As previously discussed, changes to preparer penalties had created a conflict between tax return preparers and taxpayers. The essence of the controversy was that taxpayers could report a tax issue based upon a "reasonable basis," and would be insulated from penalties if the position turned out to be wrong. However, a preparer could be penalized for the same reporting, unless he or she could show that the reported position was more likely than not to be sustained, a substantially higher standard than the taxpayer's "reasonable basis" standard. Thus, to protect themselves from penalty, preparers might encourage their clients to adopt a safer tax position than the taxpayer had to adopt under the reasonable basis standard and had to struggle to protect both themselves and their clients on issues where there was uncertainty.
The recently enacted tax act has now dropped the preparer standard down to the same "reasonable basis" standard as applies to the taxpayer. This is a welcome provision that avoids preparers having to make defensive disclosures to taxpayers to protect themselves and otherwise complicating their practice and making them a policeman for the IRS.
To summarize the revised rules:
a. Both taxpayers and their preparers can avoid penalties relating to a tax return position if there is "substantial authority" for the position. Generally, substantial authority exists if the weight of authorities supporting the taxpayer's treatment is substantial in relation to the weight of those that take a contrary position. Substantial authority includes the Code and other statutes, regs (final, temporary, and proposed), court cases, tax treaties, statements of Congressional intent, and administrative pronouncements (revenue rulings, revenue procedures, private letter rulings, technical advice memoranda, actions on decisions, general counsel memoranda, press releases, notices, and similar documents).
b. If the tax return position is adequately disclosed to the IRS in accordance with IRS requirements, the standard for avoiding penalties is dropped to a lower "reasonable basis" standard.
c. However, for tax shelters and listed transactions, penalties can be avoided only if there was a reasonable belief that it was more likely than not that the position would be sustained on its merits.
Interestingly, the change in the law does not allow for a reduction in the "more likely than not" standard under c. even with disclosure, which is a change from prior law.
Code Section 6694(a), as revised.