. Many tax return preparers have copying machines or scanners and already make copies of the returns prepared, and the IRS estimates this would not require the purchase of additional equipment. The IRS estimates that it would take an average of five minutes to make copies or prepare a record of the returns prepared. Accordingly, the burden on employers of tax return preparers to make a record of the name, taxpayer identification number, and principal place of work of each employed tax return preparer, and a copy of each return or claim for refund prepared, or a record, is insignificant.

The proposed regulations also allow the tax return preparer to generally avoid imposition of the tax return preparer penalties under section 6694 in cases when a tax return position meets the "substantial authority" standard but not the "reasonable belief that the position would more likely than not be sustained on its merits" standard if the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer, and contemporaneously documents in the tax return preparer's files that this information or advice was provided. Often, tax return preparers will choose not to advise the taxpayer of the applicable penalty standards and will instead disclose the position on a properly completed and filed Form 8275, "Disclosure Statement," or Form 8275-R, "Regulation Disclosure Statement," as appropriate, or on the tax return in accordance with the annual revenue procedure. In those instances when the tax return preparer elects to advise the taxpayer of the penalty standards, the IRS estimates that it would take an average of 15 minutes to document this advice. Accordingly, the burden on those who choose this option is insignificant.

Although the proposed regulations also conform the standards of conduct and tax return preparer penalties to the provisions of the 2007 Act, tax return preparers already enroll in educational seminars or training programs to keep up to date with the latest changes to the Code, and the provisions of the 2007 Act and the proposed regulations will generally be part of that training.

Moreover, these proposed regulations are required to comply with the provisions of section 8246 of the 2007 Act and flow directly from amendments to the Code contained in the 2007 Act.

Based on these facts, the IRS hereby certifies that the collection of information contained in these regulations will not have a significant economic impact on a substantial number of small entities. Accordingly, a Regulatory Flexibility Analysis is not required.

Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.



Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and the Treasury Department request comments on the clarity of the proposed regulations and how they can be made easier to understand. Comments are requested on the examples in the proposed regulations, and commentators are specifically invited to suggest changes to these examples or to suggest new examples that they believe would better illustrate the principles that should be included in the final regulations. The IRS and the Treasury Department also request comments on the accuracy of the certification that the regulations in this document will not have a significant economic impact on a substantial number of small entities. All comments will be available for public inspection and copying.

A public hearing has been scheduled for Monday, August 18, 2008, at 10:00 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the "FOR FURTHER INFORMATION CONTACT" section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments by [ INSERT DATE 60 DAYS AFTER PUBLICATION OF THIS DOCUMENT IN THE FEDERAL REGISTER] and an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by Monday, August 4, 2008. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.



Drafting Information

The principal authors of these proposed regulations are Matthew S. Cooper and Michael E. Hara, Office of the Associate Chief Counsel (Procedure and Administration).

List of Subjects



26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.



26 CFR Part 20

Estate taxes, Reporting and recordkeeping requirements.



26 CFR Part 25

Gift taxes, Reporting and recordkeeping requirements.



26 CFR Part 26

Estate taxes, Reporting and recordkeeping requirements.



26 CFR Part 31

Employment taxes, Income taxes, Penalties, Pensions, Railroad Retirement, Reporting and recordkeeping requirements, Social security, Unemployment compensation.



26 CFR Part 40

Excise taxes, Reporting and recordkeeping requirements.



26 CFR Part 41

Excise, Motor vehicles, Reporting and recordkeeping requirements.



26 CFR Part 44

Excise, Gambling, Reporting and recordkeeping requirements.



26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.



26 CFR Part 54

Excise taxes, Pensions, Reporting and recordkeeping requirements.



26 CFR Part 55

Excise taxes, Investments, Reporting and recordkeeping requirements.



26 CFR Part 56

Excise taxes, Lobbying, Nonprofit organizations, Reporting and recordkeeping requirements.



26 CFR Part 156

Excise taxes, Reporting and recordkeeping requirements.



26 CFR Part 157

Excise taxes, Reporting and recordkeeping requirements.



26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1, 20, 25, 26, 31, 40, 41, 44, 53, 54, 55, 56, 156, 157, and 301 are proposed to be amended as follows:



PART 1 --INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.6060-1 also issued under 26 U.S.C. 6060(a).

* * *

Section 1.6109-2 also issued under 26 U.S.C. 6109(a).

* * *

Section 1.6695-1 also issued under 26 U.S.C. 6695(b).

* * *

Section 1.6695-2 also issued under 26 U.S.C. 6695(g).

* * *

Par. 2. Section 1.6060-1 is amended by revising the section heading and paragraphs (a) and (c) and adding paragraph (d) to read as follows:



§1.6060-1 Reporting requirements for tax return preparers.

(a) In general. (1) Each person who employs one or more signing tax return preparers to prepare any return of tax or claim for refund of tax, other than for the person, at any time during a return period shall satisfy the requirements of section 6060 of the Internal Revenue Code by --

(i) Retaining a record of the name, taxpayer identification number, and principal place of work during the return period of each tax return preparer employed by the person at any time during that period; and

(ii) Making that record available for inspection upon request by the Commissioner.

