Preparer penalties depend on signing, filing, and understatement

Plain-English summary

Chief Counsel advised that a willful-or-reckless preparer penalty may apply to an unfiled amended return if the preparer signed it, because a return is deemed prepared when signed. It may also apply to a filed amended return even when the IRS disallows the claimed refund, but should not apply to an unsigned, unfiled draft. Sections 6694 and 6701 generally should not be asserted merely because a refund claim was filed after the limitations period, since a time-barred claim does not necessarily overstate the correct tax liability and may perfect an earlier timely informal claim.

Ruling snapshot

• Question: When may preparer and aiding-and-abetting penalties apply to unfiled, disallowed, or late amended refund claims?
• Outcome: Advice given: signed or filed willful understatements may trigger section 6694, but lateness alone generally does not establish an understatement.
• Key authorities: IRC §§ 6511, 6694, 6701; Treas. Reg. §§ 1.6694-1(a)(2), 1.6402-2, and 1.6402-3; United States v. Kales, 314 U.S. 186 (1941)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201519029
       Release Date: 5/8/2015
       CC:PA:01:MEHara                          Third Party Communication: None
       POSTN-103302-15                          Date of Communication: Not Applicable

UILC: 6694.00-00, 6694.02-00, 6701.00-00

date: March 25, 2015

 to:   Layne B. Cogan
       Revenue Agent
       Abusive Transactions Technical Issues
       Small Business/Self Employed
       SE:S:E:FE:SW:SD:5

from: Blaise G. Dusenberry
Senior Technician Reviewer
Branch 1
(Procedure & Administration)
CC:PA:1

subject: Assessing Preparer Penalties

       This memorandum responds to your request for assistance. This advice may not be
       used or cited as precedent.

       ISSUES

       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.

       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?

       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?

POSTN-103302-15 2

SHORT CONCLUSIONS

Issue 1: Yes. If the return is not filed, a penalty under I.R.C. § 6694(b) may be
assessed if the return preparer signed the return and the return preparer’s conduct was
willful or reckless.

Issue 2: Yes. Under the language of I.R.C. § 6694(b)(1), the return preparer penalty
may be assessed if the tax return preparer prepares any return or claim for refund with
respect to which any part of an understatement of liability is due to willful or reckless
conduct. There is no requirement that the Service allow the amounts claimed on an
amended return before the I.R.C. § 6695(b) penalty may be assessed.

Issue 3. The penalties under I.R.C. §§ 6694(a), 6694(b) or 6701 should not be
assessed merely because the return preparer made and filed a claim for refund after the
period of limitations for refunds had expired, because an “understatement of liability”
does not include claims that are barred by the period of limitations. In addition, there
may be extenuating circumstances that weigh against asserting the penalty. The
amended return, for example, may be perfecting an earlier timely informal claim for
refund.

FACTUAL SCENARIOS

Scenario 1. Return preparer made amended returns for three consecutive years which
contained an understatement of liability due to willful or reckless conduct. The taxpayer
filed the year 1 amended return but not the subsequent year amended returns, waiting
to see if the amended return was accepted. The refund claimed on the year 1 amended
return was not allowed. Examination has a copy of the amended returns for all three
years from the taxpayer. Each has the return preparer’s signature on them.
Examination also has copies of the amended returns for all three years from the return
preparer obtained during the investigation which do not have his signature on them but
have a watermark stating “Preparer Copy.”

Scenario 2. Return preparer made an amended return that contained an
understatement of liability due to willful or reckless conduct. The refund claimed on the
amended return was disallowed by the Service Center, but Examination has only
secured a copy of the amended return from the return preparer that is not signed by
him.

Scenario 3. Return preparer made an amended return that contained an
understatement of liability due to willful or reckless conduct. The amended return was
not filed, and Examination has only secured copies of an unsigned copy from the return
preparer.
POSTN-103302-15 3

Scenario 4. Return preparer made an amended return after the period of limitations for
refunds had expired and the amended return was filed.

LAW AND ANALYSIS

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.

Yes. If the return is not filed, a penalty under I.R.C. § 6694(b) may be asserted if the
return preparer signed the return. The language of I.R.C. § 6694(b) does not require
that a return be filed for the penalty to apply, only that a return is prepared. And Treas.
Reg. § 1.6694-1(a)(2) provides that a return is prepared when it is signed.

I.R.C. § 6694(a)(1) provides that if a tax return preparer—

   (A) prepares any return or claim of refund with respect to which
       any part of an understatement of liability is due to an
       unreasonable position, and

   (B) knew (or reasonably should have known) of the position,

   such tax return preparer shall pay a penalty with respect to each
   such return or claim in an amount equal to the greater of $1,000 or
   50 percent of the income derived (or to be derived) by the tax return
   preparer with respect to the return or claim.

   The penalty may be increased under I.R.C. § 6694(b) if any part of
   the understatement is due to a willful attempt in any manner to
   understate the liability for tax on the return or claim, or a reckless or
   intentional disregard of rules or regulations.

