Who does the Internal Revenue Service consider a Tax Preparer? Exploring Applicable Law

Who does the Internal Revenue Service consider a tax preparer? For such a simple question, the answer can be complicated. This is an important question for attorneys, accountants, Enrolled Agents, or other professionals. Tax returns that show substantial understatements due to tax preparer error, whether it be intentional or not, are subject to penalties under 6694 of the Internal Revenue Code. These tax preparer penalties are presumptively valid and the preparer challenging the penalty bears the burden of proving that he or she did not intentionally disregard rule or regulation pertaining to tax law, Internal Revenue Code 6694(b)(2). 

Treasury Regulation 301.7701-15 generally defines a tax return preparer as, “any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of any return of tax or any claim for refund of tax under the Internal Revenue Code.”  A person may be deemed a tax return preparer regardless of their education or professional status and regardless of their location (whether the person is within the United States or not) as long as he or she satisfies the definition of a tax return preparer. Treas. Reg. 301.7701-15(d)(e).

As with any statute, the devil is in the details.  What does the IRS consider “compensation”? What is considered a “substantial portion” of the return? And when would the IRS consider the employer of the tax preparer to be the “real” preparer and apply penalties? Are there any exemptions to this statutory scheme? Finally, how much is the penalty?

To put it simply, if you are paid for your services then you are compensated for your work. But what if you are preparing a tax return for your sister and she decides to babysit your children for the weekend to thank you. Is this compensation?  According to Treasury Regulation 301.7701-15(f)(1)(xii), it depends on the tax preparers intention. If you prepare a tax return expecting no compensation, then you are not a tax return preparer. If you expect something in return, even if it is insubstantial, then you are a tax return preparer.

A “substantial portion” of the tax return is a little harder to identify.  Any advice given to the taxpayer before the transaction occurs is not considered part of the preparation of the substantial portion of a tax return. Treas. Reg. 301.7701-15(a)(2)(i).  In order for advice to be considered part of the substantial portion of the tax return, it has to be given after the event occurred. For example, if attorney Joe gives advice about a merger (the event) and possible tax consequences before the merger occurs, Joe is not considered a tax preparer. However, if after the merger is completed, Joe continues to give advice, then he is considered a tax preparer at that time.

The analysis of what constitutes a “substantial portion of the tax return” does not end there. The IRS also looks at “substantial” in a much more practical way.  For example, in the infamous case, Goulding v. United States, 957 F.2d 1420 (7th Cir. 1992), Goulding was tax return preparer for a partnership return. The IRS concluded that Goudling was also the tax return preparer for an individual return of a partner even though Goulding did not prepare that individual’s return. The partnership return constituted only one line on the individual taxpayer’s return.  How can this be substantial? The IRS concluded, and the 7th Circuit agreed, that the one line represented a substantial portion of the taxpayer’s income and overall tax liability. See also Treasury Regulation 301.7701-15(b)(3)(iii) for an example in the corporate context.

When do you, as an employer, become liable for the tax preparation of your employee?  As an example, in Schneider v. U.S., 257 F.Supp.2d 1154 (2003), Schneider was a Certified Public Accountant that had an employee prepare a substantial portion a client’s return that Schneider signed.  There was an understatement of income determined by the IRS due to an incorrect assessment of business deductions. The court held that, “[…] being an employer of one or more persons who prepare a tax return for compensation is sufficient to qualify one as an income tax preparer.” 257 F.Supp.2d 1154, 1160.  Schneider received the penalty.  Have you ever signed a return prepared by your employee?

Volunteering your time or performing perfunctory mechanical functions in the preparation of tax returns excuse a tax preparer from penalties associated with preparation because of policy reasons. Treasury Regulation 301.7701-15(f) lists who is not a tax return preparer. People who are employees of the IRS, people who provide assistance under the Volunteer Income Tax Assistance (VITA) program established by the IRS, and any organization sponsoring or administering a program established help the elderly (provided that the program follows established guidelines), are just some of the examples of preparers who are not considered tax preparers.

The tax return preparer penalty, depending on your intent, is equal to the greater of $1,000 or 50% of the income derived or to be derived by the tax return preparer (Treas. Reg. 1.6694-2(a)) or equal to the greater of $5,000 or 50% of the income derived or to be derived by the tax return preparer (Treas. Reg. 1.6694-3(a)).  If you are liable for a penalty as a tax return preparer with the intent to deceive the IRS, you would have to pay at least $5,000 or half of the income you earned, whichever is higher.

As the above examples reveal, whether or not you will be considered a tax return preparer is plain confusing. Other contexts, such as what happens if you are an employer who does not sign the tax return, have not been addressed in this blog.  It is of paramount importance to understand how this area of law can be argued and defended.   If you are accused, it is extremely important to defend and overcome the allegations because they can cost you far more than the above monetary penalty, they can cost you your license and livelihood.    Please contact Moskowitz LLP at (415) 394-7200 or via our Tax Law Firm’s website if you have any concerns or questions regarding this complicated aspect of the tax law.