(2) The record described in this paragraph (a) must be retained and kept available for inspection for the 3-year period following the close of the return period to which that record relates.

(3) The person may choose any form of documentation to be used under this section as a record of the signing tax return preparers employed during a return period. However, the record must disclose on its face which individuals were employed as tax return preparers during that period.

(4) For the definition of the term "signing tax return preparer," see section 7701(a)(36) and §301.7701-15(b)(1) of this chapter. For the definition of the term "return period," see paragraph (b) of this section.

(5)(i) For purposes of this section, any individual who, in acting as a signing tax return preparer, is not employed by another tax return preparer shall be treated as his or her own employer. Thus, a sole proprietor shall retain and make available a record with respect to himself (or herself) as provided in this section.

(ii) A partnership shall, for purposes of this section, be treated as the employer of the partners of the partnership and shall retain and make available a record with respect to the partners and others employed by the partnership as provided in this section.

* * * * *

(c) Penalty. For the civil penalty for failure to retain and make available a record of the tax return preparers employed during a return period as required under this section, or for failure to include an item in the record required to be retained and made available under this section, see §1.6695-1(e).

(d) Effective/applicability date. This section is applicable to returns and claims for refund filed after the date that final regulations are published in the Federal Register.

Par. 3. Section 1.6107-1 is revised to read as follows:



§1.6107-1 Tax return preparer must furnish copy of return to taxpayer and must retain a copy or record.

(a) Furnishing copy to taxpayer. A person who is a signing tax return preparer of any return of tax or claim for refund of tax under the Internal Revenue Code shall furnish a completed copy of the return or claim for refund to the taxpayer (or nontaxable entity) not later than the time the return or claim for refund is presented for the signature of the taxpayer (or nontaxable entity). For electronically filed Forms 1040EZ, "Income Tax Return for Single Filers and Joint Filers With No Dependents," and Form 1040A, "U.S. Individual Income Tax Return," filed for the 2009, 2010 and 2011 taxable years, the information may be provided on a replica of a Form 1040, "U.S. Individual Income Tax Return," that provides all of the information. For other electronically filed returns, the information may be provided on a replica of an official form that provides all of the information. The signing tax return preparer may, at its option, request a receipt or other evidence from the taxpayer (or nontaxable entity) sufficient to show satisfaction of the requirement of this paragraph (a).

(b) Copy or record to be retained. (1) A person who is a signing tax return preparer of any return or claim for refund shall --

(i)(A) Retain a completed copy of the return or claim for refund; or

(B) Retain a record, by list, card file, or otherwise of the name, taxpayer identification number, and taxable year of the taxpayer (or nontaxable entity) for whom the return or claim for refund was prepared, and the type of return or claim for refund prepared;

(ii) Retain a record, by retention of a copy of the return or claim for refund, maintenance of a list or card file, or otherwise, for each return or claim for refund presented to the taxpayer (or nontaxable entity), of the name of the individual tax return preparer required to sign the return or claim for refund pursuant to §1.6695-1(b); and

(iii) Make the copy or record of returns and claims for refund and record of the individuals required to sign available for inspection upon request by the Commissioner.

(2) The material described in this paragraph (b) shall be retained and kept available for inspection for the 3- year period following the close of the return period during which the return or claim for refund was presented for signature to the taxpayer (or nontaxable entity). In the case of a return that becomes due (with extensions, if any) during a return period following the return period during which the return was presented for signature, the material shall be retained and kept available for inspection for the 3-year period following the close of the later return period in which the return became due. For the definition of "return period," see section 6060(c). If the person subject to the record retention requirement of this paragraph (b) is a corporation or a partnership that is dissolved before completion of the 3-year period, then all persons who are responsible for the winding up of the affairs of the corporation or partnership under state law shall be subject, on behalf of the corporation or partnership, to these record retention requirements until completion of the 3-year period. If state law does not specify any person or persons as responsible for winding up, then, collectively, the directors or general partners shall be subject, on behalf of the corporation or partnership, to the record retention requirements of this paragraph (b). For purposes of the penalty imposed by section 6695(d), such designated persons shall be deemed to be the tax return preparer and will be jointly and severally liable for each failure.

(c) Tax return preparer. For the definition of "signing tax return preparer," see section 7701(a)(36) and §301.7701-15(b)(1) of this chapter. For purposes of applying this section, in the case of --

(1) An arrangement between two or more signing tax return preparers, the person who employs one or more other signing tax return preparers to prepare any return or claim for refund for compensation other than for the person shall be considered to be the sole signing tax return preparer; and

(2) A partnership arrangement for the preparation of returns and claims for refund, the partnership shall be considered to be the sole signing tax return preparer.

(d) Penalties. (1) For the civil penalty for failure to furnish a copy of the return or claim for refund to the taxpayers (or nontaxable entity) as required under paragraphs (a) of this section, see section 6695(a) and §1.6695-1(a).

(2) For the civil penalty for failure to retain a copy of the return or claim for refund, or to retain a record as required under paragraphs (b) of this section, see section 6695(d) and §1.6695-1(d).

(e) Effective/applicability date. This section is applicable to returns and claims for refund filed on the date that final regulations are published in the Federal Register.

