Your CPA and the Small Business and Work Opportunity Act of 2007

Posted on September 28, 2011 by Bill Faiferlick

Your CPA has been designated as an agent for the IRS instead of your advocate. 

The 2007 Small Business and Work Opportunity Tax Act now holds any tax preparer jointly financially responsible with the client if certain deductions are denied by the Internal Revenue Service. In fact, the legislation expands the definition of preparer to apply not only to income tax returns, but also to those who prepare estate and gift, excise, exempt organizations, and employment tax returns. By default, CPAs cannot without incurring substantial risk represent the best interests of clients outside of plain vanilla accounting services. They must now place the interests of the IRS ahead of their clients.

Taking this logic a step further, since all tax preparers have tax preparer identification numbers, if a preparer is found to be in violation, the Service can easily identify their entire book of business making other clients susceptible to audits and review.

This act changes the relationship between you and your CPA or any other tax preparer. The tax preparer is now jointly financially responsible for fines for under-payment or error in the reporting of your taxes. The penalties were raised to the greater of $1,000 or half the income derived by the preparer and for “willful or reckless conduct,” to the greater of $5,000 or half the income derived by the preparer. These are substantial fines for any tax preparer.

In some cases, tax preparers will insist on greater disclosure and an increased production of documentation in the preparation of your return and increased fees resulting from the additional burden of responsibility being placed on CPAs and tax preparers.

The new law alters the standards of conduct that must be met in order to escape penalties for preparing a return where the tax obligation is understated. The standards of reporting required by tax preparers have now been increased. There must be a reasonable belief that the tax treatment of the position was more likely than not the proper treatment and there must be a reasonable basis for the tax treatment.

The intent of the act is to curb abuses by unscrupulous return preparers. The new standards are applied whether or not the preparer approaches his or her responsibility with bad intentions. The higher standards and penalties apply to tax returns prepared after May 25, 2007, including 2006 returns filed on extension.

The following are excerpts from: TECHNICAL EXPLANATION OF THE “SMALL BUSINESS AND WORK OPPORTUNITY TAX ACT OF 2007” AND PENSION RELATED PROVISIONS CONTAINED IN H.R. 2206 AS CONSIDERED BY THE HOUSE OF REPRESENTATIVES ON MAY 24, 2007 Prepared by the Staff of the JOINT COMMITTEE ON TAXATION 

Understatement of Taxpayer’s Liability by Tax Return Preparers
(sec. 8246 of the bill and secs. 6694 and 7701 of the Code)

Present Law

An income tax return preparer is defined as any person who prepares for compensation, or who employs other people to prepare for compensation, all or a substantial portion of an income tax return or claim for refund.38 Under present law, the definition of an income tax return preparer does not include a person preparing non-income tax returns, such as estate and gift, excise, or employment tax returns.

An income tax return preparer who prepares a return with respect to which there is an understatement of tax that is due to an undisclosed position for which there was not a realistic possibility of being sustained on its merits, or a frivolous position, is liable for a first-tier penalty of $250, provided the preparer knew or reasonably should have known of the position.39 For purposes of the penalty, an understatement is generally defined as any understatement with respect to any tax imposed by subtitle A (i.e., income taxes). An income tax return preparer who prepares a return and engages in specified willful or reckless conduct with respect to preparing an income tax return is liable for a second-tier penalty of $1,000.

Explanation of Provision

The provision broadens the scope of the present-law tax return preparer penalties to include preparers of estate and gift tax, employment tax, and excise tax returns, and returns of exempt organizations.

The provision also alters the standards of conduct that must be met to avoid imposition of the penalties for preparing a return with respect to which there is an understatement of tax. First, the provision replaces the realistic possibility standard for undisclosed positions with a requirement that there be a reasonable belief that the tax treatment of the position was more likely than not the proper treatment. The provision replaces the not-frivolous standard accompanied by disclosure with the requirement that there be a reasonable basis for the tax treatment of the position accompanied by disclosure.

The provision also increases the first-tier penalty from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty is imposed. The provision increases the second-tier penalty from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the tax return preparer.

Effective Date

The provision is effective for claims for refund or credit filed after the date of enactment. 

Penalty for Filing Erroneous Refund Claims
(sec. 8247 of the bill and sec. 6662 of the Code) 

Present Law

Present law imposes accuracy-related penalties on a taxpayer in cases involving a substantial valuation misstatement or gross valuation misstatement relating to an underpayment of income tax.40 For this purpose, a substantial valuation misstatement generally means a value claimed that is at least twice (200 percent or more) the amount determined to be the correct value, and a gross valuation misstatement generally means a value claimed that is at least four times (400 percent or more) the amount determined to be the correct value.

The penalty is 20 percent of the underpayment of tax resulting from a substantial valuation misstatement and rises to 40 percent for a gross valuation misstatement. No penalty is imposed unless the portion of the underpayment attributable to the valuation misstatement exceeds $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal holding company). Under present law, no penalty is imposed with respect to any portion of the understatement attributable to any item if (1) the treatment of the item on the return is or was supported by substantial authority, or (2) facts relevant to the tax treatment of the item were adequately disclosed on the return or on a statement attached to the return and there is a reasonable basis for the tax treatment. Special rules apply to tax shelters. 

Explanation of Provision

The provision imposes a penalty on any taxpayer filing an erroneous claim for refund or credit. The penalty is equal to 20 percent of the disallowed portion of the claim for refund or credit for which there is no reasonable basis for the claimed tax treatment. The penalty does not apply to any portion of the disallowed portion of the claim for refund or credit relating to the earned income credit or any portion of the disallowed portion of the claim for refund or credit that is subject to accuracy-related or fraud penalties.

Effective Date

The provision is effective for claims for refund or credit filed after the date of enactment.