4.23.17  Preparer Penalty Procedures for SB/SE Employment Tax

Manual Transmittal

September 13, 2013

Purpose

(1) This transmits revised IRM 4.23.17, Employment Tax, Preparer Penalty Procedures for SB/SE Employment Tax.

Background

Updates are made to the section for procedural and technical changes.

Material Changes

(1) Editorial and technical changes have been made throughout this Section.

(2) IRM 4.23.17.2(1). Clarified IRC 6694(a).

(3) IRM 4.23.17.3(1). Clarified the examiner's responsibility to ensure that the preparer followed all applicable Code provisions.

(4) IRM 4.23.17.3(4). Added instructions for both SB/SE and IMS case users for documenting preparer penalty comments.

(5) 4.23.17.4(1). Revised as Form 6459 is obsolete.

(6) 4.23.17.4.1. Revised to reflect that the SB/SE Employment Tax Policy Analyst for return preparers is responsible for RPC duties.

(7) IRM 4.23.17.4.2(2). Removed Note referencing TE/GE, as these procedures are SB/SE only.

(8) IRM 4.23.17.4.3(3). Cross-references provided for statute control procedures.

(9) IRM 4.23.17.5.1(2). Removed the requirement to stamp the Form 4318-ET as a no-change.

(10) IRM 4.23.17.5.3(2). Removed entire paragraph referencing obsolete Form 5838. Renumbered following paragraphs.

(11) IRM 4.23.17.5.3(6). Added that the RPC will update ERCS to Status “51” and forward the case to CCP after review.

(12) IRM 4.23.17.5.4(1). Removed reference to obsolete Form 5838.

(13) IRM 4.23.17.5.4(2). Clarified unagreed closing procedure.

Effect on Other Documents

This material supersedes IRM 4.23.17, dated February 26, 2010.

Audience

This section contains instructions and guidelines for SB/SE employees when dealing with employment tax return preparer issues.

Effective Date

(09-13-2013)

John H. Imhoff, Jr.
Director, Specialty Programs
Small Business / Self-Employed Division

4.23.17.1  (02-26-2010)
Introduction

  1. The purpose of this IRM section is to provide procedures for SB/SE employment tax examiners for opening preparer penalty cases and assessing preparer penalties under IRC 6694 and IRC 6695. It also provides procedures for SB/SE employment tax examiners for initiating a Program Action Case (PAC).

  2. Prior to May 25, 2007, preparer penalties under IRC 6694 and IRC 6695 were not applicable to employment tax returns. They were applicable only to preparers of income tax returns. The Small Business and Work Opportunity Tax Act (SBWOTA) of 2007 amended IRC 6694 and IRC 6695 to include any tax return preparer. Preparer penalties became applicable to employment tax returns filed on or after May 25, 2007.

4.23.17.2  (09-13-2013)
Law

  1. IRC 6694 provides, in part, for penalties against tax return preparers due to an understatement of a taxpayer’s liability by a tax return preparer. IRC 6694(a) imposes a penalty on any tax return preparer who prepares a return or claim for refund with respect to which any part of an understatement of liability is due to an unreasonable position and the preparer knew (or reasonably should have known) of the position. This penalty applies with respect to each return or claim for refund.

  2. IRC 6694(b) provides for increased penalties where the understatement was due to willful or reckless conduct of the tax return preparer.

  3. IRC 6695 provides for various other assessable penalties with respect to the preparation of tax returns for other persons.

4.23.17.3  (09-13-2013)
Procedures During Employment Tax Audit

  1. The purpose of asserting penalties on return preparers is to increase compliance. When examining a return prepared by a tax return preparer, it is an examiner’s responsibility to ensure that the preparer followed all applicable Code provisions. If the provisions were not followed, it is the examiner’s responsibility to assert the penalties.

  2. During all field and office examinations, a determination will be made as to whether the facts and circumstances of the examination give rise to the development of a penalty issue. This determination will be made based on oral testimony and/or written evidence obtained during the examination process. Examiners are required to comment on preparer penalties on all cases examined.

  3. A preparer penalty case is separate and distinct from the employment tax examination of the preparer’s client. A preparer penalty case can be started based on the examination of one client or the result of a preparer project.