Par. 4. Section 1.6109-2 is amended by revising the section heading and paragraphs (a) and (d) to read as follows:



§1.6109-2 Tax return preparers furnishing identifying numbers for returns or claims for refund filed after December 31, 2008.

(a) Furnishing identifying number. (1) Each return of tax or claim for refund of tax under the Internal Revenue Code prepared by one or more tax return preparers must include the identifying number of the tax return preparer required by §1.6695-1(b) to sign the return or claim for refund. In addition, if there is an employment arrangement or association between the individual tax return preparer and another person (except to the extent the return prepared is for the person), the identifying number of the other person must also appear on the return or claim for refund. For the definition of the term "tax return preparer," see section 7701(a)(36) and §301.7701-15 of this chapter.

(2) The identifying number of an individual tax return preparer is that individual's social security account number, or such alternative number as may be prescribed by the Internal Revenue Service in forms, instructions, or other appropriate guidance.

(3) If an individual tax return preparer described in paragraph (a)(2) of this section is employed by, or associated with, a person (whether an individual or entity) and prepares the return or claim for refund (other than a return prepared for the person), the identifying number is the person's employer identification number.

* * * * *

(d) Effective/applicability date. Paragraph (a) of this section is applicable to returns and claims for refund filed after the date that final regulations are published in the Federal Register, but no sooner than December 31, 2008. For returns or claims for refund filed before January 1, 2000, see §1.6109-2A(a).

Par 5. Section 1.6694-0 is revised to read as follows:



§1.6694-0 Table of contents.

This section lists the captions that appear in §§1.6694-1 through 1.6694-4.



§1.6694-1 Section 6694 penalties applicable to tax return preparers.

(a) Overview.

(1) In general.

(2) Date return is deemed prepared.

(b) Tax return preparer.

(1) In general.

(2) Responsibility of signing tax return preparer.

(3) Responsibility of nonsigning tax return preparer.

(4) Tax return preparer and firm responsibility.

(5) Examples.

(c) Understatement of liability.

(d) Abatement of penalty where taxpayer's liability not understated.

(e) Verification of information furnished by taxpayer or other third party.

(1) In general.

(2) Verification of information on previously filed returns.

(3) Examples.

(f) Income derived (or to be derived) with respect to the return or claim for refund.

(1) In general.

(2) Compensation.

(i) Multiple engagements.

(ii) Reasonable allocation.

(iii) Fee refunds.

(iv) Reduction of compensation.

(3) Individual and firm allocation.

(4) Examples.

(g) Effective/applicability date.



§1.6694-2 Penalty for understatement due to an unreasonable position.

(a) In general.

(1) Proscribed conduct.

(2) Special rule for corporations, partnerships, and other firms.

(b) Reasonable belief that the position would more likely than not be sustained on its merits.

(1) In general.

(2) No unreasonable assumptions.

(3) Authorities.

(4) Examples.

(5) Written determinations.

(6) When more likely than not standard must be satisfied.

(c) Exception for adequate disclosure of positions with a reasonable basis.

(1) In general.

(2) Reasonable basis.

(3) Adequate disclosure.

(i) Signing tax return preparers.

(ii) Nonsigning tax return preparers.

(A) Advice to taxpayers.

(B) Advice to another tax return preparer.

(iii) Requirements for advice.

(iv) Pass-through entities.

(v) Examples.

(d) Exception for reasonable cause and good faith.

(1) Nature of the error causing the understatement.

(2) Frequency of errors.

(3) Materiality of errors.

(4) Tax return preparer's normal office practice.

(5) Reliance on advice of others.

(6) Reliance on generally accepted administrative or industry practice.

(e) Burden of proof.

(f) Effective/applicability date.



§1.6694-3 Penalty for understatement due to willful, reckless, or intentional conduct.

(a) In general.

(1) Proscribed conduct.

(2) Special rule for corporations, partnerships, and other firms.

(b) Willful attempt to understate liability.

(c) Reckless or intentional disregard.

(d) Examples.

(e) Rules or regulations.

(f) Section 6694(b) penalty reduced by section 6694(a) penalty.

(g) Burden of proof.

(h) Effective/applicability date.



§1.6694-4 Extension of period of collection when tax return preparer pays 15 percent of a penalty for understatement of taxpayer's liability and certain other procedural matters.

(a) In general.

(b) Tax return preparer must bring suit in district court to determine liability for penalty.

(c) Suspension of running of period of limitations on collection.

(d) Effective/applicability date.

Par. 6. Section 1.6694-1 is revised to read as follows:



§1.6694-1 Section 6694 penalties applicable to tax return preparers.

(a) Overview --(1) In general. Sections 6694(a) and (b) impose penalties on tax return preparers for conduct giving rise to certain understatements of liability on a return (including an amended or adjusted return) or claim for refund. The section 6694(a) penalty is imposed in an amount equal to the greater of $1,000, or 50 percent of the income derived (or to be derived) by the tax return preparer for an understatement of liability with respect to tax that is due to an undisclosed position for which the tax return preparer did not have a reasonable belief that the position would more likely than not be sustained on its merits (or due to a disclosed position for which there is no reasonable basis). The section 6694(b) penalty is imposed in an amount equal to the greater of $5,000, or 50 percent of the income derived (or to be derived) by the tax return preparer for an understatement of liability with respect to tax that is due to a willful attempt to understate tax liability or that is due to reckless or intentional disregard of rules or regulations. See §1.6694-2 for rules relating to the penalty under section 6694(a). See §1.6694-3 for rules relating to the penalty under section 6694(b).

