Providing inaccurate information on a tax return isn’t a criminal offense, but tax preparers can still face civil penalties if they purposefully include false information on a tax return.
The IRS Code Section 6694 is one of the tax preparer penalties that lays out the circumstances under which the IRS can penalize a person responsible for filing a tax return.
Section 6694 penalties are imposed when a tax preparer’s management of the tax return filing process doesn’t reach the level of criminal responsibility. However, understanding Section 6694 rules requires a high level of familiarity with the US tax system.
We’ll walk you through the critical aspects of the IRS Code Section 6694 to help you avoid paying penalties.
Table of Contents
The Legal Definition of a Tax Return Preparer
The IRC offers the legal definition of a tax return preparer and specifies who and under which circumstances can file a tax return on behalf of a taxpayer.
Most importantly, a person or an organization preparing a return must have IRS Preparer Tax Identification Number (PTIN) in order to offer tax return preparation services.
Hence, tax attorneys, Certified Public Accounts, or enrolled agents must have PTIN to represent a client before the IRS. PTIN holders that don’t have professional qualifications have the authority to prepare tax returns but cannot represent their clients before the IRS.
In addition, ‘any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax … or any claim for refund of tax…. For purposes of the preceding sentence, the preparation of a substantial portion of a return or claim for refund shall be treated as if it were the preparation of such return or claim for refund.’
Consequently, only tax preparers who charge for their services can be subject to Section 6694 penalties. The paragraph above also indicates that several preparers can work on a single return and that a tax preparer can be responsible for preparing only a portion of a return.
The term ‘person’ in this paragraph refers to individuals, sole proprietorships, corporations, and partnerships. A person won’t be recognized as a return preparer under the following circumstances:
- Full-time employees who claim a refund or prepare a return for their employers
- A person that prepares a return or refund claim as a fiduciary for a taxpayer
- A person that provides typing or similar mechanical assistance during the return preparation process
- A person that prepares a tax refund claim for a taxpayer who the IRS is auditing
IRS Code Section 6694
The IRS commonly issues penalties to return preparers who fail to report tax liabilities accurately, claim tax deductions taxpayers are ineligible for, or underreport taxable income. However, the rules for administering these penalties are defined in different sections of the IRC.
The title of Section 6694 is ‘Understatement of Taxpayer’s Tax Liability,’ which indicates that this section only refers to penalties for reporting taxes inaccurately.
This section contains several subsections that explain circumstances under which a tax preparer can be penalized.
Section 6694(a)
The Penalty for Understatement Due to Unreasonable Positions is assigned when a tax preparer assumes a position they have no reasonable basis for taking. The definition of a ‘reasonable basis’ is somewhat vague.
If the chances are over 50% that a court would uphold a specific basis assumed by a tax preparer, such a basis can be considered reasonable.
On the other hand, a position is considered unreasonable:
- If a tax preparer doesn’t have the authority to assume a particular position
- If a preparer doesn’t share the position with the IRS
- If no reasonable basis for the position exists
- If a position is a tax shelter
The minimum penalty under Section 6694(a) is $1,000. However, preparers might have to pay 50% of their income from preparing a tax return or refund claim.
Section 6694(b)
The Penalty for a Preparer’s Willful Understatement of Tax is much harsher as a preparer might be fined $5,000 or 75% of the income earned from preparing a refund claim or tax return.
Penalties defined by this subsection of Section 6694 are assessed under the following circumstances:
- Intentional or reckless disregard of tax regulations
- Willful attempt to understate tax liability on a return or refund claim
Tax preparers can be subject to Section 6694(a) and Section 6694(b) penalties for the same tax return, but in this situation, the Section 6694(b) penalty will be reduced by the amount paid for the Section 6694(a) penalty.
Other Tax Preparer Penalties
The IRC contains several sections that deal with tax preparer penalties. Besides Section 6694, the IRS can also impose penalties under Section 6695, Section 6713, or Section 7407, among others.
Section 6695 describes Due Diligence penalties as follows:
- Failure to file correct information returns
- Failure to furnish identifying number
- Failure to deliver a copy to a taxpayer
- Failure to sign a tax return
- Failure to be diligent in determining eligibility for tax credits
- Negotiation of check
So, if a tax preparer claims the Earned Income Tax Credit or Child Tax Credit on a tax return, even though a taxpayer isn’t eligible for these credits, the IRS can impose a Section 6696 penalty on them.
These penalties are usually lower than Section 6694 penalties. However, a tax preparer might pay up to $25,000 for failure to file correct information returns or $510 without the maximum amount limit for each incorrectly claimed tax credit on a return.
Section 6694 Exceptions
Return preparers that can prove they acted in good faith can be exempt from Section 6694 penalties. Regs. Section 1.6694-2(e) provides guidelines on whether a preparer acted in good faith based on the circumstances and facts.
This section stipulates that penalties won’t be imposed if:
- The tax understatement is the result of an isolated and nonrecurring error
- The understatement is relatively negligible
- If a preparer followed standard practices
- If the understatement occurred due to a highly complex, uncommon, or technical law
- If a preparer followed regular office practices and the error was atypical
- If the error is the result of advice or information preparer received from a taxpayer
According to the regulations in Section 1-6694-1(e), the preparer isn’t required to audit, examine, review, or verify taxpayer information.
Good-faith reliance only implies checking the taxpayer’s information under conflicting circumstances or if the tax preparer believes the information is incomplete or inaccurate.
Frequently Asked Questions
All tax returns prepared by licensed tax professionals are considered prepared on the date a preparer signed them. Unsigned tax returns are deemed prepared once they’re filed.
If a tax preparer acts in an advisory role, the IRS considers a tax return prepared on the date when a preparer advises a taxpayer.
This section of the IRC covers only civil penalties, but tax return preparers can face criminal charges if they willfully underreport tax liabilities.
Even though Section 6694 places the responsibility on the individual that signed a tax return, the IRS can penalize a firm if members of its senior management were aware of the tax preparer’s unreasonable position.
The IRS can also penalize a firm if it determines that regular procedures were disregarded during the tax return preparation.
The statute of limitations for Section 6694 penalties is three years from the moment a tax return is filed. In some cases, the statute of limitations for these penalties can be extended.
Contact a CPA
Hiring a tax professional is the safest way to ensure your tax return is filed according to the latest tax rules and regulations. Tax return preparers that fail to report all your tax liabilities accurately on purpose are subject to penalties.
Section 6694 of the IRC specifies the circumstances under which the IRS can penalize a tax preparer.
Go to choicetaxrelief.com or call 866-8000-TAX to book a meeting with a CPA who can interpret Section 6694 for you and offer guidance on how to appeal a tax preparer penalty.
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Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
