People who charge for preparing tax returns or refund claims can face tax preparer penalties if they fail to perform their duties correctly or engage in illegal behavior. Find out what tax preparer penalties are and how you can avoid them.
Tax preparers can face serious penalties if they are negligent or break tax law. If you earn a living preparing people’s taxes, you must understand what tax preparer penalties are, and being mindful of the tax return preparer penalties you may face for not following the guidelines for preparing returns is crucial. Tax preparers have a duty to uphold tax laws and abide by professional standards.
If you are looking for information on how to reduce or waive tax debt penalties, check our tax relief guide.
The IRS is especially interested in investigating tax preparer fraud because it affects a large number of tax returns. If the IRS were to shut down a single fraudulent tax return preparer, it could prevent hundreds of fraudulent returns from being prepared and filed each tax season.
The good news is that most tax preparers are honest professionals who want to make an honest living by providing high-quality tax services. However, tax preparers can be liable for not IRS and state guidelines, whether intentionally or unintentionally. Keeping in mind the following information should help increase the odds you’ll have a successful tax season without hearing from the IRS.
What tax preparer penalties are there?
Tax preparer penalties are found in Title 26 of the U.S. Code in the Internal Revenue Code (IRC). The table below provides a summary of the main tax preparer penalties.
|Name||Penalty||Internal Revenue Code|
|Understatement due to unreasonable positions||$1,000 or 50% of the income derived by the tax return preparer||IRC § 6694(a)|
|Understatement due to willful or reckless conduct||5,000 or 75% of the income derived by the tax return preparer||IRC § 6694(b)|
|Failure to furnish a copy to the taxpayer||$50 for each failure to comply||IRC § (6695(a)|
|Failure to sign the return||$50 for each failure to sign a return or claim for a refund||IRC § 6695(b)|
|Failure to furnish identifying number||$50 for each failure to comply||IRC § 6695©|
|Failure to retain copy or list||The penalty is $50 for each failure to comply||IRC § (6695(d)|
|Failure to file correct information returns||$50 penalty for each failure||IRC § 6695€|
|Negotiation of check||A per-check penalty of $500, adjusted for inflation, with no maximum limit on the penalty amount||IRC § 6695(f)|
|Failure to be diligent in determining eligibility for certain tax benefits||$530 for each failure on each return||IRC § 6695(g)|
|Promoting abusive tax shelters||$1,000 for each entity or arrangement and participation in each sale or 100% of the income derived||IRC § 6700|
|Aiding and abetting the understatement of tax liability||$1,000 ($10,000 if the conduct relates to a corporation’s tax return)||IRC § 6701|
|Disclosure or use of information by preparers of returns||A maximum penalty of $10,000 in a calendar year. Up to $50,000 if connected to identity fraud||IRC § 6713|
|Action to enjoin tax return preparers||An injunction to stop certain actions or remove as a tax return preparer||IRC § 7407|
|Actions to enjoin specified conduct related to tax shelters and reportable transactions||An injunction to stop a person from engaging in certain forbidden conduct with respect to tax shelters and reportable transactions||IRC § 7408|
Let’s look into each of these tax preparer penalties in a little more detail. But first let’s discuss what a tax preparer is in the eyes of the IRS.
What is a Tax Preparer?
Tax return preparers are individuals who prepare tax returns or refund claims and the companies that hire tax preparers. So, yes, the company that the preparer works for can also be penalized.
The definition of a tax return preparer
Tax law defines a tax return preparer as any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of any return of tax or any claim for refund of tax under the Internal Revenue Code.
Tax preparers include preparers of all types of returns, not just income tax returns. For instance, there are tax preparers that specialize in estate and gift tax returns.
Tax return preparers are compensated for their work
Being compensated is key to defining a tax preparer. Someone just helping their mom do her taxes in TurboTax would not fit the definition of a tax return preparer. This is worth highlighting. Tax returns prepared for free are not subject to penalties.
What does the IRS consider as compensation? Generally, compensation relates to pay received or expected to be received for preparing the return. Payments for consultation, research, and compliance are all considered types of compensation.
You don’t have to be a professional to “qualify” as a tax return preparer
The IRS doesn’t require you to have a professional license or special education to be considered a tax return preparer. You don’t even have to complete an entire tax return to be considered a tax return preparer. Just working on a substantial portion of a tax return, such as a schedule, could “qualify” someone as a tax preparer.
Not all tax return preparers actually sign the tax return
You don’t have to sign a tax return to be considered a tax preparer. Although it is true that tax preparers who sign a tax return on behalf of the tax preparer have primary responsibility, non-signing preparers could also face the same level of responsibility as signing preparers.
A non-signing preparer is a tax preparer who is not a signing tax preparer but prepares all or a substantial portion of a return or claim for a refund. This includes individuals who give advice to either the taxpayer or another tax adviser that leads to a position that amounts to a substantial portion of the return.
Who is NOT a tax return preparer?
- Employees of the IRS who are performing their official duties.