(2) Date return is deemed prepared. For purposes of the penalties under section 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 within the meaning of §301.7701-15(b)(1) of this chapter fails to sign the return, the return is deemed prepared on the date the return is filed. See §1.6695-1 of this section. In the case of a nonsigning tax return preparer within the meaning of §301.7701-15(b)(2) of this chapter, the relevant date is the date the nonsigning tax return preparer provides the tax advice with respect to the position giving rise to the understatement. This date will be determined based on all the facts and circumstances.

(b) Tax return preparer --(1) In general. For purposes of this section, "tax return preparer" means any person who is a tax return preparer within the meaning of section 7701(a)(36) and §301.7701-15 of this chapter. An individual is a tax return preparer subject to section 6694 if the individual is primarily responsible for the position(s) on the return or claim for refund giving rise to an understatement. There is only one individual within a firm who is primarily responsible for each position on the return or claim for refund giving rise to an understatement. In the course of identifying the individual who is primarily responsible for the position, the Internal Revenue Service may advise multiple individuals within the firm that it may be concluded that they are the individual within the firm who is primarily responsible. In some circumstances, there may be more than one tax return preparer who is primarily responsible for the position(s) giving rise to an understatement if multiple tax return preparers are employed by, or associated with, different firms.

(2) Responsibility of signing tax return preparer. The signing tax return preparer within the meaning of §301.7701-15(b)(1) of this chapter will generally be considered the person who is primarily responsible for all of the positions on the return or claim for refund giving rise to an understatement. It may be concluded, however, based upon information received from the signing tax return preparer (or other relevant information from a source other than the signing tax return preparer) that another person within the signing tax return preparer's same firm was primarily responsible for the position(s) on the return or claim for refund giving rise to an understatement.

(3) Responsibility of nonsigning tax return preparer. If there are one or more individuals within a firm who are nonsigning tax return preparers within the meaning of §301.7701-15(b)(2) of this chapter and there is no signing tax return preparer within the meaning of §301.7701- 15(b)(1) of this chapter for the return or claim for refund within that firm, the individual within the firm with overall supervisory responsibility for the position(s) giving rise to the understatement is the tax return preparer who is primarily responsible for the position for purposes of section 6694. Additionally, if, after the application of paragraph (b)(2) of this section, it is concluded that the signing tax return preparer is not primarily responsible for the position or the IRS cannot conclude which individual (as between the signing tax return preparer and other persons within the firm) is primarily responsible for the position, the individual within the firm with overall supervisory responsibility for the position(s) giving rise to the understatement is the tax return preparer who is primarily responsible for the position for purposes of section 6694.

(4) Tax return preparer and firm responsibility. To the extent provided in §§1.6694-2(a)(2) and 1.6694-3(a)(2), an individual and the firm that employs the individual, or the firm of which the individual is a partner, member, shareholder, or other equity holder, may both be subject to penalty under section 6694 with respect to the position(s) on the return or claim for refund giving rise to an understatement. If an individual (other than the sole proprietor) who is employed by a sole proprietorship is subject to penalty under section 6694, the sole proprietorship is considered a "firm" for purposes of this paragraph (b).

(5) Examples. The provisions of paragraph (b) of this section are illustrated by the following examples:

Example 1. Attorney A provides advice to Client C concerning the proper treatment of an item with respect to which all events have occurred on C's income tax return. In preparation for providing that advice, A seeks advice regarding the proper treatment of the item from Attorney B, who is within the same firm as A, but A is the attorney who signs C's return as a tax return preparer. B provides advice on the treatment of the item upon which A relies. B's advice is reflected on C's income tax return but no disclosure was made in accordance with §1.6694-2(c)(3). The advice constitutes preparation of a substantial portion of the return within the meaning of §301.7701-15(b)(3) and the IRS later challenges the position taken on the tax return, giving rise to an understatement of liability. For purposes of the regulations under section 6694, A is initially considered the tax return preparer with respect to C's return and the IRS advises A that A may be subject to the penalty under section 6694 with respect to C's return. Based upon information received from A or another source, it may be concluded that B had primary responsibility for the position taken on the return that gave rise to the understatement because B had overall supervisory responsibility for the position giving rise to an understatement.

Example 2. Same as Example 1, except that neither Attorney A nor any other attorney within A's firm signs Client C's return as a tax return preparer. Attorney B is the nonsigning tax return preparer within the firm with overall supervisory responsibility for the position giving rise to an understatement. Accordingly, B is the tax return preparer who is primarily responsible for the position on C's return giving rise to an understatement and is subject to penalty under section 6694.

Example 3. Same as Example 1, except Attorney D, who works for a different firm than A, also provides advice on the same position upon which A relies. It may be concluded that D is also primarily responsible for the position on the return.

