Three-year periods govern assessment and refund of a preparer penalty

Plain-English summary

IRS examiners asked about the time limits that apply when a return preparer files an amended return containing a meritless refund position. Chief Counsel advised that section 6696(d) gives the IRS three years from the filing of the underlying return or refund claim to assess the section 6694(a) preparer penalty. A preparer who pays that penalty generally has three years from payment to file a refund claim. A separate rule in section 6694(d) requires a refund without regard to that limitation period if a final administrative or judicial determination finds that the return or claim did not understate liability.

Ruling snapshot

• Question: What limitation periods apply to assessing a section 6694(a) return-preparer penalty and claiming its refund?
• Outcome: Advice given
• Key authorities: IRC §§ 6694(a), 6694(d), and 6696(d); Treas. Reg. § 1.6694-1(a)(1)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201514008
       Release Date: 4/3/2015
       CC:PA:01:GSemasek
       POSTN-130782-14

UILC: 6694.01-00, 6696.00-00

date: November 07, 2014

 to:   Rochelle Armijo
       ATTI Exam Group Manager
       Southwest Area
       (Small Business/Self-Employed)

from: Blaise G. Dusenberry
Senior Technical Reviewer
(Procedure & Administration)

subject: Limitation Periods on Preparer Penalty under I.R.C. § 6694(a)

       This Chief Counsel Advice responds to your August inquiry regarding the above topic.
       This advice may not be used or cited as precedent.

       ISSUES

              (1)   What is the limitation period for making an assessment of the return
       preparer penalty authorized by I.R.C. § 6694 for preparing a return or claim for refund
       with an understatement of tax liability in the circumstances noted below?

             (2)     What is the limitation period on a refund of the preparer penalty assessed
       pursuant to I.R.C. § 6694(a)?

       CONCLUSION

             (1)     The Service must assess the penalty within 3 years of the date the
       underlying tax return or claim for refund is filed.

              (2)   Any claim for refund of an overpayment of a penalty assessed under
       I.R.C. § 6694(a) must be filed within 3 years of the date the penalty was paid to the
       Service.

POSTN-130782-14 2

FACTS

You indicated that the Service’s exam group in your area often confronts the situation of
a tax return preparer who prepares an amended income tax return (Form 1040X), which
includes a refund claim, which you described as “poorly prepared.” We interpret this to
mean that such amended income tax return includes an understatement of tax liability
attributable to an unreasonable filing position. You seek guidance on the following fact
pattern:

 A tax return preparer (P) prepares an amended tax return (Form 1040X) for a
 taxpayer for taxable year 2011. Such amended return shows an overpayment
 and includes a claim for refund. The return, though, contains a meritless filing
 position and the taxpayer’s reported overpayment on the amended return is
 based on the incorrect, meritless, position. The period of limitations on refunds
 or credits for taxable year 2011 will expire on the later of April 15, 2015 (3 years
 following the filing of the return), or two years following payment of 2011 tax.
 The taxpayer’s Form 1040X for year 2011 was a timely claim for refund
 because it was filed on or before April 15, 2015.

We address the limitation period during which the Service can assess the penalty under
section 6694(a) and the refund period. In an email to our office dated October 23, 2014
you stated that your exam group does not have a current open case involving this fact
pattern. Rather, you would like an opinion examiners can rely upon for future cases.

DISCUSSION

Code section 6694(a) imposes a penalty on a tax return preparer for any return or claim
for refund that he prepares resulting in an understatement of liability due to an
unreasonable position, about which the preparer knew or reasonably should have
known. The penalty is the greater of $1,000 or 50 percent of the income derived by the
preparer from the return or claim. The regulation implementing section 6694(a) divides
reporting positions into two categories in describing the standards against which the
return preparer’s conduct is measured. Treas. Reg. § 1.6694-1(a)(1).

For positions other than those relating to tax shelters and reportable transactions,1 this
preparer penalty applies when the return or refund claim includes an understatement of
tax liability that is due to an undisclosed position for which the return preparer did not
have substantial authority, or due to a disclosed position for which there is no
reasonable basis. Treas. Reg. § 1.6694-1(a)(1). For positions respecting tax shelters
or reportable transactions, the preparer penalty applies if the return or claim includes an
understatement of liability for which it is not reasonable to believe that the position is
more likely than not to be sustained on the merits. Id.; see generally United States v.

1
“Tax shelters” in this context means the shelters defined in section 6662(d)(2)(C) and “reportable
transaction” means a transaction that can be penalized under section 6662A.
POSTN-130782-14 3

Pugh, 717 F.Supp.2d 271, 288-89 (E.D. N.Y. 2010)(evidence was sufficient to sustain
penalty against preparer who prepared returns containing understatements of tax due to
the subtraction of wage and salary income when calculating gross income and
deductions based on a frivolous “claim of right” scheme).

Section 6696(d) includes limitation periods:

(1). . .The amount of any penalty under section 6694(a), section 6695, or 6695A
shall be assessed within 3 years after the return or claim for refund with respect
to which the penalty is assessed was filed, and no proceeding in court without
assessment for the collection of such tax shall be begun after the expiration of
such period . . .

(2) Except as provided in section 6694(d), any claim for refund of an
overpayment of any penalty assessed under section 6694 . . . shall be filed
within 3 years from the time the penalty was paid.2

For purposes of this memorandum, we assume that the taxpayer’s amended 2011
return, which includes a claim for refund based on a meritless position, is filed April 15,
2015. The Service will have until April 15, 2018 to assess the preparer penalty under
section 6694(a) against P. Assuming P pays the penalty, section 6696(b) requires that
he file a claim for refund within 3 years of payment in order to secure a refund. P’s
entitlement to a refund assumes he can show the penalty was incorrectly determined or
that he had reasonable cause and acted in good faith. I.R.C. § 6694(a)(3).

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views. I trust that this
satisfies your inquiry.

Please call (202) 317-5414 if you have any further questions.

2
The exception under section 6694(d) is as follows. Section 6694(d) requires the Service to refund any
part of a preparer penalty assessed pursuant to section 6694(a) or (b), irrespective of any limitation
period on such refund, if there is a final administrative or judicial determination that the tax return or
refund claim did not contain an understatement of liability.