These two sections of the Internal Revenue Code apply to every paid tax return preparer, regardless of credentials. If you’re preparing returns for compensation, these are the rules that can cost you money.
IRC Section 6694: Understatement Penalties
Section 6694(a) applies when a return contains an understatement of tax liability due to an unreasonable position. If the position doesn’t have substantial authority (for undisclosed positions) or a reasonable basis (for disclosed positions), and you knew or should have known about it, the penalty is the greater of $1,000 or 50% of your fee for that return.
Section 6694(b) applies when the understatement is due to willful or reckless conduct. The penalty jumps to the greater of $5,000 or 75% of your fee. “Willful” means you knew it was wrong. “Reckless” means you didn’t bother to find out whether it was right.
IRC Section 6695: Administrative Penalties
Section 6695 covers a list of procedural failures, each carrying a $50 per-return penalty (capped at $27,000 per year per category):
Failure to give the client a copy of the return. Failure to sign the return. Failure to include your PTIN on the return. Failure to retain a copy or maintain a record of the taxpayer’s information. Failure to file correct information returns.
The per-return amounts seem small. They add up fast if you’re sloppy with procedures.
The Big One: Due Diligence Under 6695(g)
If you claim the Earned Income Credit, Child Tax Credit, American Opportunity Credit, or Head of Household filing status without completing the required due diligence (Form 8867), the penalty is $600 per failure per return. A return with three of those credits and no due diligence documentation is an $1,800 penalty on a single return.
How to Avoid Them
Get trained properly before you prepare your first return. Sign every return and include your PTIN. Give every client a copy. Retain your files. Complete Form 8867 every time you claim a covered credit or filing status. Document your reasoning when you take a judgment call. And don’t sign a return you’re not comfortable with.
For training that covers the legal framework behind every return you’ll prepare, visit musespring.com.