S corporation co-owner penalty could pose a legal hazard without a preparer role

Plain-English summary

Chief Counsel considered whether the IRS should assess the willful or reckless return-preparer penalty under Section 6694(b) against an individual who co-owned an S corporation. An individual is subject to the penalty when the person is a tax return preparer and is primarily responsible for the return position that caused the understatement. A firm may also be liable only when the specific management, review-procedure, or disregard conditions in Treasury Regulation Section 1.6694-3(a)(2) are met. The advice distinguished United States v. Elsass, where a sole owner personally prepared or signed many returns and drove the decisions and calculations. Unless the co-owner acted similarly, Chief Counsel thought a personal assessment could present a legal hazard. The S corporation might instead be the proper target if it qualified as a tax return preparer and met the firm-liability conditions, but the available facts were insufficient to decide that issue.

Ruling snapshot

• Question: Could the IRS safely assess a Section 6694(b) penalty personally against a co-owner of an S corporation?
• Outcome: Advice given: the assessment could present a legal hazard unless the co-owner acted as the responsible tax return preparer.
• Key authorities: IRC §§ 6694(b), 6694(f), 6695, and 7701(a)(36); Treas. Reg. §§ 1.6694-1(b), 1.6694-3(a)(2), and 301.7701-15

Full text (IRS public release)

ID:       CCA_2018052114412547
UILC:     6694.00-00, 6694.02-00

Number: 201825028
Release Date: 6/22/2018
From:
Sent: Monday, May 21, 2018 2:41:25 PM
To:
Cc:
Bcc:
Subject: RE: IRC 6694(b) request for informal guidance


Hi -----------,

You have asked for our recommendation of whether we think an assessment of the
penalty provided for under section 6694(b) on the individual SSN of a co-owner of an S-
Corporation (S-Corp) could be a legal hazard. You have also asked whether we are
aware of any situations where the owner of an S-Corp may be held personally liable for
the penalty provided for under section 6694(b). Below, we have provided a summary of
the relevant Code sections and regulations to assist you with your decision. We have
also identified the one case we are aware of in which the owner of an S-Corp was found
personally liable for the penalty under section 6694.

Section 6694(b)(1) generally provides that a tax return preparer who prepares any
return or claim for refund with respect to which any part of any understatement of
liability is due to conduct described in paragraph (b)(2) shall pay a penalty with respect
to each such return or claim. Paragraph (b)(2) generally sets forth willful or reckless
conduct taken by a tax return preparer. Section 6694(f) cross references section
7701(a)(36) for the definition of “tax return preparer.” Section 7701(a)(36) provides that
“tax return preparer” means any person who prepares for compensation, or who
employs one or more persons to prepare for compensation, any return of tax imposed
by this title or any claim for refund of tax imposed by this title, subject to certain
exceptions not relevant here. See also Treas. Reg. § 301.7701-15.

Treasury regulation § 1.6694-1(b) provides that “[f]or the purposes of this section, ‘tax
return preparer’ means any person who is a tax return preparer within the meaning of
section 7701(a)(36) and § 301.7701-15 of this chapter. An individual is a tax return
preparer subject to section 6694 if the individual is primarily responsible for the
position(s) on the return or claim for refund giving rise to an understatement. See §
301.7701-15(b)(3). There is only one individual within a firm who is primarily
responsible for each position on the return or claim for refund giving rise to an
understatement. … In some circumstances, there may be more than one tax return
preparer who is primarily responsible for the position(s) giving rise to an understatement
if multiple tax return preparers are employed by, or associated with, different firms.”

Treasury regulation § 1.6694-3(a)(2) provides that “[a] firm that employs a tax return
preparer subject to a penalty under section 6694(b) (or a firm of which the individual tax
return preparer is a partner, member, shareholder or other equity holder) is also subject
to penalty if, and only if—(i) One or more members of the principal management (or
principal officers) of the firm or a branch office participated in or knew of the conduct
proscribed by section 6694(b); (ii) The corporation, partnership, or other firm entity failed
to provide reasonable and appropriate procedures for review of the position for which
the penalty is imposed; or (iii) The corporation, partnership, or other firm entity
disregarded its reasonable and appropriate review procedures though willfulness,
recklessness, or gross indifference (including ignoring facts that would lead a person of
reasonable prudence and competence to investigate or ascertain) in the formulation of
the advice, or the preparation of the return or claim for refund, that included the position
for which the penalty is imposed.” (emphasis added). See also IRM 20.1.6.4.4.

Our interpretation of Treasury regulation § 1.6694-3(a)(2) is that generally, the entity
(corporation, partnership, or other firm entity) that employs a tax return preparer will
simultaneously be subject to the penalty under section 6694(b) only if the specific
conditions set forth in the regulation are met. Otherwise, only the individual(s) that is
primarily responsible for the position(s) on the return or claim for refund that gives rise
to the understatement will be subject to the penalty.

We did find one case in which the owner of an entity was subject to the section 6694
penalty. In United States v. Elsass, 978 F. Supp. 2d 901 (S.D. Ohio 2013), aff’d, 769
F.3d 390 (6th Cir. 2014), the court found that the owner of an entity was a “tax return
preparer” for the purposes of the penalties provided for under sections 6694 and
6695. However, in that case, the owner was the sole-owner of the entity and personally
signed or prepared over twenty-eight of the tax returns at issue. Additionally, the owner
and the entity “were the moving force behind the decisions and calculations regarding
the returns.” Id. at 911. The court notes that “Congress intended the definition of tax
return preparer to encompass those contributing to the material decisions regarding tax
returns.” Id. at 912.

We think that unless your co-owner acted similarly to the owner in Elsass, an
assessment of the penalty provided for under section 6694(b) against that taxpayer
could present a legal hazard. Alternatively, the S-Corp may be a tax return preparer
within the definition of section 7701(a)(36), and the proper person on which to assess
the penalty under section 6694(b), but only if the requirements set forth in Treasury
regulation § 1.6694-3(a)(2) are met. We do not have enough facts in our possession to
make a recommendation as to whether the S-Corp in your case meets these
requirements.

Please let me know if you have any questions, or would like to discuss further.

Thanks,

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