Tax Preparers: Who May Be Liable, and For How Much

This is an informative blog on tax preparer liability, sketching the conditions under which a tax preparer may be liable for his or her errors, and the correlative penalties. For more on this topic, see: Tax Preparer Fraud

In the past, a tax preparer was not liable for gift (Form 709) and estate and generation-skipping (Form 706) tax returns. But a tax preparer was liable for income tax returns. Thus, for example, if a tax preparer committed an error–intentionally or unintentionally–on Forms 1040, 1040A, 1040EZ, 1041s, or 1065 (partnership) and 1041 (grantor trusts), the preparer was liable.

Today, since 2007, a tax preparer will be liable for errors committed on any return. This is because the Internal Revenue Code (IRC) §6694 was modified–broadened, really–replacing “an income tax return preparer” with “a tax return preparer.” Thus, a tax preparer may be liable for all federal tax returns and claims for refund.

Who is a “tax return preparer”? 

There are two types of tax return preparers: (1) Those licensed to practice under state law and before the IRS. These include your CPAs, attorneys, enrolled agents, enrolled actuaries, appraisers, and the like. (2) Those who are not licensed (called “unenrolled” tax preparers), who are permitted to prepare returns but disallowed from practicing before the IRS.

IRC § 7701(1)(36)(A) defines a “preparer” as “any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed . . . or any claim of refund.” Thus, a preparer does not include someone who did a tax return without receiving compensation. However, case law includes within the definition of a preparer one who did other services for the client, even though, strictly speaking, no compensation was received for preparing the return itself.

What are the tax penalties? 

Under IRC § 6694, the IRS imposes a penalty on a tax return preparer that understates a taxpayer’s liability, and that is determined by whether he made any part of the understatement due to taking an “unreasonable position” that he knew (or reasonably should have known) of the position, or if he made any part of the understatement due to “willful or reckless conduct.” A penalty of $1,000 or 50% of the income (to be) derived may occur for each error on a return or claim for refund. However, if the preparer had reasonable cause for the understatement, and he acted in good faith, then IRC 6694(a)(3) exempts these penalties. A good tax attorney should be able to inform you whether a preparer had a “reasonable cause” for the understatement.

If the preparer made an understatement with “willful or reckless conduct” he shall pay a penalty on each return (or claim for refund) of $5,000 or 50% of the income derived. What’s “willful or reckless conduct”? It is defined as any willful attempt in any way to understate a tax liability, or a reckless or intentional disregard of the tax law. IRC 6694(b)(2).

In addition to the monetary penalties, there are non-monetary penalties, like an “injunction,” which is a basically a court order saying the preparer cannot practice in her professional capacity for a certain period of time. This can be far more devastating than the monetary penalties, because she would likely lose many clients. Moreover, the preparer may be required to re-open every like and non-like return that she prepared for the years falling within the statute of limitations. Finally, a preparer may also lose his license if found liable for tax preparer fraud.

Tax law is notoriously complex, so it is understandable that mistakes occur. The IRS, however, is not so forgiving. That is why if you are tax preparer who has reason to believe that you have intentionally or unintentionally committed one of the above offenses, you need competent legal counsel. Due to the complexity of the intersection of taxation and criminal law, few attorneys are competent to handle this sort of controversy. The Tax Law Office of David W. Klasing, however, specializes in this area of law; we can help you navigate through your legal options.