2.3 Tax Return Preparer Identification and Penalties

2.3 Tax Return Preparer Identification and Penalties

Circular 230 tells a CPA how to practice before the IRS. The Internal Revenue Code tells a CPA when the person is a tax return preparer and what assessable penalties attach to that status. REG Blueprint I.A.2 asks candidates to recall who is a preparer, recall situations that produce preparer penalties, and apply those penalties to a fact pattern. These penalties run against the preparer. Taxpayer accuracy-related, failure-to-file, and failure-to-pay penalties are a different regime and belong in the taxpayer-penalty chapter, not here.

Who is a tax return preparer

IRC §7701(a)(36)(A) defines a tax return preparer as any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed by the Code or any claim for refund of tax imposed by the Code. Preparation of a substantial portion of a return or claim is treated as preparation of the return or claim. Treas. Reg. §301.7701-15 implements the definition and splits preparers into two operational roles:

• Signing tax return preparer: the individual who has primary responsibility for the overall substantive accuracy of the preparation of the return or claim. This is the person who signs as paid preparer.
• Nonsigning tax return preparer: a preparer other than the signing preparer. A person who gives tax advice on a position directly relevant to an entry on a return is treated as having prepared that entry. Whether a schedule, entry, or other portion is a substantial portion depends on whether the person knows or reasonably should know that the tax attributable to that portion is a substantial portion of the tax required to be shown. A single entry can be a substantial portion. A de minimis rule can take a nonsigning advisor out of preparer status; it does not protect a signing preparer.

§7701(a)(36)(B) exceptions — a person is not a preparer merely because the person:

• furnishes typing, reproducing, or other mechanical assistance;
• prepares a return or claim of the employer (or of an officer or employee of the employer) by whom the person is regularly and continuously employed;
• prepares as a fiduciary a return or claim for any person; or
• prepares a claim for refund in response to a notice of deficiency or after an audit has begun in the circumstances the statute describes.

Compensation is the hinge. Completing a neighbor’s return as an unpaid favor does not make the helper a §7701(a)(36) preparer. Accepting $200, a percentage of a refund, or a bartered equivalent does. A firm that employs preparers is itself a preparer and can face penalties as an employer of preparers.

PTIN, signing, and identification

IRC §6109 and the regulations require a tax return preparer to furnish an identifying number on returns and claims the preparer is required to sign. For paid preparers that number is a Preparer Tax Identification Number (PTIN), not the preparer’s Social Security number. Circular 230 §10.8 provides that any individual who for compensation prepares or assists with the preparation of all or substantially all of a tax return or claim for refund must have a PTIN (or other prescribed identifying number). Willfully preparing all or substantially all of, or signing, a return without a current PTIN is disreputable conduct under Circular 230 §10.51(a)(17).

The signing preparer signs the return in the paid-preparer section, enters the PTIN, and, where required, the employer’s EIN and firm information. A nonsigning preparer who prepared a substantial portion does not sign, but remains a preparer for §6694 purposes if the definition is otherwise met. Both signing and nonsigning preparers can be the person primarily responsible for a position.

IRC §6107 requires the preparer to furnish a completed copy of the return or claim to the taxpayer, and to retain a copy or a list of taxpayers and identification numbers for the period prescribed by regulations (generally three years). Those duties are enforced through §6695, not through §6694.

IRC §6694(a): unreasonable position

§6694(a) applies if a tax return preparer prepares a return or claim with respect to which any part of an understatement of liability is due to a position described in §6694(a)(2), and the preparer knew (or reasonably should have known) of the position. The penalty for each such return or claim, under the current Code text, is the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim. Those dollar and percentage figures are statutory. REG will give the fee in the stem; compute the greater-of amount rather than reciting a memorized flat fine.

Unreasonable position (§6694(a)(2)):

§6694(a)(3) provides a reasonable cause and good faith exception: no (a) penalty if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith. Disclosure does not convert a merely arguable, no-reasonable-basis position into a protected one. For a non-shelter position, the REG decision tree is: substantial authority, or reasonable basis plus adequate disclosure; otherwise, if the preparer knew or should have known of the position, compute greater of $1,000 or 50 percent of the fee.

Position on the return
        |
        +-- tax shelter / §6662A reportable --> need more-likely-than-not
        |
        +-- disclosed (and not shelter) -------> need reasonable basis
        |
        +-- ordinary, undisclosed -------------> need substantial authority
                    |
                    +-- if standard missed and preparer knew/should have known
                    |     --> §6694(a): greater of $1,000 or 50% of income derived
                    +-- if willful understatement or reckless/intentional disregard
                          --> §6694(b): greater of $5,000 or 75% of income derived

IRC §6694(b): willful or reckless conduct

§6694(b) applies if any part of an understatement is due to (A) a willful attempt in any manner to understate the liability for tax on the return or claim, or (B) a reckless or intentional disregard of rules or regulations. The penalty, under the current Code text (as amended in 2015), is the greater of $5,000, or 75 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim. §6694(b)(3) reduces the (b) penalty by the amount of any (a) penalty paid by the same person on the same return, so the IRS does not stack the two full amounts.