  4. Examiners are required to consider preparer penalties on all employment tax examinations, if applicable. For SB/SE, the necessary comments for preparer penalties must be recorded on the Lead Sheet 300, Penalty Approval Form – Employment Tax Case. For cases established in IMS, the primary team coordinator will create the IMS case using cycle type "Regular."

4.23.17.3.1  (02-26-2010)
Disclosure Issues

  1. A preparer penalty case is an individual Federal tax matter of the preparer. As with any individual tax matter, an examiner may disclose return information only to that individual, in accordance with IRC 6103(e)(1)(A)(i), or to the preparer’s attorney in fact, or duly authorized power of attorney, as permitted by IRC 6103(e)(6).

  2. Penalty files may include copies of tax returns or portions of tax returns prepared by the preparer who is being considered for the penalty. The penalty files may also include other information taken from examination administrative files, including workpapers and transcripts of taxpayers’ accounts whose returns were prepared by the preparer, as well as information received directly from the preparer.

  3. Information taken from the returns or copies of returns prepared by the preparer, and information from the examination files related to such returns, may be incorporated into the preparer's penalty file. Such information may be disclosed to the preparer or authorized power of attorney if the information relates to the resolution of the penalty issue (IRC 6103 (h)(4)). These disclosures may be made by the examiner during the course of the penalty determination or subsequent tax administration activity. Remember that an examiner may disclose information about the prepared returns because that information relates to the penalty determination, not because the preparer prepared the return or may have had a power of attorney to represent the taxpayer.

  4. Other information in the penalty file that does not relate to the penalty determination, such as the taxpayer’s current address or current employer, may not be disclosed to the preparer or the preparer's authorized power of attorney. If the file includes information that would seriously impair Federal tax administration if disclosed, that information must be withheld by the examiner’s manager in accordance with the manager’s authority to withhold information in accordance with IRC 6103(e)(7). Delegation Order 11-2, Authority to Permit Disclosure of Tax Information and to Permit Testimony or the Production of Documents, contains the specific delegation of authority. See IRM 1.2.49, Communications, Liaison, and Disclosure Activities.

4.23.17.3.2  (02-26-2010)
Conclusion of Employment Tax Case

  1. Generally, no return preparer penalty will be proposed until the employment tax examination is completed at the group level. If the employment tax case is unagreed, the examiner may pursue the preparer penalty after the unagreed employment tax case is submitted at the group level.

  2. The determination and settlement of the employment tax examination will at all times proceed without regard to the return preparer penalty issue.

4.23.17.4  (09-13-2013)
Establishing and Working a Preparer Penalty Case

  1. SB/SE examiners utilize a Lead Sheet 300, Penalty Approval Form – Employment Tax Case, to determine whether or not to proceed with penalties. The lead sheet is for the tax return under examination, the key case. This tax return is the client’s return of the tax return preparer. If a decision is made to proceed with a separate return preparer penalty investigation, the examiner must secure the manager’s permission. A Form 5809, Preparer Penalty Case Control Card, is used to obtain the manager’s permission.

  2. Once approved, a preparer penalty case file will be created. If the manager does not approve, the examiner should include a statement to that effect in the employment tax case.

4.23.17.4.1  (09-13-2013)
Contact the Return Preparer Coordinator

  1. A Return Preparer Coordinator (RPC) will be responsible for handling employment tax return preparer penalty cases. The Tax Policy Analyst for the Preparer Program will be responsible for RPC duties.

  2. The RPC can advise the examiner if the Return Preparer is being investigated by Criminal Investigation Division (CI), the Lead Development Center, or one of the Income Tax Examination Areas. In addition, because of knowledge of past and present Return Preparer penalty examinations, the RPC can provide invaluable assistance to the examiner at the start of the investigation regarding audit techniques, questions, and direction. The RPC can also provide coordination if more than one investigation is ongoing or contemplated.

4.23.17.4.2  (09-13-2013)
Prepare Form 5809 to Establish on ERCS – Not AIMS

  1. The examiner establishes controls on the Examination Returns Control System (ERCS) using Form 5809, Preparer Penalty Case Control Card, as the ERCS Input Document. These cases are not controlled on AIMS. In addition to information concerning the preparer, record on Form 5809 the relevant information from the client’s tax return. Use of this document allows the establishment of the Non-AIMS case on ERCS for purposes of time application and is a means of keeping a manual record of penalty action on the Preparer.

