The final return preparer regulations.

Federal regulation of tax return preparers, which began in 1976, has accelerated during the past 16 years. In response to charges that the "reasonable basis" standard permitted under old Sec. 6694 had become too lax, both the American Bar Association (ABA) and the American Institute of Certified Public Accountants (AICPA) substantially revised their standards for taking a tax return position.(1) The "realistic possibility of success" standard adopted by the ABA and AICPA was subsequently codified by the Omnibus Budget Reconciliation Act of 1989 (OBRA) in revised Sec. 6694.(2)

This article will examine and analyze the final regulations under revised Sec. 6694, issued on Dec. 30, 1991 and generally applicable to returns or refund claims filed after Dec. 31, 1991. Sec. 6694(a) provides for the imposition of a $250 penalty on a tax preparer "who . . . knew (or reasonably should have known)" about any undisclosed tax return position that results in the understatement of tax liability and that does not meet the realistic possibility standard as defined in the final Sec. 6694 regulations.(3) Revised Sec. 6694(b) imposes a $1,000 preparer penalty if there is any understatement of tax liability derived from a willful attempt to understate tax liability or due to reckless or intentional disregard of IRS rules or regulations.

Sec. 6694(a) Penalty

* Unrealistic tax return positions

Any preparer (and his employer or partnership in certain cases) may be subject to a $250 penalty under Sec. 6694(a) if there is an understatement of tax liability on a return or claim for refund that resulted from a tax return position "for which there was not a realistic possibility of being sustained on its merits. . . ."(4) The preparer of the return or refund claim will be subject to the penalty if he knew or reasonably should have known about the unrealistic return position.(5)

The realistic possibility of success standard, as defined in the Sec. 6694 regulations, differs somewhat from the applicable professional standards promulgated by the AICPA and the ABA.(6) In assessing whether a tax return position has a realistic possibility of success, the regulations provide that the standard is met "if a reasonable and well-informed analysis by a person knowledgeable in the tax law would lead such a person to conclude that the position has approximately a one in three, or greater, likelihood of being sustained on its merits . . .",(7) without consideration of the audit lottery. Although the AICPA and other commentators severely criticized the percentage odds approach when it was first proposed by the Service as both difficult, if not impossible, to determine, and inconsistent with AICPA standards (which should have been reflected in the regulations as evidenced by the legislative intent), it remained in the final regulations.(8) According to the Service, the one-in-three requirement was retained in the final regulations "because a numerical benchmark helps prevent erosion of the standard and because other definitions suggested by commentators would not provide any more meaningful guidance."(9)

In determining whether a tax return has a "realistic possibility of success," the Sec. 6694 regulations adopt the same analysis used by Regs. Sec. 1.6662-4(d)(3)(ii) for determining "substantial authority." Thus, under Regs. Sec. 1.6694-2(b)(1), tax preparers may sign a tax return with an undisclosed tax return position if their "reasonable and well-informed analysis" leads them to conclude that the position has a realistic possibility of being sustained on the merits. Preparers should heed the guidance contained in AICPA Statement on Responsibilities in Tax Practice (SRTP) No. 1, however, to advise clients if a taxpayer penalty (e.g., under Sec. 6662) could be asserted. The explanation to SRTP No. 1 states, "Disclosure [of the tax return position] should be considered when the CPA believes it would mitigate the likelihood of claims of taxpayer penalties . . . or would avoid the possible application of the six-year statutory period for assessment. . . ."(10)

* Types of authority

Regs. Sec. 1.6662-4(d)(3)(iii) identifies the types of authorities a preparer must use in determining whether a tax return position has a realistic possibility of success. This new regulation, which expands the list of authorities recognized by former Sec. 6661 regulations in defining substantial authority, is now applicable to both taxpayers and preparers. Recognized authorities include the Internal Revenue Code and other applicable statutes; temporary, proposed and final Treasury Department regulations; revenue procedures and rulings; and tax treaties, applicable regulations and official explanations of these treaties. In addition, the regulation recognizes court cases; congressional intent as found in committee reports, joint statements by managers of legislation in conference reports, and in statements by "one of a bill's managers" before legislation is enacted; Joint Committee on Taxation explanations of legislation (the "Blue Book"); technical advice memoranda and private letter rulings published after Oct. 31, 1976; actions on decisions and general counsel memoranda issued after Mar. 12, 198 1, as well as those published in Cumulative Bulletins before 1955; IRS press or information releases; announcements, notices and administrative pronouncements appearing in the Cumulative Bulletins.

