AICPA Preparer Penalty Task Force

Supplemental Recommendations

for Guidance under Section 6694 and Related Provisions

April 21, 2008

On March 17, 2008, the AICPA Preparer Penalty Task Force submitted recommendations to the Internal Revenue Service and the Treasury Department regarding guidance to be issued under Internal Revenue Code section 6694 and related provisions. The following recommendations regarding section 6694 issues that are specific to the estate, gift, and trust tax practice areas are submitted as a supplement to those recommendations.

The AICPA’s formal review procedures were waived with respect to these recommendationsand the March 17, 2008 recommendations in order to expedite the submissions. As a result, the recommendationsdo not constitute the official position of the AICPA. The AICPA may submit formal comments when section 6694 guidance is issued in proposed form.

Members of the AICPA Preparer Penalty Task Force who developed the initial recommendations are: Alan R. Einhorn, Chair; Stephen R. Buschel; Conrad M. Davis; Walter B. Doggett, III; Eve Elgin; Rochelle Hodes; James W. Sansone; and J. Edward Swails. Diane D. Fuller, John A. Galotto, and Pete Wilson also contributed to the development of the recommendations.

Members of the AICPA Estate, Gift & Trust Preparer Penalty Provision Task Force and other individuals who developed these supplemental recommendations are: Eric L. Johnson, Chair; Henry P. Alden II; Evelyn M. Capassakis; Joe L. Fischer; Daniel L. Hall; John M. Nuckolls; Justin P. Ransome; Robert A. Stover, Jr.; and Steven A. Thorne.

Recommendations

Note: References torelevant section headings and page numbersof related material in the March 17th submission (Exhibit 1) are provided for the following recommendations.

I.Potential Revision to the “Substantial Portion” SafeHarbor

(March submission, pages 3-4)

In the March submission, we recommended: (1) a safe harbor based on a percentage of tax, for all types of tax; (2) revisions to the safe harbor with respect to income tax; and (3) development of additional safe harbors with respect to taxes other than income tax. We recommend the following safe harbor with respect to estate, gift, and generation-skipping transfer tax:

Additional SafeHarbor: Estate, Gift, and Generation-Skipping Transfer Tax

If the schedule, entry or other portion of the return or claim for refund involves an amount of a taxable transfer that is---

(i) Less than the annual exclusion amount for gift tax, the taxpayer’s remaining GST exemption amount (as defined in section 2631 of the Internal Revenue Code) for generation-skipping transfer tax, or the taxpayer’s remaining applicable exclusion amount for gift or estate tax;

(ii) Eligible for a marital or charitable deduction for gift or estate tax purposes equal to the amount of the taxable transfer;

(iii) Less than $350,000 and also less than 20 percent of the tax shown on the return or claim for refund; or

(iv) Less than 10 percent of the tax required to be shown on the return (or adjustment in the case of a claim for refund),

then the schedule, entry or other portion is not considered to be a substantial portion.

II. Disclosure

(March submission, pages 11-13)

1. Disclosure Required by Indirect Preparers- Passthrough Entities / Notice 2008-13, Exhibits 2 and 3

In the March submission, we recommended that, in the case of a passthrough entity: (1) any disclosure under section 6694 should be required only at the entity level; and (2) the preparer should not have any obligation with respect to the passthrough entity interest holder solely because the preparer prepared the entity’s return. We recommend that guidance clarify that a section 6694 disclosure with respect to a non-grantor trust or estate (Form 1041) or a charitable trust (Form 5227) that issues a K-1 to a taxpayer beneficiary is only required at the entity (i.e., trust or estate) level.

2. Other Matters

In general, we recommend that the adequate disclosure rules found in Treas. reg. section 301.6501(c)-1(f) be adopted for purposes of defining adequate disclosure under section 6694 for estate and gift tax returns. In addition, we recommend that Treasury synchronize Treas. regs. section 301.6501(c) - (1)(e) and -1(f) by deleting -1(e), and allow -1(f) to apply to all gift tax transfers.