  2. Forward, via E-mail, a copy of the Form 5809 (Copy B) prepared to establish the preparer penalty case to the Return Preparer Coordinator at the start of the penalty investigation.

  3. There are two different ways of preparing Form 5809 for input on (ERCS):

    1. Method 1: Use the Return Preparer's TIN and Name. This is advantageous when one examiner will be conducting a Return Preparer Penalty investigation regardless of the number of penalties that may ultimately be asserted. Rather than create a card for each client penalty investigation, all of the penalty examinations can be condensed into one, and the sum total of hours applied and penalty amounts for each year and penalty type can be input without creating a separate Form 5809 and ERCS record for each client penalty investigation.

    2. Method 2: Use the client’s TIN and the name of the Return Preparer who is the subject of the penalty investigation. A separate Form 5809 and an ERCS record is created for each Return Preparer penalty investigation. This method is preferred when multiple examiners will each be conducting a separate Return Preparer penalty investigation on a specific preparer for a particular year. Each examiner charges their time and any penalties assessed are input to the particular client affiliated record created. The disadvantage to creating separate cards arises when there is one examiner conducting the preparer penalty investigation. A separate Form 5809 must be prepared for each penalty and the examination time must be separately input for each period onto ERCS.

  4. Source Code "49" is only to be used for the primary return selected as part of the Program Action Case (PAC) client sample originating from the Specialty Employment Tax Centralized Workload Selection and Delivery (SET-CWSD). If multi-year cases are developed in SET-CWSD for delivery to the groups, only the primary return should reflect Source Code "49." The appropriate related return source code should be used on the related returns (i.e., SC "40" for prior/subsequent & SC "44" for non-filers). In addition, Aging Reason Code "49" should now be reflected on all return preparer program returns including the primary and multiple-year returns.

    Note:

    Form 5345-D , Examination Request Master File, is NOT USED to establish a preparer penalty on ERCS.

  5. For Method 2, establish a separate ERCS record for each client / year / proposed penalty combination using the following guidelines:

    1. TIN field: record the SSN or EIN of the Preparer or Client

    2. Name field: record the "Preparer’s Name"

    3. Tax Period field: record the tax period of the client’s return

    4. Statute field: record the statute of the client’s return – P2 penalties should be assigned an alpha statute of "XX"

    5. Activity Code (ActCd) field: record one of the following codes:

    ActCd Penalty Section MFT
    501 Section 6694(a) penalty P1
    502 Section 6694(b) penalty P2
    503 Section 6695(f) penalty P3
    504 Section 6695(a), (b), (c), (d), (e) or (g) penalty P4
    505 Section 7407 injunctions P5
    828 Indirect Exam Time Used for closing the investigation file when the only time charged was for attempting, unsuccessfully, to locate the preparer

  6. When charging time to the case, use the codes in the table above.

4.23.17.4.3  (09-13-2013)
Determine Statute

  1. The statute of limitations on assessment for IRC 6694(a) and IRC 6695 expires three years from the later of the due date of the related (client) return or the date the return was filed. The deemed due date of 4/15 of the subsequent year is used to determine the statute date for all Forms 941 filed in a calendar year. There is no statute of limitations on assessment for IRC 6694(b), IRC 6700, or IRC 6701 penalties.

  2. There is no statute of limitations on actions to enjoin preparers or promoters under IRC 7407 or IRC 7408.

    Note:

    Extending the statute on a client taxpayer’s employment tax return with a Form SS-10, Consent to Extend the Time to Assess Employment Taxes, does not extend the statute for the Return Preparer Penalty Case.

  3. If the statute is less than 180 days and the preparer will agree, the statute on a return preparer penalty case under IRC 6694(a) or IRC 6695 can be extended using Form 872–D, Consent to Extend the Time on Assessment of a Tax Return Preparer Penalty. (See Rev. Rul. 78–245.) The form is sent to the Return Preparer via Letter 907P, Return Preparer Penalty Statute Extension Request. If the case has a short statute, the Specialist should follow the short statute procedures. See IRM 4.23.14, Employment Tax - Statute Control and Extension, and IRM 4.90.10, Federal, State and Local Governments (FSLG) - Statute Control Procedures.