Sources that are not authority for purposes of Secs. 6662 and 6694 include "[c]onclusions reached in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals . . . ." However, the opinion of a tax professional outside the preparing firm may help the preparer establish that a realistic possibility exists to avoid a Sec. 6694(a) penalty under the reasonable cause and good faith exception.(11)

Under Regs. Sec. 1.6694-2(b)(4), if the taxpayer has received a written determination from a revenue agent that substantial authority exists for a return position, the position will meet the realistic possibility standard. The written determination may be in a ruling or determination letter given to the taxpayer, in a technical advice memorandum that specifically names the taxpayer, or in the report of a revenue agent issued to the taxpayer when an affirmative statement was made regarding the issue for an earlier year. Both taxpayers and tax preparers should check Regs. Sec. 1.6662-4(d)(3)(iv)(A) for additional detail on when a written determination is no longer applicable for either Sec. 6662 or Sec. 6694 purposes.

* Nature of "substantial authority/realistic possibility" analysis

General guidelines for analyzing whether there is substantial authority for taxpayers or realistic possibility for preparers are found in Regs. Sec. 1.6662-4(d)(3)(ii). This regulation stresses that "[t]he weight accorded an authority depends on its relevance and persuasiveness. . . ." For example, the similarity between the material facts applicable to a particular taxpayer and the facts in a case or revenue ruling should be carefully weighed, along with an evaluation of whether the particular authority "is otherwise inapplicable to the tax treatment at issue." Moreover, an authority that simply states a result is less persuasive than a source "that reaches its conclusion by cogently relating the applicable law to pertinent facts."

The nature and age of a document, as well as the depth of analysis within the document, must also be carefully analyzed. Deletion of material facts used in arriving at the ultimate conclusion, for example, may be a critical factor in evaluating private letter rulings as authority. In addition, revenue rulings are accorded more weight than private letter rulings. Older technical advice memoranda, actions on decision and private letter rulings, moreover, generally will be given "less weight" than more recently issued ones. And, any authority listed in the preceding sentence "that is more than 10 years old generally is accorded very little weight," although the regulation concedes that a document's "persuasiveness and relevance" must be evaluated along with its age and in light of subsequent developments. Finally, the regulation admits that a "well-reasoned construction" of the Code without additional supporting authority might meet both the substantial authority and realistic possibility of success standards.

* Reasonable cause and good faith exceptions

The $250 penalty under Sec. 6694(a) may be avoided if the tax understatement was the result of reasonable cause and the CPA acted in good faith.(12) One factor to be considered in deciding whether this exception will apply is the "nature of the error." For example, a provision of the Code may be "so complex, uncommon, or highly technical that a competent preparer . . . could have made the error."(13) However, if the error could have been discovered by a general review of the return or refund claim, the exception will not apply. In addition, if the error is isolated or infrequent, the exception will generally apply unless it is sufficiently material, obvious or flagrant. Moreover, any pattern of errors on a tax return or refund claim may cause the exception not to apply.(14)

Other factors that will be considered include the tax preparer's normal office practices and the materiality of the errors. A CPA's normal office practice "must be a system for promoting accuracy and consistency in the preparation of returns or claims. . . ."(15) Generally, for signing preparers, such office practice would involve the use of checklists, review of prior returns, methods for obtaining required taxpayer information and review procedures. These procedures must be followed and then evaluated and, along with the preparer's knowledge, must indicate that "the error in question would rarely occur" and would not be repeated on "numerous returns or claims."(16) Materiality is also a critical factor; for the reasonable cause and good faith exceptions to apply, the understatement of tax liability must be "relatively immaterial." Preparers are also warned that immaterial understatements will not necessarily qualify for the exception if the errors causing the tax liability understatement "are sufficiently obvious or numerous."(17)

The Sec. 6694(a) penalty may also be avoided if the practitioner relied "in good faith" on another preparer's schedules or advice. The exception will apply if the CPA followed the advice of a preparer outside of the firm that the CPA "had reason to believe was competent to render such advice."(18) This exception is not available if on its face the advice is not reasonable or the other preparer was not aware of "all relevant facts." A practitioner may not rely on the exception if he knew (or reasonably should have known, considering the "nature" of his practice) that the advice provided was not reliable because changes in the law occurred after the advice was given. The preparer must also prove that the written or oral advice was received from the other preparer.(19)

Examples of possible applications of the reasonable cause exception may be gained by examining several revenue rulings issued before the passage of revised Sec. 6694. These rulings describe situations in which the preparer made errors or omitted income and was either absolved of liability or charged with negligence under the prior Sec. 6694 regulations. Although these rulings were issued under previous law, they do provide specific illustrations and have not yet been withdrawn. Caution must be exercised, however, in examining these rulings and Rev. Proc. 80-40(20) to ascertain whether they are still valid or consistent with the new final Sec. 6694 regulations. Likewise, useful information can also be gleaned from important court cases adjudicated under the prior regulations.(21)

