LEGAL THOUGHTS – Failure to Comply-Potential Consequences for Paid Tax Return Preparers and their Customers
COLEMAN JACKSON, ATTORNEY & LEGAL COUNSEL | Transcription of Legal Thoughts
Posted on July 17, 2024
Topic: Tax Return Preparer Due Diligence
- Welcome to Legal Thoughts my name is Coleman Jackson, and I am an attorney at Coleman Jackson, P.C., a taxation, contracts, litigation and immigration law firm based in Dallas, Texas.
- In addition to myself, we have Legal Assistant, Leiliane Godeiro, Law Clerks, Ayesha Jain and Mlaah Singh, and Administrative Assistant, Michelle Gutierrez.
- On today’s “Legal Thoughts” podcast, our Law Clerk, Mlaah Singh, will continue interviewing me in a new Legal Thoughts podcast series that we have entitled : “Tax Return Preparer Due Diligence and Preparer Penalties. ” This is episode three in this series of Legal Thoughts podcasts. We urge our audience to follow our podcast and invite all their neighbors, friends and acquaintances to please tune in to this series of Legal Thoughts Podcasts on Apple Podcast, Google Podcast, Spotify or wherever you listen to podcasts.
- The intended five episodes in our Tax Return Preparer Penalty Case Series are as follows:
- Attorney’s Key Take Aways
- Navigating Due Diligence Requirements by Paid Tax Return Preparers
- Failure to Comply – Potential Consequences for Paid Tax Return Preparers and the Taxpayers
- Managing IRS Due Diligence Investigations
- Strategies for Compliance and Risk Mitigation
Interviewer Introduction:
Hi everyone, my name is Mlaah Singh and I am a Law Clerk at the tax, business structuring, contracts, litigation and immigration law firm of Coleman Jackson, Professional Corporation. Our law firm is located at 6060 North Central Expressway, Suite 620, right here in Dallas, Texas, 75206. Our English phone number is 214-599-0431 and our dedicated Spanish language line is 214-599-0432.
- Good afternoon Attorney; thank you for allowing me to interview you once again for Episode 3 of our Paid Tax Return Preparer Diligence Requirements and this apparent uptick in IRS examinations and investigations of Paid Tax Return Preparers. Today, I hope to ask a couple of questions designed to navigate our way through these tax preparation procedures or requirements and potential consequences for tax preparers and their customers (the taxpayers).
Interviewer Question No 1: What are the potential penalties and consequences for paid tax return preparers who fail to comply with IRS due diligence requirements?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 1
Comment: Good morning Mlaah.
Attorney’s Answer: Your question gets right to the heart of the matter— how much is it going to cost a paid tax return preparer if they get this wrong.
Let me start by restating your question; which is an excellent one: “What are the potential penalties and consequences for paid tax return preparers who fail to comply with IRS due diligence requirements?”
- First of all, the Internal Revenue Code at Section 7701(a)(36) defines the term “paid tax 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 26 United States Code. So lets first make it clear who we are talking about here. We are not talking about self-filers or taxpayers preparing their own returns with one of the tax software programs widely on the market today.
- With that out of the way. Paid tax preparers are subject to essentially three types of penalties:
- Internal Revenue Code Section 6695(a) imposes several due diligence requirements on paid preparers with respect to the determination of the taxpayer’s eligibility to take certain federal tax positions, such as, the Earned Income Tax Credit, Head of Household Filing Status, Child Tax Credit and a couple of other tax positions I discussed in detailed in Episode 1 and 2 of this Series of Podcast. Paid preparer is subject to an inflation-adjusted penalty in the amount of $635 for 2024 for each violation; which means that their could be multiple $635 penalties assessed on a single tax return. The penalty was $600 for 2023 and $560 for 2022. So the potential penalties and consequences could be 10,000 and even 100,000 of thousands of dollars. It is not uncommon to see return preparers being assessed these gigantic due diligence penalties.
- In addition, Internal Revenue Code Sections 6694(a) and (b) permits the Internal Revenue Service to assess penalties against paid preparers for the understatement of a tax liability due to unreasonable tax positions. These penalties are based on a percentage of the understatement and can run as high as 75% of the understatement of tax liability.
I am limiting this discussion to the civil penalties; but, I want to remind everyone that the Internal Revenue Code is also a criminal tax statute where intentional violation of the Internal Revenue Code could lead paid return preparer and customer being investigated by the Criminal Investigation Division of the IRS for potential criminal prosecution.