III. Reliance

1. Reliance on the Literal Language of a Legal Document

We recommend that a tax return preparer may rely upon the literal language of a legal document without further verification unless so required by the document, provided that such reliance is reasonable. For example, a tax return preparer may rely upon the terms of a marital trust agreement which appears to meet all of the necessary statutory requirements to claim a marital deduction for gift or estate tax purposes, notwithstanding later findings to the contrary

2. Reliance on Appraisals and Valuations

In the March submission, we recommended that a tax return preparer should be able to rely upon appraisals, valuations, actuarial information, economic analyses, and other similar types of information if such reliance is reasonable. We recommend that for purposes of appraisals and valuations for gift and estate tax purposes, thesection 6694 regulations cross reference the appraisal requirements for adequate disclosure under Treas. reg. section 301.6501(c)-1(f)(3).

3. Reliance on Other Information to Establish Value

In situations where the gift or estate tax valuation is not supported by a formal appraisal or valuation, we recommend that the tax return preparer may rely upon certain other information that demonstrates the origin of the value (even if the value is not ultimately accepted by the Internal Revenue Service). We recommend that Treasury consider Treas. Reg. section 301.6501(c)-1(f)(2)(iv) as a starting point for the types of information which may support the origin of the value. For example, for purposes of estate tax valuation, the tax return preparer may rely upon a formula clause in a buy-sell agreement for purposes of determining the value of closely-held stock held by the estate.

Exhibit 1

AICPA Preparer Penalty Task Force

Recommendations for Guidance under Section 6694 and Related Provisions

March 17, 2008

AICPA Preparer Penalty Task Force

Recommendations for Guidance under Section 6694 and Related Provisions

March 17, 2008

The AICPA Preparer Penalty Task Force has prepared the following recommendations regarding guidance to be issued under Internal Revenue Code section 6694 and related provisions. In order to expedite the submission of these recommendations, the AICPA’s formal review procedures were waived with respect to this document. As a result, these recommendations do not constitute the official position of the AICPA. The AICPA may submit formal comments when section 6694 guidance is issued in proposed form.

Please note that these recommendations focus on issues unique to the income tax. Estate and gift tax, and possibly other tax issues, will be addressed in a later submission if necessary.

Notice 2008-13

In adopting the interim rules for tax return preparer disclosure in Notice 2008-13, Treasury and the Internal Revenue Service have established a sound framework for implementing Congress’s objectives in amending section 6694. The approach taken in the Notice strikes an appropriate balance between the requirements for return disclosure and sound tax administration. We applaud the government’s approach because it reduces unnecessary disclosures and complexity without sacrificing overall compliance or tax administration needs. We recommend that Treasury and the Service build upon the framework established by Notice 2008-13 as they develop guidance in this area, and our recommendations generally have been developed under the assumption that this framework will be retained. If Treasury and the Service adopt a different approach to tax return preparer disclosure, many of our recommendations below may need to be revised.

Recommendations

I. “Tax Return Preparer” Subject to Section 6694

A. Scope and Application of Section 6694 to Non-Signing Preparers

We believe that the concept of the non-signing preparer is central to fair and effective enforcement of section 6694 and the operation of the self-assessment system. Accordingly, we strongly recommend that the current core principles of the regulations concerning non-signing preparers be preserved as the regulations are revised. In our view, the IRS clearly has the authority to regulate non-signing preparers under section 6694. The 1976, 1989, and 2007 Acts and their legislative histories are consistent with a broad definition of “preparer” and certainly do not require that non-signing preparers be excluded from the ambit of section 6694. Moreover, regulations under sections 7701 and 6694 have applied a broad definition of “preparer” for more than 30 years. We do not believe that the 2007 amendments to section 6694 reasonably can be read as an invitation to narrow the class of individuals providing tax services to which section 6694 applies.