Sec. 6694(b) Penalty

Before the 1989 amendments, Sec. 6694(a) penalized negligent or intentional disregard of rules and regulations with a $100 fine and Sec. 6694(b) penalized a willful understatement of liability with a $500 penalty. New Sec. 6694(b) absorbs both these concepts and imposes a $ 1,000 penalty on the willful attempt to understate a taxpayer's tax liability, or any reckless or intentional disregard of rules or regulations by a tax return preparer. The mere negligent disregard of rules and regulations is no longer specifically penalized under Sec. 6694. However, according to the OBRA House Report, because Sec. 6694(a)'s realistic possibility standard is stricter than the old negligence standard, negligent behavior would be subject to the $250 penalty imposed by Sec. 6694(a).(22)

Any penalty imposed under Sec. 6694(b) is reduced by the amount of any penalty imposed under Sec. 6694(a) for the same return. Therefore, if a penalty is imposed under both Sec. 6694(a) and (b) relating to the same tax return, the maximum penalty will be $1,000 ($250 imposed under Sec. 6694(a) and $750 under Sec. 6694(b)).

For purposes of the Sec. 6694(b) penalty, a "rule or regulation" includes Code provisions, temporary or final Treasury regulations, and revenue rulings and notices (other than notices of proposed rulemaking) published in the internal Revenue Bulletin.(23)

* Willful understatement of tax liability

A willful attempt to understate tax liability occurs when the preparer disregards information furnished by the taxpayer or other persons in an attempt to wrongfully reduce the client's tax liability.(24) Regs. Sec. 1.6694-3(b) provides two examples to illustrate the imposition of the penalty for wrongfully reducing tax liability. In the first example, a preparer ignores information concerning items of taxable income, while in the second a taxpayer mentions he has only two dependents, but the tax return preparer reports six.

The test for willful understatement is explored in Regs. Sec. 1.6694-3(d), Examples 1 and 2. In Example 1, the client gives detailed check registers to the preparer. One expense incurred by the client is for domestic help. Although the check registers clearly show that the expense was personal, the preparer nonetheless deducts this expense as wages paid in the client's business. In the second example, the client again provides the preparer with detailed check registers, which the preparer ignores in knowingly overstating the client's expenses. In both examples, the $1,000 penalty under Sec. 6694(b) would be imposed.

The penalty for willful understatement applies regardless of the source of information. Thus, the client, a reporting entity issuing an information return, or even a less direct source such as a newspaper report of a substantial court judgment or lottery winning, could provide the correct information.

* Reckless or intentional disregard

In addition to the willful attempt to understate the client's tax liability, a preparer will be subject to the $1,000 penalty if the preparer takes a position that is contrary to a rule or regulation and the preparer knows of, or is reckless in not knowing of, the rule or regulation. A preparer is reckless if he makes little or no effort to discover the rule or regulation in a situation in which a reasonable preparer normally would research the issue. in the specific language in the regulations, the preparer will be considered reckless if there is a "substantial deviation" from a reasonable preparer's "standard of conduct."(25)

There are two exceptions from the reckless or intentional disregard penalty. The first exception, the "disclosure exception," applies when the preparer's position contrary to the rules or regulations is not frivolous, is adequately disclosed and, in the case of a regulation, is a good faith challenge to the validity of the regulation. The second exception, the "realistic possibility exception," only applies to positions contrary to a revenue ruling or notice: if the realistic possibility standard of Sec. 6694(a) is met, the second exception is applicable.

It is important to note that positions contrary to regulations are treated differently than other contrary positions in two important respects. First, the disclosure exception contains an extra requirement if the position is contrary to a regulation: the position must be furthered in good faith. Second, the realistic possibility exception does not apply at all if the position is contrary to the regulations.

If a preparer takes a position contrary to regulations, he must disclose the position, even if the regulation is demonstrably incorrect. This requirement could put preparers in an untenable position. For example, shortly after the enactment of the Installment Sales Revision Act of 1980, the IRS issued temporary regulations precluding taxpayers from using the installment sales method to defer gain attributable to wraparound mortgages. In 1987, the Tax Court decisively declared the temporary regulations invalid, and the IRS later acquiesced in the decision.(26) For reasons specified by the Tax Court, the IRS was simply wrong in issuing the wraparound regulations. if these Sec. 6694(b) regulations had been in place between 1981 and 1987, and a preparer chose to ignore the incorrect temporary regulations, he would have been subject to a $1,000 penalty unless the position had been disclosed and the preparer had demonstrated good faith in taking the position.

