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New rules and penalties for disclosure of tax data could land tax preparers in jail.

Success in the digital age depends upon the widespread integration of information and technology into all aspects of modern business. Federal and state laws and regulations concerning data security and privacy can have a significant impact on businesses. The IRS has strongly emphasized the need for tax preparers to protect tax return data. Beginning January 1, 2009, Treasury Regulations took effect that may lead to not only civil but criminal penalties for the disclosure of confidential tax return data by tax preparers.

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The primary motivation for the new regulations is concern by Congress and the IRS about the confidentiality of income tax return data. Another concern is the perceived abuse in the area of refund anticipation loans (RAL). RALs are short-term cash advances against a taxpayer's anticipated income tax refund. A controversial proposal that was also issued with these regulations would create a complete ban on the use of information obtained during tax preparation for the marketing of RALs.

Tax preparers must understand their new responsibilities for confidentiality and disclosure of taxpayers' information. In addition, they need to know the answers to a number of important questions raised by these regulations.

The revised rules (TD 9375 and TD 9409) include many of the original rules from the pre-existing regulations issued in the 1970s but also provide many more examples and specific details. The first of three regulations issued under IRC section 7216 explains and defines a tax preparer. The second regulation explains the types of disclosures that do not require taxpayer consent such as disclosure of tax return information to an IRS employee. The third regulation covers the consent to disclose or the proper use of information by the tax preparer. These rules significantly tighten up the requirements for a taxpayer's consent and should be understood by anyone professionally preparing a tax return.

Penalties Under IRC Sections 6713 and 7216

Two provisions of the tax code cover disclosure or use of return information by a tax return preparer. Civil penalties are imposed under IRC section 6713 for improper disclosure of tax return information. A $250 penalty is imposed for each such unauthorized disclosure or use to a maximum of $10,000 in a calendar year.

Both civil and criminal penalties are imposed under IRC section 7216. A violation of IRC section 7216 is a misdemeanor, with a maximum fine of not more than $10,000 or up to one year in prison, or both, together with the costs of prosecution. Section 7216(a) applies to disclosures made "knowingly or recklessly." Because neither the tax code nor congressional committee reports define "knowingly" or "recklessly," it presumably applies to negligent as well as intentional releases of information.

Tax Preparer

A "tax return preparer" includes any person who is engaged in the business of preparing or assisting in preparing tax returns. It also includes any person who is engaged in the business of providing auxiliary services in connection with the preparation of tax returns. All persons who develop software used to prepare or file a tax return along with any authorized IRS e-file providers are also included.

Example. Firm B is a tax return preparer and an authorized IRS e-file provider. B employs one individual, Q, to solicit the necessary tax return information for the preparation of a tax return; another individual, R, to prepare the return on the basis of the information that is furnished; a secretary, S, who types the information on the returns into a computer; and an administrative assistant, T, who uses a computer to file electronic versions of the tax returns. In this example, only R is a tax return preparer for purposes of IRC section 7701(a)(36), but all four employees are tax return preparers for purposes of IRC section 7216.

A key term in the new definition is whether tax preparers "hold themselves out." Specifically, a person will be considered engaged in the business of preparing tax returns if, in the course of the person's business, the person holds himself out to either tax return preparers or taxpayers as a person who prepares tax returns or assists in preparing tax returns. It does not matter whether or not tax return preparation is the person's sole business activity or whether or not the person charges a fee for tax return preparation services. The same language is used for anyone who provides auxiliary services in connection with a tax return, like developing software for e-filing tax returns. A person who holds himself out to tax return preparers or taxpayers as a person who performs auxiliary services, regardless of whether providing the auxiliary services is the person's sole business activity or charges a fee for the auxiliary services, will be considered a tax preparer under IRC section 7216. This definition applies even when a tax preparer is compensated on a casual basis for helping a relative, friend, or other acquaintance.

There is a limit, however, to how far the definition of tax preparer extends under these rules. A person will not be a tax return preparer merely because he leases office space to a tax return preparer or furnishes credit to a taxpayer whose tax return is prepared by a tax return preparer. Similarly, when a person either furnishes information to a tax return preparer at the taxpayer's request, furnishes hyperlinked access to a third party's tax return preparation website, or otherwise performs some service that is only incidentally related to the preparation of tax returns, she will not be considered a tax preparer under IRC section 7216.

Example. Tax return preparer P contracts with department store D to rent space in its store. D advertises that taxpayers who use P's services may charge the cost of having their tax return prepared to their account with D. Under these circumstances, D is not a tax return preparer because it provides space, credit, and other services only incidentally related to the preparation of tax returns.