Treas. Reg. § 1.6694-1(a)(2) provides that:

   [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.

A strict reading of the Code thus suggests that if an amended return made by a return
preparer contained an understatement of liability due to willful or reckless conduct, the
penalty under I.R.C. § 6694(b) could technically apply if the amended return is either
POSTN-103302-15 4

signed by the return preparer, or if it not signed by the return preparer, if the amended
return is filed.

Accordingly, in Scenario 1, the I.R.C. § 6694(b) return preparer penalty for
understatement of liability due to willful or reckless conduct may be assessed for all
three years because the return preparer made an amended return that he signed that
contained an understatement due to willful or reckless conduct. Treas. Reg. § 1.6694-
1(a)(2).

In Scenario 2, the I.R.C. § 6694(b) return preparer penalty for understatement due to
willful or reckless conduct may be assessed because the return preparer made an
amended return that contained an understatement of liability due to willful or reckless
conduct that was filed. Treas. Reg. § 1.6694-1(a)(2).

In Scenario 3, the I.R.C. § 6694(b) return preparer penalty for understatement due to
willful or reckless conduct should not be assessed because although the return preparer
made an amended return that he signed that contained an understatement due to willful
or reckless conduct, the amended return was not filed and there is no evidence the
return preparer signed the amended return. Treas. Reg. § 1.6694-1(a)(2).

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

Yes. Under the language of I.R.C. § 6694(b), the return preparer penalty may be
assessed if a tax return preparer “prepares any return or claim of refund with
respect to which any part of an understatement of liability is due to” willful or
reckless conduct. There is no requirement that the Service allow the amounts claimed
on an amended return before the I.R.C. § 6695(b) penalty may be assessed. See
James J. Schneider, CPA v. United States, 257 F. Supp. 1154 (S.D. Ind. 2003)
(deduction for artwork disallowed, preparer penalty for willful or reckless conduct under
I.R.C. § 6694(b) assessed); Swart v. United States, 568 F. Supp. 763 (C.D. Cal. 1982)
(casualty loss disallowed, preparer penalty under I.R.C. § 6694(a) assessed); Pickering
v. United States, 82-1 U.S.T.C. ¶ 9375 (E.D. Ark. 1982) (business deduction disallowed,
preparer penalty under I.R.C. § 6694(a) assessed).

Issue 3: May the I.R.C. § 6694(a)(2) 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. § 67011 penalty for aiding and

1
I.R.C. § 6701, Penalties for aiding and abetting understatement of tax liability, provides in part:

      (a) Imposition of penalty.--Any person--

      (1) 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,

POSTN-103302-15 5

abetting understatement of tax liability be assessed if the return preparer made and filed
an amended return after the period of limitations for refund claims had expired?

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 a claim for refund after the period of
limitations for refunds had expired, because an “understatement of liability” does not
include refund claims that are barred by the period of limitations.

I.R.C. § 6694(e) defines the term “understatement of liability” as follows:

   For purposes of this section, the term “understatement of liability”
   means any understatement of the net amount payable with respect
   to any tax imposed by this title or any overstatement of the net
   amount creditable or refundable with respect to any such tax.
   Except as otherwise provided in subsection (d), the determination
   of whether or not there is an understatement of liability shall be
   made without regard to any administrative or judicial action
   involving the taxpayer.

I.R.C. § 6511 establishes the basic rules for refund or credit of an overpaid tax. I.R.C.
§ 6511(b) states, “no credit or refund shall be allowed or made after the expiration of the
period of limitations prescribed … for the filing of a claim for credit or refund, unless a
claim for credit or refund is filed by the taxpayer within such period.”

When a refund is denied because the period of limitations had lapsed, it is not denied
because there is, under I.R.C. § 6694(e), an “understatement of the net amount payable
with respect to any tax imposed by this title or any overstatement of the net amount
creditable or refundable with respect to any such tax.” The claim for refund may, in fact,
reflect the correct tax liability. The refund is barred merely because the claim was made
too late.

Accordingly, the penalties under I.R.C. §§ 6694(a)(2) and 6694(b) do not apply because
a time barred claim does not fall under the definition of an understatement of liability as
defined in I.R.C. § 6694(e). For that same reason, the penalty under I.R.C. § 6701
should not asserted for time barred claims. For although I.R.C. 6694(e) applies for
“purposes of this section,” that is, section 6694, identical words in the same statute
usually have the same meaning. See Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 570

   (2) who 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

   (3) who knows that such portion (if so used) would result in an understatement of the liability for
   tax of another person,

shall pay a penalty with respect to each such document in the amount determined under subsection (b).
POSTN-103302-15 6

(1995) (normal rule of statutory construction is that identical words used in different
parts of the same act are intended to have the same meaning); 2A NORMAN J. SINGER &
SHAMBIE SINGER, STATUTES AND STATUTORY CONSTRUCTION § 46.6 at 261-3 (7th Ed.
2014).

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 Regulations2
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.

Please call (202) 317-5417 if you have any further questions.

2
See Treas. Reg. §§ 1.6402-2 and 1.6402-3.