[Code of Federal Regulations] [Title 26, Volume 13] [Revised as of April 1, 2004] From the U.S. Government Printing Office via GPO Access [CITE: 26CFR] [Page 523-525] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) Procedure and Administration--Table of Contents Sec. 1.6694-3 Penalty for understatement due to willful, reckless, or intentional conduct. (a) In general--(1) Proscribed conduct. If any part of an understatement of liability relating to a return of tax under subtitle A of the Internal Revenue Code or claim for refund of tax under subtitle A of the Internal Revenue Code is due to-- (i) A willful attempt in any manner to understate the liability for tax by a preparer of the return or claim for refund; or (ii) Any reckless or intentional disregard of rules or regulations by any such person, such preparer is subject to a penalty of $1,000 with respect to such return or claim for refund. (2) Special rule for employers and partnerships. An employer or partnership of a preparer subject to penalty under section 6694(b) is also subject to penalty only if-- (i) One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the conduct proscribed by section 6694(b); (ii) The employer or partnership failed to provide reasonable and appropriate procedures for review of the position for which the penalty is imposed; or (iii) Such review procedures were disregarded in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed. (b) Willful attempt to understate liability. A preparer is considered to have willfully attempted to understate liability if the preparer disregards, in an attempt wrongfully to reduce the tax liability of the taxpayer, information furnished by the taxpayer or other persons. For example, if a preparer disregards information concerning certain items of taxable income furnished by the taxpayer or other persons, the preparer is subject to the penalty. Similarly, if a taxpayer states to a preparer that the taxpayer has only two dependents, and the preparer reports six dependents on the return, the preparer is subject to the penalty. (c) Reckless or intentional disregard. (1) Except as provided in paragraphs (c)(2) and (c)(3) of this section, a preparer is considered to have recklessly or intentionally disregarded a rule or regulation if the preparer takes a position on the return or claim for refund that is contrary to a rule or regulation (as defined in paragraph (f) of this section) and the preparer knows of, or is reckless in not knowing of, the rule or regulation in question. A preparer is reckless in not knowing of a rule or regulation if the preparer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable preparer would observe in the situation. (2) A preparer is not considered to have recklessly or intentionally disregarded a rule or regulation if the position contrary to the rule or regulation is not frivolous as defined in Sec. 1.6694-2(c)(2), is adequately disclosed in accordance with paragraph (e) of this section and, in the case of a position contrary to a regulation, the position represents a good faith challenge to the validity of the regulation. (3) In the case of a position contrary to a revenue ruling or notice (other than a notice of proposed rulemaking) published by the Service in the Internal Revenue Bulletin, a preparer also is not considered to have recklessly or intentionally disregarded the ruling or notice if the position has a realistic possibility of being sustained on its merits. (d) Examples. The provisions of paragraphs (b) and (c) of this section are illustrated by the following examples: [[Page 524]] Example 1. A taxpayer provided a preparer with detailed check registers reflecting personal and business expenses. One of the expenses was for domestic help, and this expense was identified as personal on the check register. The preparer knowingly deducted the expenses of the taxpayer's domestic help as wages paid in the taxpayer's business. The preparer is subject to the penalty under section 6694(b). Example 2. A taxpayer provided a preparer with detailed check registers to compute the taxpayer's expenses. However, the preparer knowingly overstated the expenses on the return. After adjustments by the examiner, the tax liability increased significantly. Because the preparer disregarded information provided in the check registers, the preparer is subject to the penalty under section 6694(b). Example 3. A revenue ruling holds that certain expenses incurred in the purchase of a business must be capitalized. The Code is silent as to whether these expenses must be capitalized or may be deducted currently, but several cases from different courts hold that these particular expenses may be deducted currently. There is no other authority. Under these facts, a position taken contrary to the revenue ruling on a return or claim for refund is not a reckless or intentional disregard of a rule, since the position contrary to the revenue ruling has a realistic possibility of being sustained on its merits. Therefore, the preparer will not be subject to a penalty under section 6694(b) even though the position is not adequately disclosed. Example 4. Final regulations provide