We appreciate that there are, and have been for many years, challenges in applying the preparer penalty provisions to persons who do not physically prepare tax returns. Nonetheless, we believe that the rules for non-signing preparers are important in defining the roles and duties of signing preparers, particularly because signing preparers may, under appropriate circumstances, reasonably rely on others including non-signing preparersto avoid penalties. In addition, we believe that the non-signing preparer rules recognize the incontrovertible proposition that, in many cases, individuals who do not sign the return play a very significant role in the ultimate content of the return or claim and any related understatements.

For the same reasons, we would not support a restriction of the definition of non-signing preparer to only those individuals who review, draft, or discuss the actual return. Inclusion of individuals who do not review, draft, or discuss the actual return promotes the policies behind the section 6694 penalty. Any attempt to limit the section 6694 penalty to those individuals who physically interact with the return presupposes that the tax return preparation process is a mechanical exercise and much more static than it often is, particularly in the case of complex returns. Adopting this approach would treat those persons who provided advice later in the return preparation process as preparers, while excluding from the definition those who advised at an earlier stage, regardless of the substantive impact of the advice they render on the tax return. For example, a large corporation is likely to determine many of its tax return positions in consultation with numerous legal, financial and tax advisors over the course of the tax year, not merely after the year has ended and the filing deadline looms.

We believe that the conduct of non-signing preparers should be regulated under section 6694. It makes sense and is more efficient to have both signing and non-signing preparers subject to similar consequences under section 6694, rather than having signing preparers subject to section 6694 proceedings (and possibly Circular 230 proceedings) and non-signing preparers subject only to Circular 230 proceedings (or no proceedings at all depending upon how the amendments to section 10.34 of Circular 230 are finalized).

Many of our recommendations below are based on the assumption that the concept of non-signing preparers will continue under the revised regulations. We would need to re-evaluate many of our recommendations below if non-signing preparers were excluded from the scope of the revised section 6694 regulations, or if the categories of persons potentially subject to a section 6694 penalty otherwise were substantially narrowed.

B. “Substantial Portion” of a Return

1. Definition of a “Substantial Portion” of a Return

Notice 2008-13, at section B.3, interprets “substantial portion” as meaning:

[A] schedule, entry, or other portion of a tax return or claim for refund that, if adjusted or disallowed, could result in a deficiency determination (or disallowance of refund claim) that the preparer knows or reasonably should know is a significant portion of the tax liability reported on the tax return (or, in the case of a claim for refund, a significant portion of the tax originally reported or previously adjusted). This clarifies that any determination as to whether a person has prepared a substantial portion of a tax return and thus is considered a tax return preparer will depend on the relative size of the deficiency attributable to the schedule, entry, or other portion.

We agree with this emphasis on the importance of the relative size of the deficiency and the knowledge of the advisor. We also believe the current rule appropriately takes into account other factors such as the relative length or complexity of the portion and the relative amount of the tax liability or refund. Thus, the above-quoted language should supplement the current guidance in reg. section 301.7701-15(b)(1).

2. Application of the “Substantial Portion” Concept to an Amended Return

As noted above, Notice 2008-13 indicates that, with respect to a claim for refund, the “substantial portion” test should be based on the tax originally reported or previously adjusted. We recommend that this approach be adopted with respect to amended returns and claims for refund. Consequently, whether an item is a substantial portion of the return will be determined identically with reference to the amounts on the original return for positions on original returns and on amended returns.

3.Potential Revision to the “Substantial Portion” SafeHarbor

SafeHarbor Based on Percentage of Tax for All Taxes

We recommend, as a safe harbor with respect to all types of tax, that a person who prepares a schedule, entry, or other portion of a tax return or claim for refund will not be deemed to have prepared a substantial portion of the return or claim if the tax attributable to the schedule, entry of other portion prepared is less than 10% of the tax required to be shown on the return or claim.

