Tax Preparer Penalty: What Penalties Can Tax Preparers Incur?
When someone hires a professional to prepare their taxes, they expect that person to keep their information secure and complete the return correctly. Similarly, when the IRS accepts a return from a professional tax preparer, the agency expects the return to be accurately and competently prepared. If this doesn't happen, the tax preparer may incur penalties.
Wondering what type of penalties you can incur as a tax preparer? Curious if your tax preparer may face a penalty for an error they made on your return? Here is an overview of different types of tax preparer penalties.
Who Is A Tax Preparer?
For the purposes of this penalty, a tax preparer is anyone who prepares a tax return for money. It can also include someone who employs people to prepare tax returns for compensation. In other words, if you charge clients money to complete their tax returns, you are a tax preparer. Similarly, if you run an office full of tax preparers who you pay, you are also considered a tax preparer even if you don't personally prepare any returns.
Penalty for Understatement of Taxpayer’s Liability
Internal Revenue Code 6694 outlines the tax preparer penalties for an understatement of tax liability. If the tax preparer knew or reasonably should have known about the understatement of tax, the penalty is the greater of $1,000 or 50% of the preparer's fee. If willful or reckless conduct is involved, the penalty is the greater of $5,000 or 50% of the preparer's fee.
An understatement of tax liability occurs when the tax return doesn't report all of the taxpayer's income or claims too many deductions. For example, imagine that a client doesn't tell the tax preparer about $50,000 they won in the lottery or $20,000 they earned from side gig. If this income doesn't get reported on the tax return, the income on the return will be lower than it should be, and the tax liability will also be lower or understated.
Or imagine that a taxpayer overstates their business deductions. This also reduces their income on paper and understates their tax liability. However, if the tax preparer can prove that they had reasonable cause for preparing the return with an understatement of tax, they may be able to avoid the penalty.
No Penalty if Reasonable Cause
The tax preparer may not have to pay the penalty if they can prove that there was reasonable cause for the understatement. To assess reasonable cause, the law takes the following elements into account:
- Nature of the error — Whether or not the error was due to a part of the tax code that is very complex and a competent preparer could have easily made the mistake.
- Frequency of the error — Reasonable cause may apply if there is not a pattern of errors unless the error is obvious and material (significant).l
- The materiality of the error — Immaterial errors are not significant unless they are obvious and frequent.
- Office procedures — Does the tax preparer have procedures in place to prevent errors and mistakes on the returns that they prepare?
- Good faith reliance — The tax preparer may have reasonable cause if they reasonably relied on information provided by the client to prepare the return.
- Reliance on generally accepted industry practices — If the tax preparer's actions seem reasonable based on industry standards, they can lean on this element of reasonable cause.
If you are facing a tax preparer penalty, you should seek help from a tax attorney. They can represent you in court and argue that you have reasonable cause or that the penalty should be abated for other reasons.
You don't have to double-check every claim that your clients make when you prepare their returns. But what if your clients give you information and it leads to a gross understatement of tax on their return? It's usually reasonable to rely on their information, but you can't claim reasonable reliance if any of the following apply;
- The information is obviously unreasonable.
- You knew or should have known that the person providing the information didn't know all of the relevant facts.
- You knew the information wasn't reliable due to an update in the law.
No Penalty if No Understatement
There is no preparer penalty if the mistake didn't lead to an understatement of tax. For instance, if the mistake caused the taxpayer to pay more, the preparer should not incur a penalty. In this case, if the preparer pays a penalty and the IRS decides that there wasn't an understatement, the IRS should refund the penalty.
How The Penalty Is Calculated?
Here's an example of how the understatement of tax penalty gets calculated. Imagine that a tax preparer files an income tax return for a client, and they don't report any of the income that the client received from their side business walking dogs. However, the preparer knew about the business because they saw it advertised on social media. The preparer charged the client $500 to complete the return.
In this case, the penalty would be $1,000 or 50% of the preparer's fee. Half of the preparer's fee is $250. Because that amount is smaller than $1,000, the $1,000 penalty applies. In contrast, say that the preparer charged $3000 to file the return. In this case, their penalty would be $1,500 because that's the larger number.
As indicated above, if gross negligence were involved, the penalty is $5,000 or 75% of the preparer's fee. The higher number applies.
Maximum Penalty For Tax Return Preparer
There is no maximum amount for a tax return preparer penalty. Again, depending on whether willful misconduct was involved or not, the fee for an understatement of tax is a minimum of $1,000 or $5,000. However, it can be half of the preparer's fee if that number is higher. Say a tax preparer charges $20,000 to file a return for a corporate client. If they incur a reckless conduct fee, it will be $15,000. That is 75% of their fee.
However, this is not the only penalty. In the following section, you will see a number of small penalties that can climb up to $25,000 or even $50,000 when a preparer incurs multiple penalties.
Other Assessable Tax Preparer Penalties
IRC 6695 outlines other instances where tax preparers can incur penalties. Here is an overview of some of the potential penalties:
- Failing to give the taxpayer a copy of the return — $50 per return and up to $25,000 total.
- Failing to sign a return — $50 per return and up to $25,000 total.
- Failing to put their tax preparer ID number on the return — $50 per return and up to $25,000 total.
- Failing to retain copies of filed returns or the names and tax ID numbers associated with the returns for at least three years — $50 per return or up to $25,000 total.