(c) Understatement of liability. For purposes of this section, an "understatement of liability" exists if, viewing the return or claim for refund as a whole, there is an understatement of the net amount payable with respect to any tax imposed by the Internal Revenue Code (Code), or an overstatement of the net amount creditable or refundable with respect to any tax imposed by the Code. The net amount payable in a taxable year with respect to the return for which the tax return preparer engaged in conduct proscribed by section 6694 is not reduced by any carryback. Tax imposed by the Code does not include additions to the tax, additional amounts, and assessable penalties imposed by subchapter 68 of the Code. Except as provided in paragraph (d) of this section, the determination of whether an understatement of liability exists may be made in a proceeding involving the tax return preparer that is separate and apart from any proceeding involving the taxpayer.

(d) Abatement of penalty where taxpayer's liability not understated. If a penalty under section 6694(a) or (b) concerning a return or claim for refund has been assessed against one or more tax return preparers, and if it is established at any time in a final administrative determination or a final judicial decision that there was no understatement of liability relating to the position(s) on the return or claim for refund, then --

(1) The assessment shall be abated; and

(2) If any amount of the penalty was paid, that amount shall be refunded to the person or persons who so paid, as if the payment were an overpayment of tax, without consideration of any period of limitations.

(e) Verification of information furnished by taxpayer or other party --(1) In general. For purposes of sections 6694(a) and (b) (including meeting the reasonable belief that the position would more likely than not be sustained on its merits and reasonable basis standards in §§1.6694- 2(b) and (c)(2), and demonstrating reasonable cause and good faith under §1.6694-2(d)), the tax return preparer generally may rely in good faith without verification upon information furnished by the taxpayer. A tax return preparer, however, may not rely on information provided by a taxpayer with respect to legal conclusions on Federal tax issues. A tax return preparer may also rely in good faith and without verification upon information furnished by another advisor, another tax return preparer or other party (including another advisor or tax return preparer at the tax return preparer's firm). The tax return preparer is not required to audit, examine or review books and records, business operations, or documents or other evidence to verify independently information provided by the taxpayer, advisor, other tax return preparer, or other party. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer. The tax return preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. Additionally, some provisions of the Code or regulations require that specific facts and circumstances exist (for example, that the taxpayer maintain specific documents) before a deduction or credit may be claimed. The tax return preparer must make appropriate inquiries to determine the existence of facts and circumstances required by a Code section or regulation as a condition of the claiming of a deduction or credit.

(2) Verification of information on previously filed returns. For purposes of section 6694(a) and (b) (including meeting the reasonable belief that the position would more likely than not would be sustained on its merits and reasonable basis standards in §§1.6694-2(b) and (c)(2), and demonstrating reasonable cause and good faith under §1.6694-2(d)), a tax return preparer may rely in good faith without verification upon a tax return that has been previously prepared by a taxpayer or another tax return preparer and filed with the IRS. For example, a tax return preparer who prepares an amended return (including a claim for refund) need not verify the positions on the original return. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known by the tax return preparer. The tax return preparer must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete. The tax return preparer must confirm that the position being relied upon has not been adjusted by examination or otherwise.

(3) Examples. The provisions of this paragraph (e) are illustrated by the following examples:

Example 1. During an interview conducted by Preparer E, a taxpayer stated that he had made a charitable contribution of real estate in the amount of $50,000 during the tax year, when in fact he had not made this charitable contribution. E did not inquire about the existence of a qualified appraisal or complete a Form 8283, Noncash Charitable Contributions, in accordance with the reporting and substantiation requirements under section 170(f)(11). E reported a deduction on the tax return for the charitable contribution, which resulted in an understatement of liability for tax, and signed the tax return as the tax return preparer. E is subject to a penalty under section 6694.

Example 2. While preparing the 2008 tax return for an individual taxpayer, Preparer F realizes that the taxpayer did not provide a Form 1099 for a bank account that produced significant taxable income in 2008. When F inquired about any other income, the taxpayer furnished the Form 1099 to F for use in preparation of the 2008 tax return. F did not know that the taxpayer owned an additional bank account that generated taxable income for 2008 and the taxpayer did not reveal this information to the tax return preparer notwithstanding F's general inquiry about any other income. F signed the taxpayer's return as the tax return preparer. F is not subject to a penalty under section 6694.

Example 3. In preparing a tax return, Accountant G relies on the advice of an actuary concerning the limit on deductibility under section 404(a)(1)(A) of a contribution by an employer to a qualified pension trust. On the basis of this advice, G completed and signed the tax return. It is later determined that there is an understatement of liability for tax that resulted from the incorrect advice provided by the actuary. G had no reason to believe that the advice was incorrect or incomplete, and the advice appeared reasonable on its face. G was also not aware at the time the return was prepared of any reason why the actuary did not know all of the relevant facts or that the advice was no longer reliable due to developments in the law since the time the advice was given. G is not subject to a penalty under section 6694. The actuary, however, may be subject to penalty under section 6694 if the advice given by the actuary constitutes a substantial portion of the tax return within the meaning of §301.7701-15(b)(3) of this chapter.