This point is reinforced by Regs. Sec. 1.6694-3(d), Example 4. In that example, a final regulation provided that a particular expenditure must be capitalized. The Tax Court issued an opinion expressly invalidating the regulation. The example states that if the preparer relies on the Tax Court opinion, the $1,000 penalty will still be imposed unless the preparer adequately discloses the position. Under these circumstances the Service concedes that the position contrary to the invalidated regulation represents a good faith challenge to its validity.

However, in most situations, good faith will be more difficult to establish. How would a preparer have proven good faith with a position contrary to the wraparound regulations between 1981 and 1987? One can only wonder if disclosure containing an analysis similar to that ultimately used in the 1987 Tax Court opinion would have satisfied the IRS.

Problem Areas

* Determination of a realistic possibility of success

One of the most difficult areas not fully addressed in the Sec. 6694 regulations is how to adequately determine if a tax return position has a realistic possibility of success. The use of a percentage odds approach is not really helpful and the commentary in Regs. Sec. 1.6662-4(d)l(3)(ii) is not particularly useful either.

To illustrate this problem, one need not look further than the 1990 Supreme Court holding in Indianapolis Power and Light Co.(27) that deposits left with utility companies are not to be included as taxable income. There had been a split among the circuits on whether and when utility deposits were taxable income. The Service had asserted in Rev. Rul. 72-519(28) that in certain circumstances deposits must be included. Although the Indianapolis Power and Light decision ultimately resolved the issue in favor of the taxpayer utility companies, uncertainty had existed for a number of years. Therefore, given the degree of uncertainty that existed, a tax return preparer operating under the new Sec. 6694 regulations might have been required to disclose the tax return position on Form 8275, Disclosure Statement, unless a favorable opinion was obtained from an outside preparer to meet the standards outlined in the reasonable cause and good faith exception under Regs. Sec. 1.6694-2(d)(5). Under these new regulations, if a pre-Indianapolis Power and Light taxpayer took a tax return position contrary to that asserted by the Service in Rev. Rul. 72-519, the preparer would have had to meet the realistic possibility standard.(29)

The realistic possibility standard must also be satisfied by the appropriate date. A signing preparer must meet the standard on the date the return or refund claim is both signed and dated.(30) If a preparer did not "sign" the return, the critical factor is "the date the taxpayer signed and dated the return or claim for refund. If the taxpayer also did not date the return or claim for refund, the relevant date is the date the return or claim for refund was filed."(31) Nonsigning preparers must meet the realistic possibility standard on the date the taxpayer is provided with the advice, which is "determined based on all the facts and circumstances."(32)

* Adequate disclosure of nonfrivolous return positions

Apparently, several levels of responsibility applicable to the taxpayer and preparer exist for taking a tax return position.(33) But no tax return position can be taken that is frivolous, i.e., "patently improper."(34) The IRS considers the definition of frivolous to create an objective standard, which holds that "neither the good nor the bad intentions of a person taking a position are relevant to a determination of whether that position is frivolous. . . ."(35)

Both the preparer and the taxpayer must meet the realistic possibility standard in filing an undisclosed tax return position that is contrary to a published revenue ruling or notice.(36) A taxpayer can avoid a negligence penalty for a nonfrivolous position that is not contrary to a ruling or regulation by meeting the "reasonable basis" standard in Regs. Sec. 1.6662-3(b)(1). This "lower" standard for individual tax return positions is based on "[a] return position that is arguable, but fairly unlikely to prevail in court. . . ."(37)

Although this minimal standard would enable the taxpayer to avoid the negligence penalty based on an undisclosed tax return position, it would not permit a preparer to sign the same return since the realistic possibility standard has not been met. Accordingly, the preparer would have to require proper disclosure (as outlined below) in order to avoid a preparer penalty under Sec. 6694(a), even though disclosure might not be desired by the client. The authors believe that failure to notify a client that a tax return includes a disclosure that is required to avoid a Sec. 6694 penalty on the preparer, but which would not be needed to avoid a penalty on the client, could constitute malpractice.(38)

* Disclosure procedures

Disclosure procedures to avoid the Sec. 6694(a) and (b) penalties are contained in Regs. Secs. 1.6694-2(c) and 1.6694-3(e), respectively. These two regulations are very similar, in that they both provide different disclosure procedures for "signing preparers" and "nonsigning preparers."

