A tax preparer will likely incur a penalty when a tax position is supported by only one authority, contradicted by several other authorities, and is not disclosed on the tax return.
Understanding Tax Preparer Penalties
Tax preparers are subject to various penalties by the Internal Revenue Service (IRS) for failing to meet professional standards and for taking unreasonable positions on tax returns. These penalties are designed to ensure preparer diligence, accuracy, and compliance with the tax law. The specific scenario described above highlights a critical area of non-compliance.
The Unreasonable Position Defined
When a tax position is only weakly supported (by just one authority) and strongly contradicted by multiple other authorities, it suggests a lack of reasonable basis or substantial authority for that position. For tax preparers, the standard for avoiding penalties on undisclosed positions is generally higher than for disclosed positions.
Key elements contributing to the penalty:
- Weak Authority: Relying on a single, isolated authority, especially when it's not considered substantial, makes the position vulnerable.
- Contradictory Authorities: The presence of multiple authorities contradicting the chosen position significantly undermines its validity and reasonableness. This indicates that the preparer is taking a stance against prevailing tax law interpretations or established IRS positions.
- Lack of Disclosure: This is a crucial factor. If a tax position that lacks strong support is not disclosed on the tax return (typically via Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement), the preparer must meet a higher standard of certainty. Without disclosure, the position generally needs "substantial authority" or to be "more likely than not" correct to avoid penalties. When a position is contradicted by multiple authorities, it almost certainly fails these higher standards.
Standards of Professional Conduct for Tax Preparers
Tax preparers have a professional responsibility to adhere to specific standards regarding the accuracy and defensibility of positions taken on a tax return.
- Reasonable Basis: This is a relatively low standard, generally requiring an objective and reasonable basis for the position. It can often protect a preparer from penalties if the position is disclosed.
- Substantial Authority: This standard is higher than "reasonable basis" but lower than "more likely than not." It means that the weight of authorities supporting the position is substantial when compared to the weight of authorities contrary to the position.
- More Likely Than Not: This is the highest standard, meaning there is a greater than 50% likelihood of a position being sustained on its merits if challenged.
When a tax position is supported by only one authority and contradicted by several, it fails to meet the "substantial authority" or "more likely than not" standards required for undisclosed positions.
Impact of Disclosure
The presence or absence of disclosure significantly impacts penalty likelihood for tax preparers.
| Tax Position Support | Disclosure on Return | Penalty Likelihood | Reason |
|---|---|---|---|
| Supported by one authority, contradicted by several other authorities | No | High | Fails to meet the higher "substantial authority" or "more likely than not" standards required for undisclosed positions. The IRS considers such an undisclosed position unreasonable. |
| Supported by one authority, contradicted by several other authorities | Yes | Lower (but not zero) | While disclosure can mitigate penalties if there's a reasonable basis, such a weak and contradicted position might still be deemed frivolous or too aggressive, potentially leading to penalties regardless of disclosure. |
| Substantial Authority / More Likely Than Not | No | Low | The position meets high standards for being defensible, making disclosure unnecessary to avoid most penalties. |
Practical Implications for Tax Preparers
To avoid penalties, tax preparers must exercise due diligence and ensure that all tax positions taken on a return have adequate support.
- Research Thoroughly: Do not rely on isolated pieces of information. Consult multiple authoritative sources, including the Internal Revenue Code, Treasury Regulations, IRS rulings, and court cases.
- Evaluate Authority: Understand the hierarchy and weight of different tax authorities. A position supported by a well-reasoned court decision carries more weight than, for example, an informal IRS publication.
- Disclose Appropriately: If a position is aggressive or falls below the "substantial authority" standard but has a "reasonable basis," it should be clearly disclosed on the tax return to potentially avoid penalties.
- Document Everything: Maintain thorough documentation of research, client communication, and the rationale behind significant tax positions.
By adhering to these principles, tax preparers can mitigate the risk of incurring penalties and ensure compliance with their professional obligations.