  4. A transcript of the return on which the preparer penalty is based should be included in the preparer penalty case file for accurate monitoring of the expiration date. If the preparer does not agree, see IRM 4.23.17.5.6, Prompt Assessment Procedures.

4.23.17.4.4  (02-26-2010)
Contacting the Preparer and Conducting a Comprehensive Interview

  1. Each employment tax examination is separate and distinct from the Return Preparer Penalty Case File. Examiners will not propose or discuss preparer penalties in the presence of the taxpayer.

  2. When initiating a preparer penalty case, examiners should mail Letter 4523, Preparer Contact Letter, to the preparer to notify the preparer.

  3. A comprehensive interview of the preparer and/or the client is required to adequately develop facts and circumstances to determine if a return preparer penalty case is warranted. During the interview process, the examiner should ask the taxpayer the following questions:

    • Did the taxpayer meet with the preparer?

    • Did the taxpayer complete a questionnaire and/or have a face-to-face meeting with the preparer?

    • What documentation was provided to the preparer?

    • Did the taxpayer receive a copy of the return?

    • Was the preparer compensated?

  4. Remember to ask follow-up questions. While asking basic interview questions is required, critical information may be provided in responses to follow-up questions.

  5. The questions asked of the preparer are important to determine if additional development regarding the return preparation is warranted. If the preparer is the taxpayer’s representative, examiners may want to ask:

    • About the "interview" with the taxpayer.

    • What documentation was provided to prepare the return?

    • Was a copy of the return provided to the taxpayer?

    • Was the preparer aware of any errors, omissions, or mistakes on the return under examination?

    • Was the preparer compensated for the tax return preparation?

  6. More often than not, representatives will review the return and the taxpayer’s records prior to the initial interview. If an error has been made on the return, the preparer will probably know in advance. While the preparer is not required to disclose the error, as the examiner continues to work the case, the extent of the preparer’s knowledge should become apparent.

  7. When interviewing the taxpayer or preparer, ask if other services are provided by the preparer’s firm and how long the preparer has been preparing returns for the taxpayer. These questions will help to determine the extent of the preparer’s knowledge regarding the taxpayer’s financial situation/status. These questions will also alert the examiner as to the potential applicability of penalties. A preparer who has been preparing a client’s return for a number of years is more knowledgeable than a preparer who is preparing a client’s return for the first time.

  8. The examiner should contemporaneously document the preparer penalty case file following the conversation with the taxpayer and/or preparer. While each examiner’s interview style is different, the documentation of the facts should be consistent and recorded in the case history and on the Employment Tax Reengineering lead sheets and workpapers.

    Note:

    The taxpayer's answers to these inquiries should not be included in any workpapers in the taxpayer's case file. All information regarding the return preparer's activities and the applicability of any penalties relating to the return preparer should be separated from the taxpayer's case file. This information is then included in the Return Preparer Penalty Case File using a preparer penalty lead sheet.

4.23.17.5  (02-26-2010)
Return Preparer Case Disposition

  1. The following sections describe the different case closing procedures.

4.23.17.5.1  (09-13-2013)
No Change Cases

  1. The Group Manager will review the investigation file and document concurrence. The examiner will prepare Letter 1120, Preparer Penalty No-Change Case Letter, mail the original to the preparer and include a copy in the case file.

  2. The examiner will complete Form 5809 and E-mail a copy to the RPC.The group will update ERCS to status 90 and forward the case, closed NO CHANGE, to the RPC for review.

  3. The RPC will extract pertinent information from the file, to be retained for not less than one year. The balance of the no-change case file will not be retained.

4.23.17.5.2  (02-26-2010)
Preparer Penalties Proposed

  1. The preparer should be afforded an opportunity to meet with the Group Manager to resolve the issues. Document the actions taken on Form 4665, Report Transmittal, if the preparer does not agree.

  2. If penalties are proposed in conference with the preparer, the examiner provides the preparer with Form 5816, Report of Tax Return Preparer Penalty, and Form 886-A, Explanation of Items. When penalties are based on many different prepared returns, attach a list of client names, SSNs / EINs, and tax periods. Use a separate form for each year / return combination.