A signing preparer may use disclosure to avoid either the Sec. 6694(a) or (b) penalty by completing Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, whichever is appropriate. Form 8275-R, which is currently scheduled for release in May 1992, must be used if a preparer recommends a tax return position contrary to a regulation. Form 8275, with the label REGULATIONS in all caps in the upper right corner of the form, must be used until the new form is available.(39) In addition, for purposes of avoiding the Sec. 6694(a) penalty only, disclosure may be made on the tax return itself (without Form 8275 or 8275-R) in accordance with the annually updated revenue procedure that details the disclosures required to avoid the Sec. 6662(d) substantial understatement penalty. The current revenue procedure is Rev. Proc. 92-23.(40) An additional requirement applies to avoid the Sec. 6694(b) penalty when a rule or regulation is challenged: the rule or regulation must be adequately identified. See Table 1, "Adequate Disclosure by a Signing Preparer," above. [TABULAR DATA 1 OMITTED]

A nonsigning preparer may use the same method of disclosure as a signing preparer with respect to a position that does not satisfy the realistic possibility standard. The different disclosure requirements for purposes of the Sec. 6694(a) and (b) penalties applicable to signing preparers are also applicable to nonsigning preparers.

In addition, a nonsigning preparer may adequately disclose by providing a written or oral statement ("disclosure statement") to the taxpayer that, because the position lacks substantial authority, the preparer advises adequate disclosure to avoid a Sec. 6662 penalty. When communicating with other preparers, however, the nonsigning preparer must indicate that such disclosure is required to avoid a Sec. 6694 penalty. See Table 2, "Adequate Disclosure by a Nonsigning Preparer," on page 216. Note that the specific civil penalty to be identified in the disclosure statement depends on whether the penalty being avoided is the Sec. 6694(a) or (b) penalty and whether the recipient of the communication is the taxpayer or another preparer. [TABULAR DATA 2 OMITTED]

For instance, if the nonsigning preparer is seeking to avoid the Sec. 6694(a) penalty and is communicating with the taxpayer, the statement should notify the taxpayer that the position lacks substantial authority and a substantial understatement penalty under Sec. 6662(d) could be imposed.(41) On the other hand, if the nonsigning preparer is seeking to avoid the Sec. 6694(b) penalty due to a position contrary to a rule or regulation, the statement should notify the taxpayer that a negligence penalty described in Sec. 6662(c) could be imposed.

If the nonsigning preparer is communicating with another preparer and wants to avoid the Sec. 6694(a) penalty, the disclosure statement should state that disclosure under Sec. 6694l(a) is required. Likewise, if the nonsigning preparer is seeking to avoid the Sec. 6694(b) penalty and is writing to another preparer, the disclosure statement should note that Sec. 6694(b) disclosure is required.

In all instances, if the communication is in writing, the disclosure statement must be in writing. If the communication is oral, the disclosure statement may be oral. A facts and circumstances test applies to determine if an oral disclosure statement has in fact been given. A contemporaneously prepared memorandum to the file would normally suffice to prove that the oral statement was given.

Other Issues

* One-preparer-per-firm rule

The final Sec. 6694 regulations use the definition of "income tax preparer" found in Sec. 7701(a)(36) and Regs. Sec. 301.7701-15. However, because Regs. Sec. 1.6694-1(b)(1) provides that only one individual within a particular firm can be classified as the return preparer for Sec. 6694 penalty purposes, the distinction between a signing and nonsigning preparer is relevant. The individual who signs a return or claim for refund is the signing preparer(42) and, if associated with a particular firm, is the only individual within that firm subject to Sec. 6694 penalties.(43) In contrast, a nonsigning preparer is any other preparer, including a preparer who gives advice "to a taxpayer or to a preparer who is not associated with the same firm as the preparer who provides the advice."(44) If two or more CPAs within a firm are nonsigning preparers of the same tax return or claim for refund, the situation becomes more complex. The nonsigning preparer who has "overall supervisory responsibility for the advice given by the firm with respect to the return or claim" will ordinarily be considered the preparer for Sec. 6694 purposes.(45)

Regs. Secs. 1.6694-2(a)(2) and 1.6694-3(a)(2) describe the circumstances under which the preparer's firm (the employer or partnership) may be subject to preparer penalties in addition to those imposed on the individual preparer. Sole proprietorships that employ an individual other than the proprietor to prepare the tax return are considered firms for these purposes. Thus, both the individual preparer and the proprietorship may be penalized.(46)

* Understatement of liability, abatement and verification of taxpayer-furnished information

No penalty can be assessed under the Sec. 6694 regulations unless there is an understatement of tax liability. According to Regs. Sec. 1.6694-1(c), an income tax liability understatement occurs if, "viewing the return or claim for refund as a whole, there is an understatement of the net amount payable . . . or an overstatement of the net amount creditable or refundable. . . ." For penalty assessment purposes, the net amount payable is neither reduced for carrybacks nor increased for any additions resulting from underpayment of estimated tax under Secs. 6654 and 6655. Determination of the existence of an understatement of tax for Sec. 6694 purposes may be made in a proceeding separate from that involving the taxpayer. However, any penalty imposed under Sec. 6694 must be abated if a final judicial or administrative decision determines that the taxpayer's liability had not been understated.(47)