Tax Information

Tax return information includes any information provided in connection with the preparation of a taxpayer's tax return. This includes, but is not limited to, the taxpayer's name, address, and taxpayer ID number. It also includes information provided directly by the taxpayer to the preparer as well as information received from third parties in connection with the preparation of the taxpayer's return. Notifications from the IRS regarding e-file acceptances and rejections are also included. Tax return information does not include any information that was made available to the tax preparer in a different context that is not "in connection with tax return preparation."

Permitted Disclosures Without Taxpayer Consent

The second provision under IRC section 7216 clarifies the circumstances under which a tax preparer may disclose tax return information without taxpayer consent. For example, if while rendering an opinion on a financial statement an accounting firm obtains tax return information that reveals an untrue statement of a material fact, should the accounting firm reveal this information to the SEC as part of the registration statement?

There are a number of exceptions to the requirement that a preparer must obtain consent from a taxpayer before disclosing confidential information. First, a preparer who is lawfully engaged in the practice of law or accountancy and prepares a return for a taxpayer may use or disclose the taxpayer's tax return information to another employee or member of the law or accounting firm. For example, an accountant who prepares a return for a taxpayer may use the tax return information, or disclose it to another employee or member of the firm, for use in connection with the preparation of books, records, working papers, accounting statements, or reports for the taxpayer. Similarly, a lawyer who prepares a return for a taxpayer may use the tax return information in connection with rendering legal services, including estate planning and administration, the preparation of trial briefs, and the preparation of trust instruments for either the taxpayer or the estate. In a similar way, a lawyer who prepares a return may disclose tax return information to another employee or member of the firm while providing other legal services to the taxpayer.

In addition, the disclosure penalty rules do not apply if such use or disclosure is made pursuant to:

* The order of any federal, state, or local court,

* A subpoena issued by a federal or state grand jury,

* A subpoena issued by the U.S. Congress,

* An administrative order, demand, summons, or subpoena issued by any federal or state agency,

* A written request from a board investigating the ethical conduct of the tax return preparer, or

* A written request from the Public Company Accounting Oversight Board (PCAOB) in connection with an inspection under the Sarbanes-Oxley Act of 2002 (SOX).

Disclosures in Fulfillment of Legal and Ethical Responsibilities

A tax return preparer who is lawfully engaged in the practice of law or accountancy may, consistent with the applicable legal and ethical responsibilities, take tax return information into account. The preparer may also act upon or disclose the information to another employee or member of the preparer's law or accounting firm to enable them to take the information into account and act upon it in the course of performing legal or accounting services for another client. When appropriate, tax preparers may provide information under the following circumstances:

* To an attorney for purposes securing legal advice,

* To an employee of the Treasury Department for use in connection with any investigation of the tax return preparer conducted by the IRS or the Treasury, or

* To any officer of a court for use in connection with proceedings involving the preparer or the taxpayer before the court or any grand jury that may be convened by the court.

Example. Tax preparer A, a member of an accounting firm, renders an opinion on a financial statement of M Corporation that is part of an SEC registration statement. After the registration statement is filed, but before its effective date, B, a member of the same firm, prepares an income tax return for N Corporation. In the course of preparing the return, B discovers that N does business with M Corporation and concludes that the information given by N Corporation should be considered by A to determine whether the financial statements contain an untrue statement of material fact or omit a material fact required to keep the statement from being misleading. B discloses the tax return information of N Corporation to A for this purpose. A determines that there is an omission of material fact and that an amended statement should be filed, advising M Corporation and the SEC of this. A explains that the omission was revealed as a result of confidential information that came to A's attention after the statement was filed, but A does not disclose the identity of the taxpayer or the tax return information itself. The disclosure penalty rules do not apply to B's disclosure of N's tax return information to A and A's use of the information in advising M Corporation and the SEC to file an amended statement.

Disclosures to Other Tax Preparers

There are three different situations discussed in the regulations under IRC section 7216 whereby tax preparers disclose taxpayer information to other preparers. The first situation involves a taxpayer disclosing information to a preparer located within the United States. If a taxpayer furnishes tax return information to a preparer located within the United States, an employee or member of that firm will be allowed to use the tax return information for the purpose of performing services that assist in the preparation of the taxpayer's tax return without their consent. If, however, an employee or member to whom the tax return information is to be disclosed is located outside of the United States, the taxpayer's prior consent under Treasury Regulations section 301.7216-3 is required.

