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Unit - 2 Tax Preparers & Penalties

1. Tax Preparer Definition & Scope

  • Who is a Preparer?

    • Prepares/employs others to prepare returns for compensation.

    • Includes advice making return completion "mechanical."

    • Substantial Portion: Income/deductions/credits ≥ $10K OR $400K + >20% AGI/GI.

    • Exclusions: Employees, fiduciaries, typists, future planners.

  • Primary Responsibility:

    • One preparer per return (oversees accuracy).

    • Cannot delegate core tasks (e.g., applying tax law, final review).

  • Compensation Required: No gift/favor qualifies unless agreed payment.

2. Preparer Duties & Procedures

  • Signature & ID:

    • Sign before presenting to the taxpayer.

    • Include PTIN (individual) or EIN (firm).

  • Copies & Records:

    • Give taxpayer copy upon presentation.

    • Retain returns 3 years (4 years for employment taxes).

  • Inquiry & Accuracy:

    • Rely on client info in good faith but investigate if red flags.

    • Verify software outputs (e.g., broker data errors).

  • Correcting Errors:

    • Form 4852: Disputed W-2/1099.

    • Form 8082: Inconsistent K-1/1040.

    • Form 4598: Employer non-cooperation.

3. Tax Positions & Authority

  • Substantial Authority:

    • Weight of supporting authorities > contrary.

    • Disclosure + reasonable basis avoids penalties.

  • Tax Shelters:

    • "More likely than not" standard.

    • Penalty: $1K or 50% of preparer income.

4. Penalties (Detailed Breakdown)

Violation Penalty Notes
Procedural Failures (no signature, PTIN, copy, records) $60 each, max $31.5K/yr Reasonable cause exemption.
Understatement:
- Unreasonable position $1K or 50% income Disclose to avoid.
- Willful/reckless $5K or 75% income No statute of limitations.
Disclosure Violations $250/disclosure ($10K/yr max) Criminal: $1K + 1 yr prison.
Abusive Tax Shelters $1K/sale or 100% income Lesser of the two.
Due Diligence Failures (EITC, CTC, AOTC, HOH) $635/error Keep Form 8867 + docs 3 yrs.
Negotiating Refunds $635/check Cannot endorse taxpayer checks.
Fraud $250K (indiv)/$500K (corp) + 3 yrs prison Sec. 7206.
Tax Evasion $100K/$500K + 5 yrs Felony under Sec. 7201.

5. Tax Shelters (Reportable Transactions)

File Form 8886 for:

  1. Listed: IRS-identified avoidance.

  2. Confidential: Min fee $250K (corp)/$50K (others).

  3. Contractual Protection: Refund if tax benefit denied.

  4. Losses: >$10M (corp)/$2M (indiv)/$50K (forex).

  5. Transactions of Interest: Potential evasion.

6. Due Diligence (Credits/HOH)

  1. Form 8867: Complete & submit.

  2. Compute Credits: Use IRS worksheets.

  3. Interview Taxpayer: Document eligibility.

  4. Retain Records: 5 items for 3 years:

    • Form 8867, worksheets, client docs, inquiry log, notes.

7. Accuracy-Related Penalties

  • 20% for: Negligence, understatement, valuation errors.

  • 40% for:

    • Gross valuation misstatement (200%+ error).

    • Undisclosed lack of economic substance.

  • No software defense (Tax Court ruling).

8. Fraud Indicators (Badges of Fraud)

  • Income: Hidden accounts, unreported cash.

  • Expenses: Fake deductions, inflated claims.

  • Records: Two sets of books, altered invoices.

  • Conduct: False statements, hindering audits.

9. Key Exceptions & Defenses

  • Reasonable cause + good faith avoids penalties.

  • Disclosure (Form 8275): Avoids understatement penalties if reasonable basis.

  • Confidentiality Privilege:

    • CPAs/EAs protected in noncriminal IRS cases.

    • Excludes tax shelter promotions.

10. Data Security & Free File

  • IRS Free File: AGI ≤ $84K (2024).

  • Security Measures: Firewalls, encryption, backups.

  • Report Cybercrime: Unauthorized EFIN use, client data breaches.

Mnemonics & Exam Tips

  • "$10K/$400K/20%": Substantial portion thresholds.

  • "CDKRR": Due diligence steps (Compute, Disclose, Knowledge, Record Retention).

  • Penalty Tiers:

    • Unreasonable: $1K/50% → Willful: $5K/75%.

  • Fraud Triggers: Concealment, false entries, evasion tactics.

⚠️ Critical Notes:

  • Preparer ≠ Practitioner (unless Circular 230 applies).

  • No compensation = No preparer status.

  • Economic Substance: Must change taxpayer’s position meaningfully (beyond tax benefits).

Visualize this as a flowchart or hierarchical chart for recall!

Tax Preparer  
├─ Definition ($10K/$400K/20%)  
├─ Duties (Sign, PTIN, Copy, Records)  
├─ Penalties  
│  ├─ Understatement ($1K/50% → $5K/75%)  
│  ├─ Disclosure ($250 per)  
│  └─ Fraud ($250K + 3 yrs)  
└─ Defenses (Disclosure, Reasonable Cause)

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