(f) Income derived (or to be derived) with respect to the return or claim for refund --(1) In general. For purposes of sections 6694(a) and (b), income derived (or to be derived) means all compensation the tax return preparer receives or expects to receive with respect to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement. In the situation of a tax return preparer who is not compensated directly by the taxpayer, but rather by a firm that employs the tax return preparer or with whom the tax return preparer is associated, income derived (or to be derived) means all compensation the tax return preparer receives from the firm that can be reasonably allocated to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement. In the situation where a firm that employs the individual tax return preparer (or the firm of which the individual tax return preparer is a partner, member, shareholder, or other equity holder) is subject to a penalty under section 6694(a) or (b) pursuant to the provisions in §§1.6694-2(a)(2) or 1.6694-3(a)(2), income derived (or to be derived) means all compensation the firm receives or expects to receive with respect to the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement.

(2) Compensation --(i) Multiple engagements. For purposes of applying paragraph (f)(1) of this section, if the tax return preparer or the tax return preparer's firm has multiple engagements related to the same return or claim for refund, only those engagements relating to the position(s) taken on the return or claim for refund that gave rise to the understatement are considered for purposes of calculating the income derived (or to be derived) with respect to the return or claim for refund.

(ii) Reasonable allocation. For purposes of applying paragraph (f)(1) of this section, only compensation for tax advice that is given with respect to events that have occurred at the time the advice is rendered and that relates to the position(s) giving rise to the understatement will be taken into account for purposes of calculating the section 6694(a) and (b) penalties. If a lump sum fee is received that includes amounts not taken into account under the preceding sentence, the amount of income derived will be based on a reasonable allocation of the lump sum fee between the tax advice giving rise to the penalty and the advice that does not give rise to the penalty.

(iii) Fee refunds. For purposes of applying paragraph (f)(1) of this section, a refund to the taxpayer of all or part of the amount paid to the tax return preparer or the tax return preparer's firm will not reduce the amount of the section 6694 penalty assessed. A refund in this context does not include a discounted fee or alternative billing arrangement for the services provided.

(iv) Reduction of compensation. For purposes of applying paragraph (f)(1) of this section, it may be concluded based upon information provided by the tax return preparer or the tax return preparer's firm that an appropriate allocation of compensation attributable to the position(s) giving rise to the understatement on the return or claim for refund is less than the total amount of compensation associated with the engagement. For example, the number of hours of the engagement spent on the position(s) giving rise to the understatement may be less than the total hours associated with the engagement. If this is concluded, the amount of the penalty will be calculated based upon the compensation attributable to the position(s) giving rise to the understatement. Otherwise, the total amount of compensation from the engagement will be the amount of income derived for purposes of calculating the penalty under section 6694.

(3) Individual and firm allocation. If both an individual within a firm and a firm that employs the individual (or the firm of which the individual is a partner, member, shareholder, or other equity holder) are subject to a penalty under section 6694(a) or (b) pursuant to the provisions in §§1.6694-2(a)(2) or 1.6694-3(a)(2), the amount of penalties assessed against the individual and the firm shall not exceed 50 percent of the income derived (or to be derived) by the firm from the engagement of preparing the return or claim for refund or providing tax advice (including research and consultation) with respect to the position(s) taken on the return or claim for refund that gave rise to the understatement. The portion of the total amount of the penalty assessed against the individual tax return preparer shall not exceed 50 percent of the individual's compensation as determined under paragraphs (f)(1) and (2) of this section.

(4) Examples. The provisions of this paragraph (f) are illustrated by the following examples:

Example 1. Signing Tax Return Preparer H is engaged by a taxpayer and paid a total of $21,000. Of this amount, $20,000 relates to research and consultation regarding a transaction that is later reported on a return, and $1,000 for the activities relating to the preparation of the return. Based on H's hourly rates, a reasonable allocation of the amount of compensation related to the advice rendered prior to the occurrence of events that are the subject of the advice is $5,000. The remaining compensation of $16,000 is considered to be compensation related to the advice rendered after the occurrence of events that are the subject of the advice and return preparation. The income derived by H with respect to the return for purposes of computing the penalty under section 6694(a) is $16,000, and the amount of the penalty imposed under section 6694(a) is $8,000.

Example 2. Accountants I, J, and K are employed by Firm L. I is a principal manager of Firm L and provides corporate tax advice for the taxpayer after all events have occurred subject to an engagement for corporate tax advice. J provides international tax advice for the taxpayer after all events have occurred subject to a different engagement for international tax advice. K prepares and signs the taxpayer's return under a general tax services engagement. I's advice is the source of an understatement on the return and the advice constitutes preparation of a substantial portion of the return within the meaning of §301.7701-15(b) of this chapter. I is the nonsigning tax return preparer within the firm with overall supervisory responsibility for the position on the taxpayer's return giving rise to an understatement. Thus, I is the tax return preparer who is primarily responsible for the position on the taxpayer's return giving rise to the understatement. Because K's signature as the signing tax return preparer is on the return, the IRS advises K that K may be subject to the section 6694(a) penalty against K to the understatement. K provides information that I is the tax return preparer with primary responsibility for the position that gave rise to the understatement and K formed a reasonable belief that the position would more likely than not be sustained on the merits by relying on the advice provided by I. Furthermore, K has reasonable cause because K relied on I for the advice on the corporate tax matter. The IRS, therefore, assesses the section 6694 penalty against I. The portion of the total amount of the penalty allocable to I does not exceed that part of I's compensation that is attributable to the corporate tax advice engagement. In the event that Firm L is also liable under the provisions in §1.6694-2(a)(2), the IRS assesses the section 6694 penalty in an amount not exceeding 50 percent of Firm L's firm compensation based on the engagement relating to the corporate tax advice services provided by I where there is no applicable reduction in compensation pursuant to §1.6694-1(f)(2)(iii).

