Preparer penalties assessed on employer.

S is an S corporation in the business of tax return preparation. S has one shareholder, A, and at least one employee (N), who is A's niece. Although A and N have signed returns as the preparer for S, they have not received wages from S. A has prepared the majority of the returns that S prepared for clients. Approximately one-half of the returns A signed included S's name and employer identification number (EIN). A signed the other returns using only her name and Social Security number.

On audit, the Service requested from A a list of returns, and/or copies of returns, required to be maintained under Sec. 6107(b). A did not cooperate; the IRS assessed a penalty under Sec. 6695(d) for approximately 1,100 returns, against both A and S separately.

Law

Sec. 6107(b) requires an income tax return preparer, for a period of three years after the close of the return period, to (1) retain a completed copy of the return or claim, or a list of the names and taxpayer identification numbers of the taxpayers for whom the return or claim was prepared; and (2) make the copy or list available for inspection on request by the Service.

Any income tax return preparer who fails to comply with Sec. 6107(b) must pay a penalty of $50 for each such failure, unless it is shown that it is due to reasonable cause and not willful neglect (Sec. 6695(d)). The maximum penalty is $25,000.

"Preparer" Defined

An "income tax return preparer" is any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of any return or refund claim; see Sec. 7701(a)(36)(A) and Regs. Sec. 301.7701-15(a). As a general rule, when there is an employment arrangement between two or more income tax return preparers, the employer is deemed to be the sole income tax return preparer; see Regs. Sec. 1.6107-1(c).

S employed N (and possibly others) to prepare tax returns. Because S employs agents or employees to prepare income tax returns for compensation, S is an income tax return preparer as to those returns or refund claims for purposes of Secs. 6107(b) and 6695(d).

As to the returns A prepared, the question of who is subject to the Sec. 6695(d) penalty depends on whether S employed A. This is determined under common law rules applicable in determining the employer-employee relationship; see Nu-Look Design, Inc., 356 F3d 290 (3d Cir. 2004). Several factors used to determine the existence of the employer-employee relationship are (1) the right to control the details of the work; (2) furnishing of tools and workplace; (3) withholding of taxes, workers' compensation and unemployment insurance funds; (4) right to discharge; and (5) permanency of the relationship. Although no one factor is controlling, the most important factor is the right to control. Some cases have held that when a sole shareholder of an S corporation is the "central worker" of the corporation and performs more than minor services for the corporation, the sole shareholder should be treated as an employee; see Nu-Look Design, Inc.

If facts reveal that there was an employer-employee relationship between S and A for some or all of the returns A signed, the penalty for those returns should be asserted only against S. However, if the facts show that there was no employer-employee relationship for some or all of the returns A signed, the penalty for those returns should be asserted only against A as the actual preparer.

The fact that A signed the majority of the returns is not a key factor here, especially as A signed half of them using only her own name and EIN. As it is not clear whether A was an employee of S, there are insufficient facts to determine whether the absence of S's identification was due to an error or lack of an employment arrangement.

In addition, if A establishes sufficient facts to prove that the failure to provide the information was due to reasonable cause and not willful neglect, the penalty will need to be abated for each instance for which she establishes reasonable cause; see Sec. 6695(d).

CHIEF COUNSEL ADVICE 200542034 (10/21/05)