Additional SafeHarbor - Income Tax

Current reg. section 301.7701-15(b)(2) provides as a safe harbor the following objective rule for determining when a person will not be deemed to have prepared a “substantial portion” of an income tax return:

(2) For purposes of applying the rule of paragraph (b)(1) of this section, if the schedule, entry, or other portion of the return or claim for refund involves amounts of gross income, amounts of deductions, or amounts on the basis of which credits are determined which are --

(i) Less than $2,000; or

(ii) Less than $100,000, and also less than 20 percent of the gross income (or adjusted gross income if the taxpayer is an individual) as shown on the return or claim for refund,

then the schedule or other portion is not considered to be a substantial portion. If more than one schedule, entry or other portion is involved, they shall be aggregated in applying the rule of this paragraph (b)(2). … This paragraph shall not apply to a person who prepares all of a return or claim for refund.

This provision was promulgated in November 1977 and no adjustments have been made to it since then. Based on the Bureau of Labor Statistics’ Inflation Calculator ( and the CPI in 1977 versus the CPI in 2008, $2,000 in 1977 is equivalent to $6,966 in 2008 buying power, and $100,000 in 1977 is equivalent to $348,317 in 2008 buying power.

We recommend that the dollar amounts in the reg. section 301.7701-15(b)(2) safe harbor be updated to $10,000 and $400,000, respectively, and periodically be revisited as warranted.

Additional SafeHarbor - Other Taxes

We recommend that similar safe harbors also be provided with respect to the preparation of tax returns and claims for refund for taxes other than the income tax, such as estate and gift tax. We look forward to working with you on these issues.

C. Distinction between Preparing a Return and Providing Clerical and Mechanical Services

Current section 7701 regulations exclude from the definition of income tax return preparer persons who only perform typing, reproduction, or other mechanical assistance. We understand this provision also covers ministerial acts that do not involve the exercise of judgment or discretion and non-substantive alterations, such as a correction or change limited to a transposition error, misplaced entry, spelling error, or arithmetic correction. We recommend that this approach be continued.

We also recommend that the application of this rule with regard to software providers, payroll service companies, and service bureaus be the subject of additional guidance.

D. One Preparer Per Firm Rule

Under section 7701, both the individual who prepares a return or claim for refund for compensation, and the employer of that individual, may be tax return preparers. As such, both the individual preparer and the firm that the individual preparer is associated with may be subject to preparer penalties.

1. Current Regulations

The current regulations provide that no more than one individual associated with a firm may be subject to a penalty under section 6694. If a signing preparer is associated witha firm, the only individual in that firm liable for the penalty will be the signing preparer. If no individual associated with the firm is the signing preparer, only the individual with overall supervisory responsibility for the advice given by the firm with respect to the return or claim for refund is subject to the penalty. This is the so-called one preparer per firm rule. The corollary to this rule under the regulations is that, in the case of multiple persons from a firm who provide advice with respect to a return or claim for refund, the signing preparer (or if there is none, the individual with overall supervisory responsibility for the return) cannot claim reliance on advice from another person in the firm as a defense to the penalty.

We have concerns regarding the equitable application of the penalty to individual preparers when there are multiple preparers of a return within the same firm. This emphasis on the signing preparer, combined with imposition of the penalty on a per-return or claim for refund basis, rather than a per-position basis, unfairly allows noncompliant preparers to avoid a penalty, while exposing the compliant preparer to a penalty. The current approach ignores the fact that there may be multiple understated positions on any one return or claim for refund and that each position could be prepared by a different preparer.

2. Position-Based Approach

We urge Treasury and the IRS to use this opportunity to rationalize the structure of signing and non-signing preparers from the same firm, based on a focus on positions rather than returns. We offer the following recommendations to fairly impose liability based on the behavior of the individual preparer, not based on whether the preparer or someone in the preparer's firm happens to be the signing preparer.