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New Reality of Transfer Tax Returns

The Internal Revenue Service released Notice 2008-13 on Jan. 2, 2008, to provide interim guidance on the application of tax preparer return penalties put in place by The Small Business and Work Opportunity Act of 2007.

The Internal Revenue Service is not backing away from the new preparer rules. We ignore them at our peril

By Roy M. Adams, partner, Constantine | Cannon Roy M. Adams & Associates PLLC, New York

The Internal Revenue Service released Notice 2008-13 on Jan. 2, 2008, to provide interim guidance on the application of tax preparer return penalties put in place by The Small Business and Work Opportunity Act of 2007. This is the act that swept transfer tax returns into the penalty dragnet.

The interim regs essentially say that tax return preparers must have a reasonable basis for any position taken on a tax return. Preparers may rely on their clients’ information—unless it should have been obvious that the information could be incorrect. If the information on its face appears reasonable, the preparer can rely on it without independent verification.

Sounds good so far, right?

Problem is: these interim regs also say that the return preparer may not ignore the implications of information furnished to him or known to him. Moreover—he must make reasonable inquiries if information furnished by other advisors helping to prepare the return appears to be incorrect or incomplete.

In other words, if you prepare a transfer tax return, expect the IRS to hold you accountable for it.

A tax return preparer is considered not to have acted in good faith if: the advice is unreasonable on its face; the preparer knew or should have known that the third party advisor was unaware of all the facts; or, the tax preparer knew or should have known at the time any claim for refund was filed that the advice was no longer reliable due to developments since the advice was given.

There are penalties for returns that take unreasonable positions. And at first blush those sanctions might not seem harsh. The penalty is $1,000 per return or one half of the preparers fee with respect to the return or any claim for refund—whichever is greater.

So how does this all play out? As usual, one picture is worth 1,000 words:

Say a client marches into your office and shows you an appraisal of his business that he intends to give to his children. He’s asking you to fill out the gift tax return. The appraisal says the business is worth $3 million. But you happen to know (or should know) that the business has 7,000 employees.

You cannot possibly prepare and submit a gift tax return in good faith indicating the business being gifted is worth $3 million. You’d be ignoring the obvious. No business with 7,000 employees can be worth a mere $3 million—unless it had an extraordinarily bad year.

Indeed, if you make the mistake of submitting that return without further investigation, get your checkbook ready to pay the penalty. If your position was merely “unreasonable,“ the penalty is $1,000 per return or half the preparer’s fee. If, however, you willfully or recklessly understated values or took any other position so characterized, then the penalty jumps to $5,000 or half of the preparer’s fee.

“Okay, so what?” you might say. “It’s just $1,000 or half my fee. Maybe it’s $5,000.”

To some, that may not be a lot of money.

But think again.

What if, like most financial planners, accountants, trust officers and lawyers, you prepare hundreds of transfer tax returns? Well, then, I suspect the penalty gets your attention. Fifty non-good faith returns means penalties of at least $50,000.

That's just the penalty as proposed by the interim guidance. The final regs could be much worse. Undoubtedly, there also will be penalties besides the financial ones currently in place. For example, as with Circular 230, the preparer could be banned from submitting returns to the IRS. In other words, you could be put out of business.

Indeed, the proposed regs under Circular 230 (issued Sept. 26, 2007) provide in Section 10.34(a) that a practitioner may not sign a tax return as a preparer unless the practitioner has a reasonable belief that the tax treatment of each position on the return would more likely than not be sustained on its merits or there is a reasonable basis for each position, and each position is adequately disclosed to the IRS.

In addition, the Circular 230 regs would add that “reasonable basis” is a higher standard than the “not frivolous” or “not patently improper” standards. The “reasonable basis” standard is not satisfied by a position that is merely arguable or colorable. The possibility that a tax return will not be audited, that an issue will not be raised on audit or that an issue will be settled may not be taken into account.

Clearly, tax return preparation will never be the same. And the role of estate planners has changed. You now are the watchdogs of your clients’ returns.

The law that brought us this new responsibility had the rather misleading title of the Small Business and Work Opportunity Tax Act of 2007, Title VIII B of H.R. 2206, the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007, P.L. 110-28. (May 25, 2007); Notice 2007-54, 2007-27 I.R.B. 12 (June 11, 2007); clarified by Notice 2008-11, 2008 WL 36922 (Dec. 31, 2007); Notice 2008-13, 2008 WL 36924 (Jan. 2, 2008).

Who would vote against “Small Business and Work Opportunity”? No one, of course. But that title and its sequella say absolutely nothing about the new tax preparer return penalties put into Internal Revenue Code Section 6694 that now affect all our lives.

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