Willful omission of gross receipts the preparer saw on a Form 1099, instructing a client to omit cash wages, or intentionally ignoring a regulation the preparer has read, is (b) conduct. An aggressive but disclosed position taken in good faith after research is analyzed under (a), not (b). Income derived is the preparer’s compensation for that return or claim, not the taxpayer’s refund and not the firm’s annual billings to other clients.

Numeric illustration. Signing fee $4,000. Willful omission of $80,000 of gross receipts. Seventy-five percent of $4,000 is $3,000. Greater of $5,000 or $3,000 is $5,000. If the same fee supported only a §6694(a) unreasonable undisclosed position, greater of $1,000 or 50 percent of $4,000 ($2,000) is $2,000.

§6694(c) allows a preparer who, within 30 days of notice and demand, pays at least 15 percent of the (a) or (b) penalty and files a refund claim to stay levy and court collection until a specified district-court proceeding is resolved. §6694(d) abates the penalty if there is a final determination that the taxpayer’s liability was not understated. Understatement of liability (§6694(e)) means any understatement of the net amount payable, or overstatement of the net amount creditable or refundable, determined without regard to later administrative or judicial action involving the taxpayer except as provided in (d).

IRC §6695 procedural penalties, due diligence, and disclosure

§6695 imposes separate assessable penalties for process failures. The Code states dollar amounts ($50 for most of (a)–(e); $500 for (g) due diligence) and calendar-year caps (generally $25,000 for several of the $50 penalties), and §6695(h) indexes those figures for inflation for returns and claims filed in calendar years beginning after 2014. REG does not require reciting the current inflation-adjusted dollars; it does require knowing which failure is being tested and that reasonable cause (not willful neglect) can excuse several of the $50-style failures.

High-level map:

• §6695(a): failure to furnish a copy of the return or claim to the taxpayer (§6107(a)).
• §6695(b): failure of a signing preparer to sign the return or claim.
• §6695(c): failure to furnish the preparer’s identifying number (PTIN).
• §6695(d): failure to retain a copy or a list of returns prepared.
• §6695(e): failure to file correct information returns about preparers employed.
• §6695(f): negotiation of a taxpayer’s refund check (related also to Circular 230 §10.31, which forbids endorsing or negotiating a government check issued to a client in respect of a federal tax liability).
• §6695(g): failure to comply with due-diligence regulations for determining eligibility for specified benefits, including the earned income credit, child tax credit/additional child tax credit/other dependent credit, American opportunity credit, and head-of-household filing status. In practice this is the Form 8867 Paid Preparer’s Due Diligence Checklist, knowledge of the facts, and retention of contemporaneous records. The (g) penalty is per failure (and can apply more than once on a single return if multiple credits are mishandled).

Unauthorized disclosure: §§6713 and 7216

A paid preparer who uses or discloses tax return information other than as the Code and regulations allow faces a civil penalty under IRC §6713 (statutory $250 per disclosure or use, with a calendar-year cap stated in the statute) and, for knowing or reckless unauthorized disclosure or use, a criminal misdemeanor under IRC §7216 (statutory fine of not more than $1,000, imprisonment of not more than one year, or both, plus costs of prosecution). Permitted uses include preparing the return, obtaining the taxpayer’s consent in the form the regulations prescribe, and disclosures required by a court order. Using a client list harvested from returns to market a non-tax product without compliant consent is the classic violation. Circular 230 §10.51(a)(15) independently treats willful unauthorized use or disclosure as disreputable conduct.

Preparer penalties versus taxpayer penalties

Do not mix the two stacks. §6694 and §6695 assess against the preparer. The taxpayer’s own accuracy-related penalty (§6662), civil fraud penalty (§6663), failure-to-file and failure-to-pay additions (§6651), and estimated-tax penalty live in a later chapter. A single bad return can produce both a preparer §6694(a) penalty and a taxpayer §6662 penalty; one does not offset the other. Representation after a notice of proposed deficiency is a procedure issue, not a preparer-identification issue; continue that thread in /study-guides/cpa-reg/tax-procedure/audits-appeals-judicial.

AICPA Statements on Standards for Tax Services

Circular 230 and the Code are not the only rules that bind a CPA in tax practice. The AICPA Statements on Standards for Tax Services (SSTSs) are the enforceable tax practice standards for AICPA members. Revised SSTSs Nos. 1–4, adopted by the Tax Executive Committee and effective January 1, 2024, reorganize the prior statements by type of tax work and add standards on data protection, reliance on tools, and representation of tax clients before taxing authorities. REG does not require quotation of SSTS text. What it does require is the hierarchy:

• State board / CPA license — legal authority to hold oneself out as a CPA.
• Circular 230 — duties and sanctions for practice before the IRS, applicable to CPAs as practitioners.
• IRC §§6694, 6695, 6713, 7216 — assessable and criminal preparer provisions, applicable because of preparer status, not because of AICPA membership.
• SSTSs — professional standards that bind AICPA members in tax services, in addition to Circular 230 and the Code. A CPA who is an AICPA member can violate the SSTSs (and face AICPA ethics enforcement) even when OPR has not opened a Circular 230 case.

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