Tax Preparer Penalties Explained

By Kevan McLaughlin

I had the privilege of offering comments as Chair of the Taxation Section’s Tax Procedure & Litigation Committee for the California Lawyers Association (“CLA”) on the proposed regulations under IRC § 6695(g), Tax Return Preparer Due Diligence Penalty under Section 6695(g). I, along with several colleagues, focused on four items. Most notable from my position was the impact of a return preparer’s preexisting personal or professional knowledge with a client.

The new regulations stipulate that the tax return preparer must not know, or have reason to know, that any information used by the tax return preparer in determining the taxpayer’s eligibility to file as head of household or in determining the taxpayer’s eligibility for, or the amount of, any credit described in the section and claimed on the return or claim for refund is incorrect. If understood to be so, the tax return preparer may not ignore the implications of information furnished to, or known by, the tax return preparer, and must make reasonable inquiries if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information furnished to the tax return preparer appears to be incorrect, inconsistent, or incomplete. Furthermore, the tax return preparer must also contemporaneously document in the preparer’s paper or electronic files any inquiries made and the responses to those inquiries.

The proposed regulation lacks guidance regarding what, if anything, a return preparer can do with their preexisting knowledge. In practice, the issue arises in two scenarios. First, the return preparer has a preexisting personal relationship with the taxpayer. This circumstance is particularly prevalent in tight ethnic communities. For example, a preparer may know that the parents or other relatives of a child are deceased because of prior social interactions with the particular child’s aunt. When the aunt later asks the preparer to help file her taxes, the preparer would have the preexisting personal knowledge and may not think to make, or document, any additional inquiries about the qualifying child, i.e., where the child’s parents are. The second scenario involves the preparer providing non-tax services and having some professional knowledge spillover. 

In either event, the return preparer does not know, nor has any reason to know, the information provided by the taxpayer is incorrect. Moreover, even if the preparer did think to ask additional questions, social insensitivity or perceived professional incompetence may prevent them from actually doing so.

Nevertheless, the proposed US Treasury Regulation § 1.6695-2(b)(3)(i) requires prepares to make additional inquiries “if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information furnished to the tax return preparer appears to be incorrect, inconsistent, or incomplete.” Thus, without guidance, the preparer is left in an incredibly difficult situation.

Also at issue was the lack of a more workable standard to define the requisite level of knowledge criterion in positive, rather than negative terms. It’s generally difficult to prove a negative. As such, we recommended that the language be modified to the following:

The tax return preparer must verify that all information provided to the tax return preparer by the taxpayer and used by the tax return preparer in determining the taxpayer’s eligibility for, or the amount of, any credit described in paragraph (a) ofthis section and claimed on the return or claim for refund is correct to the best of the tax return preparer’s knowledge, and that no information provided to the tax return preparer by the taxpayer and used by the tax return preparer is incomplete, or inconsistent with other information provided to the tax return preparer by the taxpayer.”

In other words, if a tax return preparer is going to be contemporaneously documenting inquiries (as required by the proposed Treasury Regulations § 1.6695-2(b)(3)), the tax return may as well also document information provided and relied upon by the tax return preparer in determining status or credit eligibility, and in the process determine whether any inconsistent information may contradict or otherwise undermine the information provided and relied upon by the tax return preparer.

If you’re a tax preparer wanting to become familiar with these and other regulations before the busy season hits, give us a call!

About the author: As the founder of McLaughlin Legal, San Diego tax attorney Kevan P. McLaughlin focuses his practice on all aspects of Federal and California tax law, with a particular emphasis on representing taxpayers in civil and criminal tax litigation and controversy cases. Reach him at kevan@mclaughlinlegal.com.

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