The following is my explanation of the new rules, which was written in the November, 2007 issue of the International Wealth Protection Monitor, with some minor editing in January, 2008. Some of this information is duplicated above, but not much.
law passed in 2007 will result in a potential conflict of interest
between taxpayers and
their tax preparers. The bottom line is that tax preparers are now
subject to a
higher standard of certainty than taxpayers with respect to any
potentially aggressive tax positions. In addition, tax
preparers must file a disclosure form about any
questionable tax positions on a return in order to avoid severe
penalties. The disclosure form will be like a neon light to
the IRS to identify returns with aggressive tax positions.
Business and Work Opportunity Tax Act (P.L. 110-28, Section
8246) enacted on May 25, 2007 included
a provision that imposed significantly greater penalties on tax
preparers for preparing
a tax return with an “unreasonable tax position” or an “understatement
willful or reckless conduct”. Most
conscientious preparers are not going to be concerned about being
willful or reckless conduct, but the laws that define an “unreasonable
are a source of considerable concern to tax professionals. This law
extended the definition of return preparers to include preparers of
gift tax returns, employment and excise tax returns and to some tax
advisors (such as lawyers) who have no direct involvement in the
preparation of any tax forms.
addition, the new law requires preparers to disclose any positions
taken on a
return unless the preparer believes the position is more likely than
to be sustained on its merits in the event of a dispute with the IRS.
contrast, taxpayers are only required to have an expectation of a
possibility” that an undisclosed position will be sustained on
the event of a dispute with the IRS.
of a position taken on a tax return is realistically seen as a red
light and an
invitation for an audit by most taxpayers and preparers. Obviously,
want to avoid the chances of being audited if only because of the time
cost. But taxpayers also want to utilize every reasonable opportunity
minimize their taxes and many taxpayers want to utilize some very
tax saving arrangements without having to disclose them in a separate
But the new
penalties represent a much greater financial risk to preparers.
preparer could be penalized as much as $250 for an unrealistic position
not disclosed on Form 8275. Now, the penalty is the greater of $1,000
or 50% of
the fees received. For the majority of simple tax returns, the
greater than the total fee. Where a preparer is only charging an
average fee of
$200, a penalty of $1,000 on a disputed item would result in being VERY
conservative about ambiguous transactions and a tendency to disclose
that isn’t absolutely clear and supported by case law.
and complicated returns where the fee might be $10,000, a single
position that does not meet the more likely than not
result in a
penalty of $5,000. I suspect the penalty would not be deductible, which
have the effect of consuming the entire fee for most tax preparers. (A
fee might result in $5,000 after taxes, which would be consumed by the
are left with a huge amount of ambiguity as to what constitutes an
position and whether a particular deduction, exclusion or credit is
than not to be sustained (by the courts) on its merits.
By way of
an example, the U.S. Tax Court recently ruled in favor of a taxpayer in
with the IRS about the proper tax treatment of a reimbursement of
expenses for the spouse and family of a proprietor. It’s been my view
for many decades that this was a
settled and non-controversial issue. Suddenly, the IRS decides to take
court. And there is currently no indication whether they will continue
dispute the issue. If I have a client who is using such a plan, should
disclosed? If in doubt, I want to disclose it even if I might think it
the standard of being more likely than not to be sustained. But the
would not want to disclose the issue because it certainly satisfies the
realistic possibility standard that applies to the taxpayer.
What if the
taxpayer says, “Let me prepare the return and I’ll pay you to review it
that’s a catch-22 because the tax law essentially states that if a
a return for compensation before it is filed, he or she has to sign the
as a paid preparer. This means that
taxpayers who want to utilize the realistic possibility standard are
have to do so without the benefit of help from tax professionals.
have two choices.
We can either quit
preparing returns and exposing ourself to
these preposterous penalties or, if we continue to prepare returns, we
have to inform clients that we can’t include any undisclosed
their return with which the IRS might not agree. Anything less than
that puts us
in the position of having to guess about the possible outcome and
is a “more likely than not”
possibility that the disputed item would be
sustained in the appeals process or in a court to which the dispute
And --- if the taxpayer
decides to foregoe the time and expense of an appeal, the tax preparer
is left with having to pay the penalty if the IRS asserts that the tax
item should have been disclosed.
Here is an
example of an
addition that many tax preparers will begin to include in their
The 2007 Small Business and Work Opportunity Tax Act requires our firm as tax return preparers to conform to a higher standard than the taxpayer when an undisclosed tax position is being taken on your tax return. This higher standard requires the preparer to have a reasonable belief that the undisclosed tax position would more likely than not be sustained on its merits if challenged by the IRS, and that there be a reasonable basis for the tax treatment. Moreover, we may have to spend additional time preparing your return because of the extra research and analysis necessary to meet the standard. Accordingly, by signing this letter you acknowledge that you are aware of this difference in standards, and consent to our preparation of your federal income tax return in accordance with the standards applicable to our firm as tax preparers.
If we conclude as a result of our research that you are required to disclose a transaction on your tax return, you consent to attach a completed Form 8275 or 8275R to your tax return after we discuss the situation with you and you also agree to hold our firm harmless with respect to any and all actual and consequential damages (including but not limited to taxes, penalties, interest, and attorneys fees and costs) that you incur as a result of including such disclosures with your filed tax returns.
various engagement letters will differ to some extent from this example.
adoption of the earlier
rules that effectively eliminated the opportunity for taxpayers to
penalties by getting a written opinion from a tax professional -- and
now with the
much higher penalties that are imposed on tax preparers for failing to
a tax position with which the IRS might not agree -- the government has
effectively eliminated any reasonable opportunity for aggressive tax
To avoid penalties, tax preparers will have to either require clients
disclose all questionable positions or will have to prepare returns
positions that are clearly acceptable to the IRS – even if the IRS is
aggressive in how they interpret and administer the law.
that I can see is to prepare a return based on very conservative
to then prepare an amended return to take advantage of any uncertain
positions -- but that would be an even higher level of disclosure.
choice will be made
by taxpayers and their tax advisors or preparers, it will result in
by tax preparers and higher fees for taxpayers and more work for the
suspect that some preparers will respond to this new law by inundating
with a huge volume of disclosure forms for every vaguely uncertain
the return. If every tax return included half a dozen disclosure forms,
would lose their effectiveness in highlighting potentially aggressive
2007, the IRS issued Notice 2007-54 to extend the effective date of
this new law from May 25, 2007 to returns prepared after 2007.
addition, in January of 2008, they issued three notices to provide
iterim guidance to tax preparers until proposed regulations could be
Some commentators believe this law may be challenged in the courts because it puts taxpayers and their tax advisors at odds with each other and effectively forces taxpayers to utilize the more conservative position that applies to their preparers than the position that still applies to self-prepared returns.Vernon Jacobs
Dec. 15, 2007