Change in the Tax Preparer Standard

Copy of Legislative Alert sent to Federal Key Persons of Representatives Charles Rangel and Jim McCrery and Senators Max Baucus and Charles Grassley

Date: July 12, 2007
Re:Contact Your Member of Congress to Encourage Equalizing Tax Return Preparer Standards with Taxpayer Standards Background

On May 25, 2007, Congress enacted the U.S. Troop Readiness, Veteran’s Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007 (“the Act”).

Section 8246 of the Act increased the tax return reporting standards applicable to tax return preparers under section 6694 of the Internal Revenue Code for undisclosed, non-tax avoidance items, from the “realistic possibility of success” standard to the “more likely than not” standard. As under prior law, if that reporting standard cannot be satisfied and the preparer wants protection from the possible imposition of an understatement penalty, a disclosure of the item on the return is necessary.

Section 8246 of the Act is a major change in tax policy, but it was not the subject of a hearing. Thus, the full consequences of this provision were not studied by Congress. Also, this change was not based on a recommendation from the Treasury Department. In its “Blue Book” of recommended legislation, issued in February 2007, Treasury did address the section 6694 penalty, but only recommended an increase in the dollar amount of the penalty. Treasury did not recommend a change in the preparer standards. Even the IRS Chief Counsel commented about the sudden and unexpected change to section 6694, noting that the IRS had been “blindsided” by the provision in the Act.

The section 6694 understatement penalty was added to the Internal Revenue Code in 1989, as part of an overhaul of the entire penalty regime. At that time, in contrast to the lack of consideration given to making the recent change to the section 6694 reporting standards, there were two years of Congressional hearings and study, several extensive reports by an IRS task force created to study the penalty regime, and meetings and input from various professional organizations. Reporting standards and their implications to the tax system and tax policy are too important to be given no consideration prior to a change.

Problems Caused by the Change in the Preparer Standard

First, because the change raises the tax return reporting standard for preparers (“more likely than not”) above the standard for taxpayers (“substantial authority”), it creates the potential for conflicts of interest between preparers and their clients; as a result, it affects the nature of the representation of taxpayers and a taxpayer’s right to representation.
Second, applying the “more likely than not” standard to a tax return preparer results in a fundamental change in the role of the preparer, from that of an advocate to that of an advisor.
Third, it will be extremely difficult, if not impossible, to determine the probable correctness of the treatment of some routine items with the degree of certainty required for the higher “more likely than not” standard because: (1) there sometimes is little guidance for the tax treatment of an item at the time the item must be reported on a return; and (2) the proper treatment of an item frequently depends on an analysis of unique or unusual facts and circumstances that were not contemplated in published guidance.
Fourth, a disclosure made under a system with a “more likely than not” standard could be viewed as a concession on the merits.
Fifth, the potential penalties on a preparer for failure to satisfy that high standard are so severe that preparers will feel compelled to protect themselves by urging their clients to include disclosures for virtually every item for which there is even the slightest uncertainty regarding the proper treatment (Fines under section 6694 and Circular 230 could be imposed on the preparer, possibly totaling up to 150% of fees derived from the return. In addition, the preparer could be subject to disciplinary action by the IRS Office of Professional Responsibility.) These excessive disclosures for routine tax return positions will overburden tax administration, thereby defeating the purpose of the disclosure system and also undermining the electronic filing initiative, which currently is not capable of processing a large number of disclosures in a return.

AICPA’s Proposed Legislative Solution to the Change in the Preparer Standard

To avoid this disruption to our tax system, the AICPA recommends that the section 6694 tax return preparer standards be equalized with the taxpayer standards. For tax shelter (“tax avoidance”) items the “more likely than not” standard should continue to apply. For non-tax shelter (“non-tax avoidance”) items, the “substantial authority” standard should apply.

What Key Persons Need to Do

Please contact the Congressman or Senator for whom you are a Key Person and encourage them to amend section 6694 of the Internal Revenue Code to equalize tax return preparer standards with taxpayer standards at the “substantial authority” level.

Emails, telephone calls or faxed letters are the best ways to communicate with Congress. You can find your Member’s phone and fax numbers through our Legislative Action Center ( www.aicpa.org/advocacy ). Due to increased communication restrictions to Congressional offices, e-mail capability through our site is limited to key persons who live in their Member’s district. If you do not live in the Member’s district for whom you are a key person it is best to call the Member’s office or fax a letter to their office. Please note that to access the key person area of the legislative action center, your email address is your log in.

Please let us know about your conversation with your Member, or send us a copy of the letters you fax. You can reach me by e-mail at congaffairs@aicpa.org or call me at (202) 434-9206 or contact Peter Kravitz, Director of Congressional & Political Affairs at congaffairs@aicpa.org or at (202) 434-9218.

Thank You

Thank you for your continued support of the Key Person Program. Your participation on this issue is extremely important to the profession and it is critical that Congress hear your views. This issue has the potential of being harmful to the public and to our members.

cc: AICPA Board of Directors State Society Chief Volunteer and Staff Officers, Key Person Coordinators and Legislative Staff in Iowa, Louisiana, Montana and New York