Like all tax return preparers, CPAs may rely "in good faith" on facts submitted by the client without having to verify information contained in the underlying books and records. However, because preparers cannot ignore the implications of information available to them or actually known by them, they "must make reasonable inquiries if the information as furnished appears to be incorrect or incomplete."(48) Furthermore, a preparer must specifically inquire if documentation exists to support deductible items, such as entertainment expenses permitted under Sec. 274.(49)

* Imposition of penalty, appeal and deposit of 15% of penalty

Penalties under Sec. 6694 are imposed on investigation of the prepared tax return. Before assessment, a report of the investigation is sent to the return preparer that includes an indication of the proposed penalty. Under Regs. Sec. 1.6694-4(a)(1), unless the statute of limitations is about to expire, a 30-day letter will be sent to the preparer including notice of the proposed penalty and the preparer's administrative appeal rights. If the preparer makes a timely request, an assessment will not be made until the administrative determination has been finalized.

The statute of limitations on the imposition of a Sec. 6694 penalty is found in Sec. 6696(d). Again, different rules apply for Sec. 6694(a) and (b). A penalty under Sec. 6694(a) may be assessed up to the date three years after the prepared return is filed. A penalty under Sec. 6694(b) may be assessed at any time; this means there is no statute of limitations for a Sec. 6694(b) penalty. Once assessed, the normal statute of limitations for collection under Sec. 6502 applies. The statute of limitations to file a claim for refund of a Sec. 6694 penalty is three years from the time the penalty is paid.

When the administrative determination of a Sec. 6694 penalty has been finalized, the IRS will send the preparer a statement of notice and demand. Within 30 days of the notice and demand, the preparer must pay at least 15% of the penalty.(50) If less than the full amount of the penalty is paid, the preparer must file a claim for refund immediately; if the full amount is paid, the preparer has three years to file the claim for refund. If a claim for refund is filed, the IRS cannot begin collection procedures on any amount due until the later of (1) the earlier of 30 days after the claim is denied or six months after the claim is filed or (2) the final resolution of any court appeal.(51)

If less than the full amount of the penalty is paid, the preparer has only 30 days to file a court appeal; if the full amount is paid, the preparer has six months plus 30 days after filing the claim for refund to appeal. This judicial appeal must be filed in an appropriate U.S. district court.(52) Note that at least 15% of the assessed penalty must be paid to obtain judicial review of the assessment.

Effective Dates

Regs. Secs. 1.6694-1 through 1.6694-3, which cover the main penalties under Sec. 6694, are generally applicable for any tax advice given or any documents prepared after Dec. 31, 1991. However Regs. Sec. 1.6694-3(c)(3), which covers tax advice on a position contrary to a revenue ruling or notice, is applicable after Dec. 31, 1989 for any documents that are prepared or any tax advice that is given. Preparers should also check the regulations for any exceptions to the effective dates, especially Regs. Sec. 1.6694-4. Notice 90-20,(53) which was also applicable in some prior years, should also be carefully examined.(54)

Conclusion

CPA tax practitioners who recommend controversial tax return positions must be extremely wary. They will have to balance their role as client advocates with their responsibility to the tax system, potential liability claims by clients, both penalties under Sec. 6694, as well as possible sanctions by the IRS Director of Practice in particular cases. Disclosure of a tax return position may ultimately be the best protection for both the client and the tax practitioner, but knowledge of the final Sec. 6694 regulations will at least afford the CPA the opportunity to avoid being penalized.(55)

Abbreviations Commonly Used in The Tax Adviser

TTA         The Tax Adviser
AFTR2D      American Federal Tax Reports,
            second series (Prentice-Hall)
Ann.        IRS Announcement
CB          Cumulative Bulletin
Cir.        Court of Appeals
Cl. Ct.     Claims Court
COBRA       Consolidated Omnibus Budget
            Reconciliation Act of 1985

Cong. Rec. Congressional Record 

DC          District Court
DRA         Deficit Reduction Act of 1984
ERISA       Employee Retirement Income
            Security Act of 1974
ERTA        Economic Recovery Tax Act of 1981
Fed. Reg.   Federal Register
F2d         Federal Reports, second series
F Supp      Federal Supplement
GCM         General Counsel's Memorandum
H. Rep.     House Ways and Means
            Committee Report
IR          Internal Revenue News Release
IRB         Internal Revenue Bulletin
LTR         IRS Letter Ruling
PL          Public Law