  3. If penalties are being proposed via mail, send Letter 1125, Preparer Penalty 30-Day Letter, along with the Form 5816 and Form 886-A.

4.23.17.5.3  (09-13-2013)
Agreed Preparer Penalty Case

  1. For agreed cases, the preparer signs Form 5816 . Solicit payment from preparer and if the preparer pays, prepare Form 3244-A, Payment Posting Voucher - Examination.

  2. Complete Form 8278, Computation and Assessment of Miscellaneous Penalties. When more than one penalty under different IRC sections will be assessed against the same preparer for the same period, complete a separate Form 8278 for each penalty.

  3. Prepare Letter 1195, Acceptance Letter - Agreed Preparer Penalty Case, and a pre-addressed envelope, and include both in the case file. Attach Form 3198, Special Handling Notice for Examination Case Processing, to each penalty case file. Identify the case as a return preparer penalty case in the "Other" section and reference the applicable IRC section.

  4. If the preparer filed a joint income tax return, annotate with either "Assess on Primary SSN" or "Assess on Secondary SSN" in the "Other" section to identify the individual against whom the penalty is to be asserted.

  5. Route the investigation case file to the RPC. Annotate the Form 3198, Special Handling Notice for Examination Case Processing, to indicate that the Letter 1195 and addressed envelope are enclosed in the file. Complete Form 5809, Preparer Penalty Case Control Card, and include in case file for RPC.

  6. The group clerk will update the return preparer case on ERCS to status "41" and use Form 3210, Document Transmittal, to mail the case to the RPC. After review, the RPC will update ERCS to Status "51" and forward the case to Centralized Case Processing (CCP).

4.23.17.5.4  (09-13-2013)
Unagreed Case Closing Procedure

  1. The examiner provides the preparer with:

    • Letter 1125, Preparer Penalty 30-Day Letter,

    • Form 5816, Report of Tax Return Preparer Penalty, (remove bottom part of the form),

    • Form 886-A, Explanation of Items, or equivalent,

    • Publication 1, Your Rights as a Taxpayer,

    • Publication 5, Your Appeal Rights and How To Prepare a Protest If You Don't Agree, and

    • Publication 594, The IRS Collection Process.

  2. The case then goes into suspense for 30 days, during which time the preparer may agree or protest. If response is agreed, follow the procedures for agreed case. If no response, follow the procedures for Prompt Assessment.

    Note:

    If the client employment tax examination case is unagreed, the unagreed preparer penalty investigation file can not be submitted to Appeals before the employment tax examination case file.

4.23.17.5.5  (02-26-2010)
Protest to the Penalty

  1. If the preparer submits a pre-assessment protest (written) within 30 days, the investigation file will be reviewed for:

    1. Adequacy of the protest,

    2. Development of the issue(s), and

    3. Managerial involvement.

  2. The examiner will prepare the assessment document, Form 8278, Computation and Assessment of Miscellaneous Penalties. When more than one penalty under different IRC sections will be assessed against the same preparer for the same period, complete a separate Form 8278 for each penalty.

  3. Complete Form 5809 and include in case file for RPC. The group clerk will update ERCS to Status "41" and forward the case, UNAGREED, to the RPC for review. After review, the RPC will update ERCS to Status "21" and forward the case to Technical Services to be sent to Appeals via Form 3210.

  4. An unagreed Return Preparer Penalty Case file cannot be submitted to Appeals for pre-assessment consideration if there is less than 180 days remaining on the assessment statute of limitations. Form 872-D , Consent to Extend the Time on Assessment of Tax Return Preparer Penalty, is used to extend the statute in a preparer penalty investigation. See IRM 4.23.17.4.3, Determine Statute.

4.23.17.5.6  (02-26-2010)
Prompt Assessment Procedures

  1. If the preparer refuses to extend the statute and preparer penalty are proposed, forward the preparer penalty case for prompt assessment.

  2. Send the preparer Form 5816, Report of Tax Return Preparer Penalty, with the bottom part of the report removed along with an explanation of the reason for the quick assessment and a discussion of the preparer’s Appeals rights.