- Those working under the IRS’s Volunteer Income Tax Assistance (VITA) program.
- Volunteers in a Low-Income Taxpayer Clinic.
- Individuals who provide typing, copying, or printing assistance.
- Individuals who prepare a return or refund claim of the employer for whom they are employed.
- Preparers of returns or refund claims when the preparer is either a fiduciary or an officer, general partner, or employee of the fiduciary.
Understatement due to unreasonable positions – IRC § 6694(a)
The penalty is the greater of $1,000 or 50% of the income derived by the tax return preparer with respect to the return or claim for refund.
Understatement due to willful or reckless conduct – IRC § 6694(b)
The penalty is the greater of $5,000 or 75% of the income derived by the tax return preparer with respect to the return or claim for refund.
Failure to furnish a copy to the taxpayer – IRC § (6695(a)
A preparer must provide the taxpayer with a complete copy of their tax return or refund claim no later than the date the return is presented for the taxpayer’s signature. The copy can be in any form that is acceptable to both the taxpayer and the tax preparer. If desired, a preparer can request a receipt or other evidence from the taxpayer that the copy was received. The penalty is $50 for each failure to comply.
Failure to sign return – IRC § 6695(b)
The penalty is $50 for each failure to sign a return or claim for a refund.
Failure to furnish identifying number – IRC § 6695(c)
Any return or claim for refund prepared by a preparer must include the preparer tax identification number (PTIN), the employer’s number, or both. This requirement applies to signing preparers, who must furnish the applicable number on the return or refund claim after completion and before presentation to the taxpayer (or nontaxable entity) for signature. The penalty is $50 for each failure to comply. A preparer who uses his or her Social Security number or an expired PTIN can also be subject to the penalty.
Failure to retain copy or list – IRC § (6695(d)
A signing tax return preparer must retain a completed copy of a taxpayer’s return or claim for refund, or retain, on a list, the taxpayer’s name and identification number, and make the copy or list available for IRS inspection upon request. The copy or list must be retained for a three-year period. The penalty is $50 for each failure to comply.
Failure to file correct information returns – IRC § 6695(e)
For each return period, a person who employs one or more signing preparers must retain a record of the name, PTIN, and principal workplace of each preparer. This record must be retained for the three-year period following the close of the return period to which it relates and must be available for IRS inspection upon request. A sole-proprietorship preparer must retain this record with respect to his or her own work, and a partnership must retain this record with respect to its partners and other employees. Note that the IRS has opted for a recordkeeping requirement in lieu of an actual filing. There is a $50 penalty for each failure to include, retain, and make available a record and for each failure to include a required item.
Negotiation of check – IRC § 6695(f)
An individual tax preparer may not endorse or otherwise negotiate a tax refund check issued to a taxpayer if the individual was the return preparer. A preparer who violates this provision is subject to a per-check penalty of $500, adjusted for inflation, with no maximum limit on the penalty amount. There are exceptions for banks that prepare tax returns and also when the taxpayer authorizes the preparer to affix the taxpayer’s name to a refund check for purposes of depositing the check into the taxpayer’s account.
Failure to be diligent in determining eligibility for certain tax benefits – IRC § 6695(g)
Failure to determine eligibility or the amount for earned income credit and other tax benefits is subject to penalty. The penalty for returns filed in 2020 is $530 for each failure on each return.
Promoting abusive tax shelters, etc. – IRC § 6700
This penalty applies to anyone who organizes or sells abusive tax shelters. If the person makes statements that the person knows or has reason to know are false or fraudulent as to any material matter regarding the tax benefits of the transaction can be penalized 50% of the gross income derived from the activity. If the person provides a gross valuation overstatement, the penalty is $1,000 for each entity or arrangement and participation in each sale (or, if lesser, 100% of the income derived from the activity).
Aiding and abetting the understatement of tax liability – IRC § 6701
The penalty is $1,000 ($10,000 if the conduct relates to a corporation’s tax return) for aiding and abetting in an understatement of tax liability. A violator can be penalized only once for documents relating to the same taxpayer for a single tax period or event.
Disclosure or use of information by preparers of returns – IRC § 6713
The penalty is $250 for each unauthorized disclosure or use of information obtained for, or in connection with, the preparation of a return. The maximum penalty imposed on any person shall not exceed $10,000 in a calendar year. If a disclosure or use is made in connection with a crime relating to the misappropriation of another person’s taxpayer identity, whether or not such crime involves any tax filing, the penalty increases to $1,000 for each use or disclosure, with a maximum of $50,000 per person per calendar year.
Fraud and false statements – IRC § 7206
Those who receive this penalty shall be guilty of a felony and, upon conviction, face a fine of not more than $100,000 ($500,000 in the case of a corporation), imprisonment of not more than three years, or both.
Fraudulent returns, statements or other documents – IRC § 7207
Those who receive this penalty shall be guilty of a misdemeanor and, upon conviction, a fine of not more than $10,000 ($50,000 in the case of a corporation), imprisonment of not more than one year, or both.