Example 3. Same facts as Example 2, except that I provides the advice on the corporate matter when the events have not yet occurred. I's advice is the cause of an understatement position on the return but I is not a tax return preparer pursuant to §301.7701-15(b)(2) or (3) of this chapter. K has reasonable cause because K relied on I for the advice on the corporate tax matter and K is not limited to reliance on persons who provide post-transactional advice if such reliance is reasonable and in good faith. I, K and Firm L are not liable for the section 6694 penalty.

(g) Effective/applicability date. This section is applicable to returns and claims for refund filed, and advice provided, after the date that final regulations are published in the Federal Register.

Par. 7. Section 1.6694-2 is revised to read as follows:



§1.6694-2 Penalty for understatement due to an unreasonable position.

(a) In general --(1) Proscribed conduct. Except as otherwise provided in this section, a tax return preparer is liable for a penalty under section 6694(a) equal to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer for any return or claim for refund that it prepares that results in an understatement of liability due to a position if the tax return preparer knew (or reasonably should have known) of the position and either --

(i) The position was not disclosed as provided in this section and there was not a reasonable belief that the position would more likely than not be sustained on its merits; or

(ii) The position was disclosed as provided in this section but there was no reasonable basis for the position.

(2) Special rule for corporations, partnerships, and other firms. A firm that employs a tax return preparer subject to a penalty under section 6694(a) (or a firm of which the individual tax return preparer is a partner, member, shareholder or other equity holder) is also subject to penalty if, and only if --

(i) One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the conduct proscribed by section 6694(a);

(ii) The corporation, partnership, or other firm entity failed to provide reasonable and appropriate procedures for review of the position for which the penalty is imposed; or

(iii) Such review procedures were disregarded by the corporation, partnership, or other firm entity through willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.

(b) Reasonable belief that the position would more likely than not be sustained on its merits --(1) In general. A tax return preparer may "reasonably believe that a position would more likely than not be sustained on its merits" if the tax return preparer analyzes the pertinent facts and authorities, and in reliance upon that analysis, reasonably concludes in good faith that the position has a greater than 50 percent likelihood of being sustained on its merits. In reaching this conclusion, the possibility that the position will not be challenged by the Internal Revenue Service (IRS) (for example, because the taxpayer's return may not be audited or because the issue may not be raised on audit) is not to be taken into account. The analysis prescribed by §1.6662-4(d)(3)(ii) (or any successor provision) for purposes of determining whether substantial authority is present applies for purposes of determining whether the more likely than not standard is satisfied. Whether a tax return preparer meets this standard will be determined based upon all facts and circumstances, including the tax return preparer's diligence. In determining the level of diligence in a particular situation, the tax return preparer's experience with the area of Federal tax law and familiarity with the taxpayer's affairs, as well as the complexity of the issues and facts, will be taken into account. A tax return preparer may reasonably believe that a position more likely than not would be sustained on its merits despite the absence of other types of authority if the position is supported by a well-reasoned construction of the applicable statutory provision. For purposes of determining whether the tax return preparer has a reasonable belief that the position would more likely than not be sustained on the merits, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer, advisor, other tax return preparer, or other party (including another advisor or tax return preparer at the tax return preparer's firm), as provided in §1.6694-1(e).

(2) No unreasonable assumptions. A position must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the taxpayer or any other person. For example, a position must not be based on a representation or assumption that the tax return preparer knows, or has reason to know, is inaccurate.

(3) Authorities. The authorities considered in determining whether a position satisfies the more likely than not standard are those authorities provided in §1.6662-4(d)(3)(iii) (or any successor provision).

(4) Examples. The provisions of paragraphs (b)(1) through (b)(3) of this section are illustrated by the following examples:

Example 1. A new statute is silent as to whether the taxpayer may take advantage of certain tax benefits. The Treasury Department and the IRS have not issued any interpretative guidance for the newly enacted provision. A well-reasoned construction of the statutory text supports the position that a taxpayer may claim the tax benefits. Preparer M may avoid the section 6694(a) penalty by taking the position that M reasonably believed that the taxpayer's position would more likely than not be sustained on its merits.

Example 2. After the passage of legislation containing a new statutory provision, a taxpayer engaged in a transaction that is adversely affected by the new provision. Prior law supported a position favorable to the taxpayer. Preparer N believes that the new statute is inequitable as applied to the taxpayer's situation. The statutory language, however, is unambiguous as applied to the transaction to deny the result claimed by the taxpayer previously. In considering the new statutory provision as applied to the taxpayer's position, N may not avoid the section 6694(a) penalty by taking the position that the tax return preparer reasonably believed that the position would more likely than not be sustained on its merits.