INTERVIEWER: Mlaah Singh, Tax Law Clerk
Interviewer Comment:
- Interviewer Comments: Thank you for outlining the potential penalties and consequences for paid tax preparers who fail to comply with IRS due diligence requirements. It’s clear these implications are significant and can escalate quickly, especially with the inflation-adjusted penalties you mentioned.
Interviewer Question No 2: Can you explain how a paid tax return preparer’s failure to comply with due diligence requirements might impact their clients? What would happen if even a clients hired tax return preparer does something incorrectly?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 2
Oh, I kind of touched on the implications briefly in passing just now with potential criminal tax investigation by CI. The taxpayer could obviously get caught up in CI’s investigating paid preparers. Taxpayers must do their due diligence when choosing their paid tax preparer because taxpayers are responsible for the accuracy of their annual tax returns or refund claims.
As for implications on the taxpayer when their paid preparer runs afoul of the paid preparer due diligence requirements—
- When a paid preparer is being examined in a Paid Preparer Due Diligence Exam, most, if not all of the returns prepared during the exam period will likely be audited for accuracy and entitlement to claim the tax positions. So the taxpayer is likely to be audited. The Taxpayer is likely to incur a tax adjustment if the IRS examiner finds errors; therefore the taxpayer may have to pay more taxes, penalties and interest due to actions of their paid preparer.
- Erroneous tax positions could lead a taxpayer from being banned from claiming certain credits in the future, even though, they may otherwise qualify for the tax position in the future. For example, Internal Revenue Code Section 32(k)(1) (A) has two disallowance periods:
- Taxpayers who claimed these earned income tax credit is banned from claiming the EITC for two subsequent tax periods if the IRS examiner determines that the taxpayer’s EITC claim is due to reckless or intentional disregard of the federal income tax laws; and
- Taxpayers who claimed the earned income tax credit is banned form claiming the EITC for ten subsequent tax periods if the IRS examiner determines that the taxpayer’s EITC claim is due to fraud.
Note that very similar bans apply when taxpayers erroneously claims the Child Tax Credit, Additional Child Tax Credit and the Other Dependent Credits. Word to the wise: Paid tax return preparers must strictly comply with the eligibility and computational rules governing all of the tax positions on Form 8867, Paid Preparer’s Due Diligence Checklist because not only are they subject to huge preparer penalties as I discussed in the previous question but the taxpayer could be banned from taking perfectly legitimate tax positions but for the errors or omissions of their paid preparer. There may be other consequences to the taxpayer as well, such as, credit damage, tax liens, lost of job due to IRS Collections.
INTERVIEWER:Mlaah Singh, Tax Law Clerk
Interviewer Comment:
- Interviewer Comment: Moreover, the prospect of being barred from claiming certain credits for extended periods due to preparer errors highlights the long-term consequences that taxpayers may face. This not only impacts immediate financial obligations but also limits future tax benefits that the taxpayer may otherwise be entitled to.
Interviewer Question No 3: What specific actions or omissions by paid tax return preparers are most likely to result in penalties for non-compliance? What are common mistakes made by taxpayers?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 3
Let me take your second question first. Taxpayer’s make mistakes when they fail to wisely select their paid tax preparer. Often time that unwise selection decision is followed by failing to review their return before its filed with the IRS. The third big mistake I have seen them make over the years is either go right back to the paid return preparer upon receipt of the IRS proposed adjustment notice or quite often ignoring the IRS letter all together which is generally disastrous because IRS letter typically have certain deadlines to take actions to challenge the liability.
Let me now turn to your first question: What specific actions or omissions by paid tax return preparers are most likely to result in penalties for non-compliance? Let me keep this general; I am not going to discuss any specific cases:
- Failure to obtain and preserve contemporaneous documentation.
- Failure to make proper inquiry in situations where a seasoned well-informed paid preparer would have sought additional facts.
- Failure to know the facts with regards to business taxpayers. Schedule C examinations of self-employed taxpayers is a huge part of paid preparer due diligence examinations and often times paid preparers has failed to ascertain the facts with respect to income and deduction items on the return.
- Failure to keep organized business records. The Internal Revenue Code requires that paid preparers keep a copy of Form 8867, Paid Preparer Due Diligence Checklist and the contemporaneous records for each taxpayer for three years.
- Failure to properly compute the credits based on the facts. Sometimes it appears paid preparers make lots of assumptions about how well they personally know the taxpayer without actually obtaining objective facts.