- Not filing certain informational returns of tax preparers that you pay — $50 per return or up to $25,000 total.
- Signing a client's refund check related to an understatement of tax — $500 per check.
- Failing to diligently check a client's head of household filing status or earned income tax credit (EITC) — $500 each.
You may be able to avoid all of these penalties if you can show reasonable cause and prove that reckless conduct wasn't involved. Note that these fees are subject to adjustment for inflation.
Penalties for Promoting Abusive Tax Shelters
IRC 6700 says that the penalty for organizing or participating in an abusive tax shelter is the lesser of $1,000 or 100% of the income the preparer earned from the activity. This applies per activity. If you make a statement that a deduction or credit based on an abusive tax shelter is allowable, the penalty is 50% of the income you receive.
An abusive tax shelter is an illegal investment that promises to lower the investor's tax liability. Generally, it involves a maze of transactions through several entities that only exist to lower tax liabilities. If you know about an abusive tax shelter, you can report it to the IRS by emailing [email protected]
Penalties for Aiding and Abetting Understatement of Tax Liability
According to IRC 6701, the penalty for aiding or abetting the understatement of a tax liability is $1,000 in general or $10,000 if related to a corporate tax liability. You don't have to personally prepare the return to incur this penalty.
It can also apply if you tell a subordinate to file a tax return with an understated liability. Similarly, the penalty can apply if you know that a subordinate is filing a return with an understated tax liability and you don't stop them. You cannot incur this penalty if you just type or copy a return.
If you incur this penalty, you cannot also face a penalty for promoting an abusive tax shelter or unreasonable position of understating a taxpayer's liability for the same return.
Disclosure or Use of Information by Preparers of Returns
IRC 6713 says that if a tax preparer discloses information they receive to do a tax return, the penalty is $250 per disclosure and up to $10,000 per year. However, this fee is a lot higher if the disclosed information is used to commit identity theft. In that case, the fine is $1,000 for disclosure or up to $50,000 per year.
Fraud and False Statements
Fraud and false statements under US Code 7206 are felonies. The fine can be up to $100,000 ($500,000 for a corporation) and up to three years in prison. This includes the following actions:
- Signing a return under penalties of perjury when you know it is materially incorrect.
- Aiding, assisting, or advising the preparation of a return or document that is materially fraudulent or false.
- Falsely or fraudulently executing a bond, permit, entry, or other document required by internal revenue laws.
- Removing or hiding goods on which a tax should be imposed with the intent to evade a tax assessment.
- Hiding property upon which a levy is authorized with intent to deter the collection of tax.
- Concealing property or withholding or falsifying records related to an offer in compromise application.
Fraudulent Returns, Statements, or Other Documents
IRC 7207 says that if you deliver or disclose a list, return, statement, or document that you know to be false, you will face a fine of $10,000 and up to one year in prison. The penalty is up to $50,000 for a corporation.
Disclosure or Use of Information by Preparers of Returns
Under IRC 7216, if you recklessly use or disclose client information for something other than preparing a tax return, it is a misdemeanor. The maximum penalty is a fine of up to $1,000 and up to one year in prison.
Action to enjoin tax return preparers
According to IRC 7407, the United States can bring a civil action against a tax preparer to prevent them from acting as a tax preparer if the following apply:
- The tax preparer incurred a penalty under section 6694 or 6695.
- The tax preparer misrepresented their eligibility to practice before Internal Revenue Service or misrepresented their experience or education.
- The tax preparer guaranteed the allowance of a tax credit or payment of a refund.
- The tax preparer engaged in fraudulent or deceptive conduct to interfere with the administration of the Internal Revenue laws.
Under section 7408 of the IRC, the courts can also ban a tax preparer if they participate in a tax shelter or violate section 330 or title 31. The rules of section 330 state that anyone who practices before the Department of the Treasury must be of good character, have the right qualifications, and be competent.
FAQs About Tax Preparer Penalties
People have a lot of questions about tax preparer penalties. Here are answers to some of the most common questions.
What are IRS preparer penalties?
These are penalties that the IRS imposes on tax preparers. There are a range of different penalties for everything from failing to give a client a copy of their return to making reckless mistakes that understate the tax due on the return. There are also penalties for disclosing a client's information or using it to commit identity theft.
How much is the IRS fine for a tax preparer who has made a mistake filing a client's taxes, caused by a lack of due diligence?
If the lack of due diligence was related to a head of household filing status or an EITC claim, the fine is $500 each. If the lack of due diligence leads to an understatement of tax, it's $1000 or 50% of the preparer's fee. If reckless behavior was involved, the fine is $5000 or 75% of the taxpayer's fee.
Are tax preparers liable for mistakes?
Yes, tax preparers are civilly and criminally liable for mistakes unless they can prove that there was reasonable cause, no understatement of tax was involved, or they reasonably relied on information from the taxpayer. However, the tax preparer is not liable for the taxpayer's liability. For instance, if a taxpayer gets a tax assessment because their preparer understated their income, the taxpayer is liable for the assessment, not the tax preparer.
What is the penalty for a tax preparer not signing a return?
If a tax preparer doesn't sign a return, they can incur a penalty of $50 per return and up to $25,000 per year.
Have additional questions about tax preparer penalties? Want to talk with a tax attorney about a penalty? Need help dealing with a tax preparer? Then, use TaxCure to search for a tax pro today.