Example 3. While preparing the taxpayer's return, Preparer O determines that a statute is silent as to whether the taxpayer may take a certain position on the taxpayer's 2007 Federal income tax return. Three private letter rulings issued to other taxpayers in 2002 and 2003 support the taxpayer's position. Temporary regulations issued in 2004, however, are clearly contrary to the taxpayer's position. After the issuance of the temporary regulations, the earlier private letter rulings cease to be authorities and are not taken into account in determining whether the taxpayer's position satisfies the reasonable belief that the position would more likely than not be sustained on its merits standard. Preparer O may not avoid the section 6694(a) penalty by taking the position that the tax return preparer reasonably believed that the taxpayer's position would more likely than not be sustained on its merits.

Example 4. In the course of researching whether an interpretation of a phrase in the Internal Revenue Code (Code) is a position that more likely than not will be sustained on its merits, Preparer P discovers that the only relevant authorities include decisions of five U.S. courts of appeal. Three U.S. courts of appeal have construed the language as being taxpayer favorable. Two other U.S. courts of appeal, however, have construed the identical language as being favorable to the government's position. The U.S. court of appeals in the jurisdiction where the taxpayer is located has not addressed this issue. P reasonably believes that the taxpayer's facts more closely parallel the facts involved in the three U.S. courts of appeals' decisions that were taxpayer favorable. Under the analysis prescribed by §1.6662-4(d)(3)(ii), P may avoid the section 6694(a) penalty by taking the position that the tax return preparer reasonably believed that a well-reasoned position consistent with the taxpayer favorable interpretation would more likely than not be sustained on its merits.

(5) Written determinations. The tax return preparer may avoid the section 6694(a) penalty by taking the position that the tax return preparer reasonably believed that the taxpayer's position satisfies the "more likely than not" standard if the taxpayer is the subject of a "written determination" as provided in §1.6662-4(d)(3)(iv)(A).

(6) When "more likely than not" standard must be satisfied. For purposes of this section, the requirement that a position satisfies the "more likely than not" standard must be satisfied on the date the return is deemed prepared, as prescribed by §1.6694-1(a)(2).

(c) Exception for adequate disclosure of positions with a reasonable basis --(1) In general. The section 6694(a) penalty will not be imposed on a tax return preparer if the position taken has a reasonable basis and is adequately disclosed within the meaning of paragraph (c)(3) of this section. For an exception to the section 6694(a) penalty for reasonable cause and good faith, see paragraph (d) of this section.

(2) Reasonable basis. For purposes of this section, "reasonable basis" has the same meaning as in §1.6662-3(b)(3) or any successor provision of the accuracy-related penalty regulations. For purposes of determining whether the tax return preparer has a reasonable basis for a position, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer, advisor, other tax return preparer, or other party (including another advisor or tax return preparer at the tax return preparer's firm), as provided in §1.6694-1(e).

(3) Adequate disclosure --(i) Signing tax return preparers. In the case of a signing tax return preparer within the meaning of §301.7701-15(b)(1) of this chapter, disclosure of a position for which there is a reasonable basis but for which the tax return preparer does not have a reasonable belief that the position would more likely than not be sustained on the merits is adequate if the tax return preparer meets any of the following standards:

(A) The position is disclosed in accordance with §1.6662-4(f) (which permits disclosure on a properly completed and filed Form 8275, "Disclosure Statement," or Form 8275-R, "Regulation Disclosure Statement," as appropriate, or on the tax return in accordance with the annual revenue procedure described in §1.6662-4(f)(2)).

(B) For income tax returns, if the position would not meet the standard for the taxpayer to avoid a penalty under section 6662(d)(2)(B) without disclosure (no substantial authority), the tax return preparer provides the taxpayer with the prepared tax return that includes the disclosure in accordance with §1.6662-4(f).

(C) For income tax returns, if the position would otherwise meet the standard for nondisclosure under section 6662(d)(2)(B)(i) (substantial authority), the tax return preparer advises the taxpayer of all the penalty standards applicable to the taxpayer under section 6662. The tax return preparer must also contemporaneously document the advice in the tax return preparer's files.

(D) For income tax returns, if section 6662(d)(2)(B) does not apply because the position may be described in section 6662(d)(2)(C) or section 6662A (a tax shelter, reportable transaction with a significant purpose of tax avoidance or evasion, or a listed transaction), the tax return preparer advises the taxpayer that there needs to be at a minimum substantial authority for the position, that the taxpayer must possess a reasonable belief that the tax treatment was more likely than not the proper treatment in order to avoid a penalty under section 6662(d) or section 6662A as applicable, and that disclosure will not protect the taxpayer from assessment of an accuracy-related penalty if either section 6662(d)(2)(C) or 6662A applies to the position. The tax return preparer must also contemporaneously document the advice in the tax return preparer's files.

(E) For returns or claims for refund that are subject to penalties pursuant to section 6662 other than the substantial understatement penalty under section 6662(b)(2) and (d), the tax return preparer advises the t