Regs. Sec. Treasury Regulation Rev. Proc. Revenue Procedure

Rev. Rul.   Revenue Ruling
RRA         Revenue Reconciliation Act of 1989
Sec.        Section (refers to the Internal
            Revenue Code of 1986 unless
            otherwise indicated)
S. Rep.     Senate Finance Committee Report
SSRA        Subchapter S Revision Act of 1982
Sup. Ct.    Supreme Court
TAM         Technical Advice Memorandum
TAMRA       Technical and Miscellaneous
            Revenue Act of 1988
TC          Tax Court (regular decision)
TC Memo     Tax Court (memorandum decision)
TD          Treasury Decision
TEFRA       Tax Equity and Fiscal
            Responsibility Act of 1982
TRA         Tax Reform Act of 1986
USTC        United States Tax Cases
            (Commerce Clearing House)

(1) ABA Committee on Ethics and Professional Responsibility, Formal Op. 85-352 (1985); AICPA Federal Taxation Executive Committe, Statements on Responsibilities in Tax Practice (SRTP) (1988 Rev.). The SRTPs were again revised slightly in 1991 and Interpretation 1-1 on the realistic possibility standard was issued in December 1990. (2) See Gardner, Willey and Woehlke, "The Realistic Possibility Standard," 22 The Tax Adviser 279 (May 1991). (3) To avoid a penalty, even a disclosed tax return position must be nonfrivolous, as defined in Regs. Sec. 1.6694-2(c). Tax practice by CPAs is also governed by Treasury Department Circular No. 230. See Gardner and Woehlke, "The Search for Enforceable Tax Practice Standards," 173 The Journal of Accountancy 38 (Jan. 1992), for additional information on tax practice standards. (4) Regs. Sec. 1.6694-2(a)(1). Regs. Sec. 1.6694-2(a)(2) provides guidance on the circumstances under which the entity (partnership or employer) may also be subject to the Sec. 6694(a) penalty. (5) Regs. Sec. 1.6694-2(a)(1). (6) Gardner, et al., note 2, at 280-285. (7) Regs. Sec. 1.6694-2(b)(1). (8) See Gardner, et al., note 2, at 285. See also the Tax Division of the American Institute of Certified Public Accountants' Comments on Proposed Taxpayer Accuracy and Preparer Regulations, May 22, 1991, at 9; and Banoff, "Determining and Weighing Valid Legal Authority to Avoid Accuracy-Related and Preparer Penalties: The Proposed Regulations Continue the Controversy," 69 Taxes 259 (May 1991), at 286-287. (9) "Public Comments, Section 6694(a) Provisions: Subsection 1, One-in-Three Definition of the Realistic Possibility Standard," as reprinted in 23 Tax Analysts' Daily Tax Highlights and Documents 3152ff (12/31/91) (hereinafter cited as Highlights and Documents). (10) AICPA Federal Taxation Executive Committee, Statement on Responsibilities in Tax Practice (1991 Rev.) No. 1 (SRTP No. 1), at .11. See also SRTP No. 8 for the form of advice rendered to clients and Regs. Sec. 1.6694-2(c)(3) for the disclosure rules if the CPA is concerned about whether the realistic possibility standard is met. (11) Regs. Secs. 1.6662-4(d)(3)(iii) and 1.6694-2(d)(5). See also "Public Comments, Section 6694(a) Provisions: Subsection 2, Authorities," reprinted in Highlights and Documents, note 9, at 3154, for additional rationale on why articles and treatises do not constitute authority for Sec. 6694(a) purposes. (12) Regs. Sec. 1.6694-2(d). (13) Regs. Sec. 1.6694-2(d)(1). (14) Regs. Sec. 1.6694-2(d)(1) and (2). (15) Regs. Sec. 1.6694-2(d)(4). (16) Id. (17) Regs. Sec. 1.6694-2(d)(3). (18) Regs. Sec. 1.6694-2(d)(5). (19) Id. See also Darlene Swayze, 785 F2d 715 (9th Cir. 1986)(57 AFTR2d 86-1050, 86-1 USTC [paragraph] 9291), rev'g and rem'g unreported DC decision, in which a relatively unsophisticated preparer avoided a preparer penalty by reyling on the advice of tax "experts" such as attorneys and CPAs. According to Regs. Sec. 1.6694-2(d)(5), the category of other preparers also includes "a person who would be considered a preparer under [Regs. Sec.] 1.6694-1(b) had the advice constituted preparation of a substantial portion of the return or claim for refund. . . ." (20) Rev. Proc. 80-40, 1980-2 CB 