The IRS looked into the application of the preparer penalties under §§6694 and 6701 in various circumstances in Chief Counsel Advice 201519029.  The memo was produced to answer queries about whether the IRS is able to assert the §6694 penalty in two cases, as well as whether it was appropriate to assert either penalty under §6694 or the penalty for aiding and abetting under §6701 in another situation.

Generally the penalty under IRC §6694(a) may be assessed against a preparer who prepares a return that contains an understatement due to an unreasonable position and knew, or reasonably should have known, of the position.  An unreasonable position is one that that either failed to have substantial authority (as defined in §1.6662-4(d)) and was not disclosed (generally using a Form 8275 or 8275-R) or, even if disclosed, the position not have a reasonable basis (as defined in regulation §1.6662-3).  The penalty is the greater of $1,000 or ½ of the fees received by the preparer related to the position.

The penalty under §6694(b) applies when the understatement arises from willful or reckless conduct on behalf of the preparer related to a position that gives rise to an understatement of tax on the return.  Willful or reckless conduct includes either a willful attempt to understate the tax liability on the return or a reckless or willful disregard of rules or regulations.  In that case the penalty is the greater of $5,000 or ½ of the fees received by the preparer.

The §6701 aiding and abetting penalty of $1,000 applies to a preparer who:

• Aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,
• Knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and
• Knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

The memorandum answers inquiries into three specific fact situations and the applicability of the penalty.

The first question posed in the CCA is:

Issue 1: May the I.R.C. § 6694(b) preparer penalty for understatement of liability due to willful or reckless conduct be assessed if the return preparer made an amended return which was never filed.

In the situation detailed a taxpayer had received three amended returns from a preparer. The taxpayer filed the first amended return, holding back the other two until he saw if the IRS was going to allow the first one.  The IRS, taking the position that there was no merit to the position, disallowed the refund claim.  The taxpayer never filed the other two returns, but did provide copies to the IRS showing that they had been signed by the preparer. 

Assuming for purposes of the example that the preparer’s conduct in preparing each return was a willful attempt to obtain an improper refunds, is the IRS limited to assessing a penalty only on the amended return that the taxpayer actually filed?

The memorandum finds that the IRS is not limited to asserting the penalty on only the filed return, but rather can assess three separate preparer penalties.  The memorandum cites Reg. §1.6694-1(a)(2) for determining when a return has been prepared for purposes of the penalty.  That regulation provides:

[f]or purposes of the penalties under section 6694, a return or claim for refund is deemed prepared on the date it is signed by the tax return preparer. If a signing tax return preparer within the meaning of §301.7701–15(b)(1) of this chapter fails to sign the return, the return or claim for refund is deemed prepared on the date the return or claim is filed.

Thus when the preparer signed the amended return the return had been willfully or recklessly prepared with an understatement of tax, at which point the §6694(b) penalty could be assessed by the IRS.  If the preparer does not sign the return, the IRS may still assert the penalty based on the second sentence cited above, but then only when the taxpayer actually files the return.

The second issue looks at the situation where an amended return is filed but a refund is never issued to the taxpayer.  Again the preparer had willfully prepared an amended return that attempted to obtain an improper refund.

As the question is put:

Issue 2: May the I.R.C. § 6694(b) preparer penalty for understatement of liability due to willful or reckless conduct be assessed if amended returns were filed but the Internal Revenue Service (Service) disallowed the refund?

Or, to put it simply, does the fact that the government never actually was “missing” money in its accounts mean that a penalty cannot be asserted—the view being no underpayment ever existed.

The memorandum answers this question in the negative as well.  IRC §6694(b) imposes a penalty upon the willful attempt to understate the client’s tax and does not require that the attempt be successful.

The final question is more interesting—and the fact it was asked suggests that some in the IRS were considering viewing the penalties as being very broadly applicable.  The issue as stated is:

Issue 3: May the I.R.C. § 6694(a) preparer penalty for understatement of liability due to unreasonable positions, the I.R.C. § 6694(b) preparer penalty for understatement of liability due to willful or reckless conduct or the I.R.C. § 6701 penalty for aiding and abetting understatements of tax liability be assessed if the return preparer made and filed a claim for refund after the period of limitations for refund claims had expired?

This question for all practical purposes asks if the mere preparation of a claim for refund after the statute of limitations had expired on a claim for the year in question gives rise to any of the three penalties:

• Understatement due to an unreasonable position under §6694(a) (based on the idea the preparer should have known the statute had expired);
• Willful or reckless conduct under §6694(b) (preparing the amended return where the preparer knew or should have known that the law specifically barred the claim); or
• Aiding and abetting under §6701 (knowing the document, if accepted by the IRS, would result in receipt of a payment that should not be paid per the statute).

In this case the memorandum cautions against any assessment of any of those penalties based solely on the fact the statute had expired prior to the preparation of the amended return.

The memorandum notes that an “understatement of liability” does not include any claims that are barred by the statute of limitations.  The memorandum notes:

May the I.R.C. § 6694(a) preparer penalty for understatement of liability due to unreasonable positions, the I.R.C. § 6694(b) preparer penalty for understatement of liability due to willful or reckless conduct or the I.R.C. § 6701 penalty for aiding and abetting understatements of tax liability be assessed if the return preparer made and filed a claim for refund after the period of limitations for refund claims had expired?

As well, the memorandum goes on to note there are valid reasons why a preparer would prepare an amended return that appears to be outside the statute for claiming a refund:

In addition, there may be extenuating circumstances that weigh against asserting the penalty when an amended return appears to be filed out of time. The amended return may, for example, be perfecting an earlier timely informal claim for refund. Despite the requirement that a claim be submitted on one of the Service's forms supplied for that purpose, a document submitted to the Service that fails to satisfy Treasury Regulations can be treated as an informal refund claim. It has long been recognized that a claim for refund need not be in any specific form, and informal refund claims, timely filed, which adequately notify the Internal Revenue Service that a refund is being sought, have been held to toll the statute of limitations and, if defective, may be perfected by the filing of a formal claim after the lapse of the statutory period. United States v. Kales, 314 U.S. 186, 194 (1941); American Radiator & Standard Sanitary Corp. v. United States, 162 Ct. Cl. 106, 113-114, 318 F.2d 915, 920 (1963); Hollie v. Commissioner, 73 T.C. 1198 (1980).

Accordingly, we conclude that the penalties under I.R.C. §§ 6694(a)(2), 6694(b), or 6701 should not be assessed merely because the return preparer made and filed an amended return after the period of limitations for refunds had expired.