that certain expenses incurred in the purchase of a business must be capitalized. One Tax Court case has expressly invalidated that portion of the regulations. Under these facts, a position contrary to the regulation will subject the preparer to the section 6694(b) penalty even though the position may have a realistic possibility of being sustained on its merits. However, because the contrary position on these facts represents a good faith challenge to the validity of the regulations, the preparer will not be subject to the section 6694(b) penalty if the position is adequately disclosed in the manner provided in paragraph (e) of this section. (e) Adequate disclosure--(1) Signing preparers. In the case of a signing preparer, disclosure of a position that is contrary to a rule or regulation is adequate only if the disclosure is made in accordance with Sec. 1.6662-4(f) (1), (3), (4) and (5) (which permit disclosure on a properly completed and filed Form 8275 or 8275-R, as appropriate). In addition, the disclosure of a position that is contrary to a rule or regulation must adequately identify the rule or regulation being challenged. The provisions of Sec. 1.6662-4(f)(2) (which permit disclosure on the return in accordance with an annual revenue procedure) do not apply for purposes of this section. (2) Nonsigning preparers. In the case of a nonsigning preparer, disclosure of a position that is contrary to a rule or regulation is adequate if the position is disclosed in the manner provided in paragraph (e)(1) of this section. In addition, disclosure of a position is adequate in the case of a nonsigning preparer if, with respect to that position, the preparer complies with the provisions of paragraph (e)(2) (i) or (ii) of this section, whichever is applicable. (i) Advice to taxpayers. In the case of a nonsigning preparer who provides advice to the taxpayer with respect to a position that is contrary to a rule or regulation, disclosure of that position is adequate if the advice includes a statement that-- (A) The position is contrary to a specified rule or regulation and, therefore, is subject to a penalty described in section 6662(c) unless adequately disclosed in the manner provided in Sec. 1.6662-3(c)(2) (which permits disclosure on a properly completed and filed Form 8275 or 8275-R, as appropriate, and which requires adequate identification of any rule or regulation being challenged); and (B) In the case of a position contrary to a regulation, the position must represent a good faith challenge to the validity of the regulation. If the advice with respect to the position is in writing, the statement concerning disclosure also must be in writing. If the advice with respect to the position is oral, advice to the taxpayer concerning the need to disclose also may be oral. The determination as to whether oral advice as to disclosure was in fact given is based on all facts and circumstances. Contemporaneously prepared documentation of the oral advice regarding disclosure generally is sufficient to establish that the advice was given to the taxpayer. (ii) Advice to another preparer. If a nonsigning preparer provides advice to another preparer with respect to a position that is contrary to a rule or regulation, disclosure of that position is considered adequate if the advice includes a statement that disclosure [[Page 525]] under section 6694(b) is required. If the advice with respect to the position is in writing, the statement concerning disclosure also must be in writing. If the advice with respect to the position is oral, advice to the preparer concerning the need to disclose also may be oral. The determination as to whether oral advice as to disclosure was in fact given is based on all facts and circumstances. Contemporaneously prepared documentation of the oral advice regarding disclosure generally is sufficient to establish that the advice was given to the other preparer. (f) Rules or regulations. The term ``rules or regulations'' includes the provisions of the Internal Revenue Code, temporary or final Treasury regulations issued under the Code, and revenue rulings or notices (other than notices of proposed rulemaking) issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. (g) Section 6694(b) penalty reduced by section 6694(a) penalty. The amount of any penalty to which a preparer may be subject under section 6694(b) for a return or claim for refund is $1,000 reduced by any amount assessed and collected against the preparer under section 6694(a) for the same return or claim. (h) Burden of proof. In any proceeding with respect to the penalty imposed by section 6694(b), the Government bears the burden of proof on the issue of whether the preparer willfully attempted to understate the liability for tax. See section 7427. The preparer bears the burden of proof on such other issues as whether-- (1) The preparer recklessly or intentionally disregarded a rule or regulation; (2) A position contrary to a regulation represents a good faith challenge to the validity of the regulation; and (3) Disclosure was adequately made in accordance with paragraph (e) of this section. [T.D. 8382, 56 FR 67518, Dec. 31, 1991]