774. (21) See, e.g., Rev. Rul. 80-263, 1980-2 CB 376; Rev. Proc. 80-40, id.; Rev. Rul. 80-262, 1980-2 CB 375; Rev. Rul. 80-266, 1980-2 CB 378; John Brockhouse, 577 F Supp 55 (N.D.Ill. 1983)(52 AFTR2d 83-5756, 83-1 USTC [paragraph] 9410), aff'd, 749 F2d 1248 (7th Cir. 1984)(55 AFTR2d 85-445, 84-2 USTC [paragraph] 10,005). (22) OBRA House Report, 101st Cong. (1989), at 289. (23) Regs. Sec. 1.6694-3(f). (24) Regs. Sec. 1.6694-3(b). (25) Reg. Sec. 1.6694-3(c)(1). (26) Professional Equities, Inc., 89 TC 165 (1987), acq. 1988-2 CB 1. (27) Indianapolis Power and Light Co., 493 US 203 (1990)(65 AFTR2d 90-394, 90-1 USTC [paragraph] 50,007). (28) Rev. Rul. 72-519, 1972-2 CB 32. (29) See Gardner, Willey and Bottin, "New Supreme Court decision shows when deposits will not be taxable on receipt," 44 Taxation for Accountants 326 (June 1990). (30) Regs. Sec. 1.6694-2(b)(5)(i)(A). (31) Regs. Sec. 1.6694-2(b)(5)(i)(B). (32) Regs. Sec. 1.6694-2(b)(5)(ii). Regs. Sec. 1.6662-4(d)(3)(iv)(C) states that substantial authority must exist on the date the return is filed or "on the last day of the taxable year to which the return relates." (33) See "How Does the Audit Lottery Impact Practitioners' Advice?" 6 Raby Report on Tax Practice 1 (Sep. 1991) (hereinafter, "Raby Report"). See also Banoff, note 8, for a discussion of the tax return position standards under the proposed regulations. (34) Regs. Sec. 1.6694-2(c)(2). (35) "Public Comments, Section 6694(a) Provisions: Subsection 6, Definition of Frivolous," as reprinted in Highlights and Documents, note 9, at 3155. (36) Regs. Secs. 1.6694-2(b)(1), 1.6694-3(c)(3) and 1.6662-3(b)(2). See "Public Comments, Section 6694(a) Provisions: Adequate Disclosure, Subsection 7(b), Tensions Between Accuracy-Related Penalties and the Preparer Penalties," reprinted in Highlights and Documents, note 9, at 3155. Preparers should examine Regs. Sec. 1.6662-3(c) to ascertain which specific disclosure requirements exist to avoid the negligence penalty under Sec. 6662. (37) Regs. Sec. 1.6662-4(d)(2). (38) Raby Report, note 33. Conceivably, malpractice could occur if (1) the preparer owed a duty to notify the client that there was no need for disclosure to avoid a taxpayer penalty, (2) the preparer failed in this duty to notify, (3) there is actual damage to the client and (4) the failure of the duty is the "proximate cause" of the damage. See Causey and McNair, The Tax Practitioner (Mississippi State, MS: Accountant's Press, 1990), at 106. (39) "Public Comments, Section 6694(b) Provisions: Subsection 3, Adequate Disclosure," reprinted in Highlights and Documents, note 9, at 3156. Notice 90-20, 1990-1 CB 328, contains somewhat different disclosure requirements than under the final Sec. 6694 regulation. See, generally, Coustan and Banoff, "Dodging the Bullet: Avoiding the Accuracy-Related and Preparer Penalties Through Reasonable Cause and Good Faith, or Disclosure," 69 Taxes 351 (June 1991). (40) Rev. Proc. 92-23, IRB 1992-13 (3/30/92). (41) Regs. Sec. 1.6694-2(c)(3)(iii)(A). Of course, this advice to the taxpayer is not relevant if the Sec. 6662(d) threshold would not be exceeded when the taxpayer takes the position. The regulations do not anticipate this situation. (42) Regs. Sec. 1.6694-1(b)(2). (43) Regs. Sec. 1.6694-1(b)(1). (44) Regs. Sec. 1.6694-1(b)(2). (45) Regs. Sec. 1.6694-1(b)(1). (46) Id. (47) Regs. Sec. 1.6694-1(d). (48) Regs. Sec. 1.6694-1(e)(1). (49) See the example in Regs. Sec. 1.6694-1(e)(2). (50) Regs. Sec. 1.6694-4(a)(3). (51) Regs. Sec. 1.6694-4(a)(4). (52) Regs. Sec. 1.6694-4(b). (53) Notice 90-20, note 39. (54) Regs. Sec. 1.6694-1(f). (55) See the discussion of disclosure in Raby Report, note 33; Gardner and Woehlke, note 3; SRTPs Nos. 1-8 (1991 Rev.).

Editor's note: Professor Gardner is a member of the AICPA Tax Division's Responsibilities in Tax Practice Committee. Mr. Woehlke is an employee of the American Institute of Certified Public Accountants. Their views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.