These are a few basic actions or omissions that I can think of right now that I have seen in Paid Preparer Due Diligence Examinations. Paid preparers have to (1) obtain the facts at the time they are preparing the return, (2) accurately complete Form 8867, (3) accurately compute the credits, and (4) maintain Form 8867 and the contemporaneous records for three years
INTERVIEWER:Mlaah Singh, Tax Law Clerk
Interviewer Comment:
- Interviewer Comment: Thank you, Mr. Jackson. These guidelines not only uphold professional standards but also safeguard taxpayers’ interests by ensuring accurate reporting. By emphasizing the importance of obtaining and verifying factual information during preparation, paid preparers play a pivotal role in maintaining the integrity of tax filings and minimizing the risk of penalties due to non-compliance.
Interviewer Question No 4: What steps can paid tax return preparers take to ensure they are meeting all due diligence requirements and avoid potential penalties?
Interviewee: Coleman Jackson, Lawyer
ATTORNEY ANSWER – QUESTION 4
- Paid preparers have to (1) obtain the facts at the time they are preparing the return, (2) accurately complete Form 8867, (3) accurately compute the credits, and (4) maintain Form 8867 and the contemporaneous records for three years
- Finally, Paid preparer’s must annually complete federal tax courses from a credible continuing education provider to ensure they are up to date on federal tax law. Most CPE providers offer a comprehensive Form 1040 course with annual updates. Likewise CPE providers provide courses on Partnership taxation, corporate taxation, trust and estate taxation and many more tax topics. Bottom line, paid tax preparers must keep themselves knowledgeable to competently prepare their customers tax returns each year.
- And if they receive that knock on their door.. The IRS Examiner seeking to perform a Paid Preparer Due Diligence Investigation- they should seek help because the consequences for them and their customers are extremely high.
INTERVIEWER WRAP-UP: MlaahSingh, Tax Law Clerk
Attorney, thank you for sitting with me today in our second podcast on this very important topic: “Tax Return Preparer Due Diligence Requirements & IRS Paid Preparer Penalty Cases” I surely hope our audience will benefit from this Legal Thoughts series on tax preparer due diligence requirements and due diligence penalty cases. Attorney in this Episode you have clearly explained how regular, hardworking, innocent taxpayers can also suffer grave financial lost when they erroneously claim credits or take tax positions for which they are not entitled. Thanks Attorney for navigating us through this! Folks, stay tune for upcoming Legal Thoughts Podcasts on this important federal tax topic! We intend to publish Episode three in this series of podcast in about two weeks.
Our audience can send us inquires at www.cjacksonlaw.com if they have questions or wish to comment on our podcasts in this series or any of our Legal Thoughts podcasts, blogs, or Law Watch Videos posted on our U-tube Channel. You can send an email directly to attorney at cj@cjacksonlaw.com and suggest other tax topics that you want us to discuss in future Legal Thoughts Podcast. We are open to your ideas for topics in tax and business law.
Our listeners who want to hear more podcasts like this one please subscribe to our Legal Thoughts Podcast on Apple Podcast, Google Podcast, Spotify or wherever you listen to your podcast. Everybody take care! And come back in about two weeks, for more taxation, business structuring, contracts litigation and immigration Legal Thoughts from Coleman Jackson, P.C., located right here in Dallas, Texas at 6060 North Central Expressway, Suite 620, Dallas, Texas 75206.
English callers: 214-599-0431 | Spanish callers: 214-599-0432 |Portuguese callers: 214-272-3100
ATTORNEY’S CLOSING REMARKS:
This is the end of “LEGAL THOUGHTS” for now
- By the way, another important topic our law firm has been talking about since last year is this one: All our small business owners must listen to our earlier podcasts on the Corporate Transparency Act’s Beneficial Ownership Information Reporting Requirements because the Initial BOI reports are due on or before January 1, 2025 for most small and medium sized businesses structured under any State Business Structuring Laws. Such as, Limited Liability Companies, Corporations and so forth. These initial BOI reports are required to be filed with the Financial Crimes Enforcement Network by January 1, 2025. Small Business Owners and those who substantially control them must educate themselves and comply with the CTA because the penalties are up to $500 per day and up to 2 years in federal prison upon conviction for willful failure to comply with this new federal law.
Until next time, take care.
If you want to see or hear more taxation, business structuring and contracts litigation and immigration LEGAL THOUGHTS from Coleman Jackson, P.C. Subscribe to our Legal Thoughts Podcast on Apple Podcast, Google Podcast, Spotify or wherever you listen to your podcast. Stay tuned! We are here in Dallas, Texas and want to inform, educate and encourage our communities on topics dealing with taxation, litigation and immigration. Until next time, take care.