The second situation involves the disclosure of taxpayer information by one preparer to another. Disclosure of tax return information to another tax return preparer that is assisting in the preparation of the return generally does not require the taxpayer's consent. Nevertheless, consent will be required if the services provided are substantive determinations of advice affecting the tax liability. A substantive determination involves an analysis, interpretation, or application of the law. In other words, when a tax preparer seeks any type of advice from another preparer in connection with the preparation of the return, consent must be obtained from the taxpayer under Treasury Regulations section 301.7216-3. The regulations provide three examples of authorized disclosures in this context; all three involve some aspect of electronic filing. The first authorized disclosure occurs when one preparer discloses tax return information to another for the purpose of having the second preparer transfer the return by means of some type of tax return processing service. The second authorized disclosure occurs when a tax preparer transfers the return to an authorized IRS e-file provider for the purpose of electronically filing the return with the IRS. The third authorized disclosure occurs when one preparer provides information to a second preparer for the purpose of making the information concerning the return available to the taxpayer. This would include, for example, whether the return has been accepted or rejected by the IRS, or the status of a refund.

The third disclosure situation involves the taxpayer furnishing tax return information to preparers located outside the United States. If a taxpayer initially furnishes tax return information to a preparer located outside the United States, an employee or member of the preparer firms may use such tax return information for the purpose of performing services that assist in the preparation of the tax return without taxpayer's consent under Treasury Regulations section 301.7216-3.

Payment for Services

Tax return information may be used for the limited purpose of processing or collecting a fee for the preparation services, but this is limited to information the taxpayer gave the preparer for the purpose of making the payment. For example, if the taxpayer gives the preparer a credit card to pay for tax preparation services, the preparer may disclose the taxpayer's name, credit card number, credit card expiration date, and amount due to the credit card company to process the payment. Any tax return information that the taxpayer did not give the preparer for the purpose of making payment may not be used or disclosed by the tax return preparer without the taxpayer's prior written consent.

Disclosure and Taxpayer Consent

For disclosures or uses of tax return information occurring as of January 1, 2009, the provisions of Treasury Regulations section 301.7217-3 apply. These regulations strengthen taxpayers' control of their information by requiring that tax preparers give taxpayers specific information, including who will receive the tax return information and the specific items that will be disclosed or used. This allows taxpayers to make knowing, informed, and voluntary decisions about the disclosure or use of their information by the preparer. Vitally important questions are also addressed under this regulation. For example, what if, while performing an audit, an accountant discovers information from a tax return that has a direct bearing on the audit? May the accountant consider that information without violating the new disclosure rules? More specifically, what if an outside auditor learns about an illegal or unethical practice from tax return data? May that information be used without violating the new disclosure rules?

Treasury Regulations section 301.7217-3 provides that, unless IRC section 7216 or Treasury Regulations section 301.7217-2 specifically authorizes the disclosure or use of tax return information, a preparer may not disclose or use tax return information prior to obtaining the taxpayer's knowing and voluntary written consent The regulations also discuss circumstances whereby a tax preparer may condition its provision of services upon a taxpayer's consent to disclosure of the tax return information to another preparer for their assistance.

Example. Tax return preparer P, located in the United States, is retained by Company C to prepare the tax returns for its employees. Employee E works for C outside the United States. To provide tax return preparation services for E, P requires the assistance of a preparer who works for P's affiliate in the country where E works. P may condition its provision of services upon E consenting to the disclosure of tax return information to the tax return preparer in the country where E works.

Form and Content of Taxpayer's Consents

The form and content of a taxpayer's consents are prescribed in great detail. A taxpayer's consent to a tax return preparer's disclosure or use of tax return information must include: the names of both the tax return preparer and the taxpayer, the intended purpose of the disclosure, the specific recipients of the tax return information, and the particular use authorized. For example, if the preparer intends to use tax return information to generate solicitations for products or services other than tax preparation, the consent must identify each specific type of product or service. Examples of products or services that must be identified include, but are not limited to: balance-due loans, mortgage loans, mutual funds, individual retirement accounts, and life insurance. The consent must also specify the tax return information to be disclosed or used by the preparer. It must be signed and dated by the taxpayer.

Additional Guidance for Consents and Electronic Signatures

Additional guidance for tax return preparers regarding the format and content of consents are explained in Revenue Procedure 2008-35. It also provides specific requirements for electronic signatures when a taxpayer executes an electronic consent to the disclosure or use of the taxpayer's tax return information.