Disclosure or use of information by preparers of returns – IRC § 7216
Persons who knowingly or recklessly disclose information furnished in connection with a tax return or using such information for any purpose other than preparing or assisting in the preparation of such return shall be guilty of a misdemeanor. Upon conviction, the penalty includes a fine of not more than $1,000, imprisonment for not more than one year, or both.
Action to enjoin tax return preparers – IRC § 7407
The U.S. government may sue in federal district court to obtain an injunction to stop a tax return preparer from engaging in certain conduct forbidden by this IRC section or to prohibit a person from continuing to act as a tax return preparer altogether.
Actions to enjoin specified conduct related to tax shelters and reportable transactions – IRC § 7408
The U.S. government may sue in federal district court to obtain an injunction to stop a person from engaging in certain forbidden conduct with respect to tax shelters and reportable transactions, including any action or failure to take action.
How to Avoid Tax Preparer Penalties
You can generally avoid tax preparer penalties by preparing tax returns accurately and on time and complying with applicable laws and regulations. Tax preparers have to stay up-to-date with the latest policies and procedures. In gray areas, they need to use their professional judgment to make sure they stay on the right side of the law.
The IRS communicates important information to tax preparers using websites such as irs.gov/tax-professionals, which provides guidelines and links to the latest notices.
The IRS is not the only resource professionals can use to stay informed. The American Institute of CPAs, the world’s largest member association representing the accounting profession, publishes checklists that can be used to help stay in compliance with the IRS. Using professional resources and staying up-to-date with guidelines can help a preparer prove due diligence and good-faith efforts if there are issues along the way.
Do your due diligence
Ultimately, it is the taxpayer who is responsible for providing accurate information in their returns. So, generally, you can assume your client’s statements are accurate. However, you may still need to verify the information and ask follow-up questions.
Don’t turn a blind eye to clear errors or omissions just to give your client a bigger refund. It’s definitely not worth an IRS investigation. Ask the right questions to get the refund they deserve under the tax laws, even if it’s not the refund they want.
Many taxpayers will compare multiple tax preparers to determine which one offers the biggest return or does a “better job” at minimizing their tax debt. This can put a preparer in a tough position because they want to keep their client’s business.
Reasonable cause and good-faith exceptions
Penalties can also be avoided if it can be proven that there was reasonable cause and the preparer acted in good faith. There are some factors that can be used to determine whether the preparer acted in good faith:
- The law in question is complex, uncommon, or highly technical;
- The understatement resulted from an isolated and nonrecurring error;
- The understatement is relatively immaterial;
- Normal and appropriate office practices were followed;
- The tax preparer relied on the advice of others, including information from the taxpayer, and the information was not unreasonable; and/or
- Generally accepted industry practices were followed.
Fortunately, good-faith reliance on information means the preparer is not required to audit, review, examine, or verify information beyond reasonable inquiries unless conflicting facts are known. In addition, tax preparers who use information from a previously filed return do not have to verify information unless there is reason to believe the information is incorrect or incomplete.
Watch out for patterns
The IRS can detect patterns among returns that seem unusual in two different ways. First, if all of your clients have a similar amount of a certain item, that very well could and should raise a red flag.
The other pattern to watch out for is if your returns are outliers among the general population. This could actually be due to legitimate reasons. Most of your clients could be wealthier than the general population. Regardless, if your clients’ returns are consistently and noticeably different than returns in the same area, the IRS may want to take a closer look.
Beware of common red flags
Some tax regulations receive more abuse than others. The Earned Income Tax Credit (EITC) is a frequent target of tax fraud for a number of reasons. One reason for this is that it’s refundable, so even taxpayers who don’t owe anything can receive get a credit. EITC eligibility can also result in a good-sized refund, particularly for those with multiple dependant children.
So it is no surprise that the IRS spends a lot of time and effort looking into EITC fraud. Interestingly though, many taxpayers who are actually eligible for the EITC don’t know about it and don’t claim it.
Familiarize yourself with the EITC eligibility requirements. Those with many lower-income clients, especially, should make the EITC a specialty, both to help their clients get the maximum allowable refund and to avoid a potential problem with the IRS.
While primary responsibility usually lies with one individual, firms may also be responsible for penalties if one of their employees or equity holders commits a punishable act. If a firm employs a tax preparer who is found liable for a penalty, the firm could also be subject to a penalty.
You can avoid tax preparer penalties
Your clients depend on you to manage their tax issues, and you earn that trust through transparency, good customer service, and demonstrating your expertise.
You must also avoid the potential pitfalls that come with preparing your client’s tax returns by practicing due diligence, evaluating any risks, and regularly reviewing IRS tax policies and guidelines. If you do not adhere to the IRS tax rules for preparing returns, you could be liable for fines, penalties, and even jail time.
It is of the utmost importance that preparers be well-informed of the requirements and regulations and exercise care in following them. In addition, preparers must follow best practices and exercise their professional judgment in all aspects. This not only helps ensure that the preparer provides a good work product for their clients but also helps avoid costly penalties and sanctions.