New Guidance Helps CPAs Minimize Tax Penalties
Knight, Lee G., Knight, Ray A., Journal of Accountancy
The regulations now encourage voluntary self-assessment.
The Internal Revenue Service continues to attack problems of tax understatement, poor tax advice and careless return preparation. It released new regulations covering the accuracy-related penalty of Internal Revenue Code section 6662 and the section 6694 tax preparer penalties in December 1991. The IRS also issued revenue procedure 91-19 to update its rules of adequate disclosure to reduce a substantial understatement penalty and avoid a tax preparer penalty.
This article reviews both the regulations and the updated disclosure rules. CPAs who prepare federal income tax returns should become familiar with these rules and regulations so their exposure to the accuracy-related and tax preparer penalties is minimized.
ACCURACY-RELATED PENALTY REGULATIONS
Section 6662 imposes a 20% accuracy-related penalty on any portion of a tax underpayment attributable to one or more of the following types of misconduct:
* Negligence or disregard of rules or regulations.
* Substantial understatement of income tax.
* Substantial valuation misstatement under chapter 1 of the code.
* Substantial overstatement of pension liabilities.
* Substantial estate or gift tax valuation understatement. The penalty increases to 40% if the misconduct meets the section 6662 criteria for a goss valuation misstatement, a goss overstatement of pension liabilities or a gross estate or gift tax valuation understatement.
The regulations provide ordering rules for computing the total accuracy-related and fraud penalties imposed on a given return and define terms related to the first three types of misconduct. The new guidelines apply to all taxpayers who file income tax returns and generally are effective for returns due after 1989. The adequate disclosure regulations, however, apply only to returns due after 1991.
Ordering of penalties. The regulations clarify that only one accuracy-related penalty applies to a given return, even though the underpayment may be attributed to more than one type of misconduct. For example, the maximum penalty imposed on any portion of an underpayment attributable to both negligence (which alone triggers a 20% penalty) and a gross valuation misstatement (which alone triggers a 40% penalty) is 40%. The regulations also provide that an accuracy-related penalty may apply in addition to a section 6651 penalty for failure to timely file a tax return, but not in addition to a section 6663 fraud penalty.
Negligence or disregard of rules or regulations. This component of the accuracy-related penalty applies if any portion of a tax underpayment results from negligence or disregard of rules or regulations. The regulations define negligence to include any failure to make a reasonable attempt to comply with the tax laws or to exercise ordinary and reasonable care in the preparation of a return. A taxpayer is negligent if he or she fails to keep adequate books and records or to substantiate items properly. A position is considered negligent if it lacks a reasonable basis.
Negligence is strongly indicated when a taxpayer fails to include on a return income shown on an information return or fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion that seems to be "too good to be true." Negligence also is strongly indicated when the returns of a partner and the partnership or an S corporation shareholder and the S corporation are not consistent.
Disregard of rules or regulations includes any careless, reckless or intentional disregard of the code, temporary or final regulations, revenue rulings or notices. A disregard is careless if the taxpayer fails to exercise reasonable diligence to determine the correctness of a return position contrary to a rule or regulation; reckless if the taxpayer makes little or no effort, as judged by the standard of conduct for a reasonable person, to determine whether a rule or regulation exists; and intentional if the taxpayer knows of the disregarded rule or regulation. …