If a taxpayer furnishes consent to disclose or use tax return information electronically, the taxpayer must furnish the preparer with an electronic signature to verify that consent. Treasury Regulations section 301.7216-3(a) requires that the consent be knowing and voluntary. For an electronic consent to be valid, therefore, it must be furnished in a manner that ensures affirmative, knowing consent to each disclosure or use. To be valid, the tax preparer must obtain the taxpayer's electronic signature in one of three ways. First, the preparer may assign the taxpayer a personal identification number (PIN) that is at least five characters long, which the taxpayer affirmatively enters. Second, the tax preparer may have taxpayers type their name and hit "enter" to authorize the consent. The third option involves any other manner in which the taxpayer affirmatively enters five or more characters that are unique to that taxpayer and used by the preparer to verify the taxpayer's identity.

Consent to disclose or use tax return information with respect to a taxpayer not filing a return in the Form 1040 series may be in any format, including an engagement letter, as long as the consent complies with the requirements of form and content discussed above. Additionally, the multiple disclosure requirements of Treasury Regulations section 301.7216-3(c)(l) are inapplicable to consents to disclose or use tax return information with respect to taxpayers not filing a return in the Form 1040 series. Solely for purposes of non-1040 filers, a consent may allow disclosure to a descriptive class of entities engaged by a taxpayer or its affiliate for purposes of services in connection with the preparation of tax returns, audited financial statements, or other financial statements or financial information as required by a government authority, municipality, or regulatory body.

Timing Requirements and Limitations

A taxpayer must provide written consent before a preparer discloses or uses the tax return information. Retroactive consents are not permitted. In addition, there is a time limit on requesting consent in the context of solicitation. A preparer may not request a taxpayer's consent to disclose or use tax return information for the purposes of soliciting business unrelated to tax return preparation after the preparer provides a completed return to the taxpayer for their signature. Moreover, a consent document may specify the duration of the taxpayer's consent to the disclosure or use of tax return information. If a consent does not specify its duration, it will be effective for a period of one year from the date the taxpayer signed the consent. Finally, if a taxpayer declines a request for consent to the disclosure or use of tax return information for the purposes of soliciting business unrelated to tax return preparation, the preparer may not solicit another consent from the taxpayer for a substantially similar purpose to that of the rejected request.

Other Issues

A tax preparer located within the United States may not obtain consent to disclose a taxpayer's Social Security number (SSN) to a tax preparer located outside of the United States. In addition, the tax return preparer must redact or otherwise mask the taxpayer's SSN before the tax return information is disclosed outside of the United States. If, however, a tax preparer located within the United States initially receives or obtains a taxpayer's SSN from another preparer located outside of the United States, the U.S. preparer may, without consent, retransmit the taxpayer's SSN to that non-U.S. preparer.

A consent may authorize the disclosure of all information contained within a return; however, it must also provide that the taxpayer has the ability to request a more limited disclosure of tax return information as the taxpayer may direct. In addition, the preparer must provide a copy of the executed consent to the taxpayer at the time of execution. This requirement may also be satisfied by giving the taxpayer the opportunity, at the time of executing the consent, to print the completed consent or save it in electronic form.

Protecting Information

The changes to IRC section 7216 and the accompanying regulations represent an effort by Congress and the IRS to safeguard taxpayer information. The statute is exceedingly protective of taxpayer information and forbids a tax preparer from disclosing return information or using it for any purpose other than preparing the taxpayer's return. Congress considers these protections necessary because of the enormously sensitive and confidential nature of tax return information.

The new rules in the regulations are effective for disclosures or uses of tax return information as of January 1, 2009. Preparers who have not yet reviewed them should do so and update their office procedures where necessary. The definition of tax return preparer is now broader than under pre-existing rules. For example, a CPA's administrative assistant is subject to IRC section 7216 if he is compensat ed for assisting with return preparation, even if he is not a preparer under section 7701(a)(36). There are a number of exceptions to the consent requirements under these rules. In most cases, however, preparers will need to explain the new privacy safeguards to taxpayers and have them sign a consent form to gain permission to prepare their income tax returns. An error in this context could lead to financial penalties, or it could even land a tax preparer in jail.

John R. McGowan, PhD, CPA, is a professor of accounting in the John Cook School of Business at Saint Louis University, St. Louis, Mo.
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Title Annotation:federal taxation
Author:McGowan, John R.
Publication:The CPA Journal
Geographic Code:1USA
Date:May 1, 2009
Words:3822
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