  3. Letter 1125, Preparer Penalty 30-Day Letter, is not sent to the Preparer.

  4. Forward to the RPC a copy of Form 5816, along with a completed Form 8278, Computation and Assessment of Miscellaneous Penalties, and Form 2859, Request for Quick or Prompt Assessment.

  5. Annotate Form 3198 with "Quick Assessment" on the "Other" line in the Expedite section. The investigation file should be forwarded to the RPC when completed.

  6. Upon request, the preparer will be provided the same Appeals rights post-assessment as would have been provided if the request for Appeals consideration was received before the assessment.

4.23.17.6  (02-26-2010)
Referral to the Office of the Director of Professional Responsibility

  1. The Office of Professional Responsibility (OPR) exercises jurisdiction over Attorneys, CPA's, Enrolled Agents, Enrolled Actuaries, Enrolled Retirement Plan Agents, and Appraisers. Examiners should exercise discretion in making referrals of specific cases.

  2. In matters involving non-willful conduct, a referral should only be made when it can be established that the preparer has a pattern of failing to meet the required standards of Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, Enrolled Retirement Plan Agents, and Appraisers before the Internal Revenue Service. An isolated instance in which a penalty may apply should not, in and of itself, require a referral unless willful conduct is involved. Accordingly, the imposition of penalties under IRC 6694(a) and IRC 6695(a) through (e) should not automatically generate a referral to the director of the OPR. A referral to OPR is mandatory in the event that the preparer is determined to have violated IRC 6694(b). For a further discussion regarding referral criteria, see IRM 4.11.55.4.2.2, When Should A Referral Be Made To OPR?

  3. When making a referral to OPR, examiners will:

    • Prepare Form 8484, Report of Suspected Practitioner Misconduct, and obtain signature approval of their manager,

    • Send the completed Form 8484 to the Return Preparer Coordinator for routing to the Director, Office of Professional Responsibility.

4.23.17.7  (02-26-2010)
Program Action Case (PAC) Procedures for SB/SE Employment Tax

  1. A Program Action Case (PAC) is an investigation where clients of questionable preparers are examined to determine whether preparer penalties and/or injunctive actions against the preparer(s) are warranted.

  2. If, during the course of an employment tax audit, an examiner believes a preparer’s noncompliance is pervasive, consideration should be given to opening a PAC. With managerial approval, examiners should forward the following information via secure E-mail to the Employment Tax Return Preparer Coordinator (RPC):

    1. Name of preparer,

    2. Address of preparer,

    3. EIN, SSN, and/or PTIN of preparer, and

    4. A detailed description of the suspected non-compliance.

  3. IRM 4.1.10, Planning and Special Programs - Return Preparer Program Coordinator, contains general procedures for conducting a PAC. The following procedures are specific to SB/SE Employment Tax examiners for making a preparer referral to initiate a PAC:

    1. The RPC will determine whether a PAC is warranted and whether there are any ongoing PACs or investigations currently open on the referred preparer. A separate PAC cannot be opened if there is already an open PAC or investigation. Examiners and/or Group Managers must not research preparers on their own; all referrals must be routed through the designated RPC.

    2. If there is another open PAC or investigation in SB/SE Exam, Criminal Investigation (CI), LB&I, TE/GE, or other Business Operating Division, the RPC will provide the employment tax referral information to the responsible RPC.

    3. The RPC will prepare an analysis of the preparer’s clients’ returns to determine if the issue identified by the examiner is prevalent.

    4. If the issue is not prevalent or insufficient information is available, the RPC will notify the Group Manager that a PAC is not warranted. The examiner may submit additional information that will be considered by the RPC.

    5. When appropriate, the RPC will submit a referral package with the necessary research to the Preparer Steering Committee (PSC) for consideration of a PAC. The RPC will notify the Group Manager that the referral has been forwarded to the PSC for consideration.

    6. The PSC will be comprised of the SB/SE Employment Tax Territory Managers and the RPC. The PSC will meet periodically, as necessary, to review the preparer research and select those they determine warrant a PAC.

    7. The PSC will prepare a PAC Request Memo and submit it to the Policy Program Manager for routing and approval by the Director, Specialty Programs, through the Chief, Employment Tax Operations.

    8. If the PAC is approved, the RPC will notify the Group Manager and coordinate with Campus to ensure that the necessary returns are selected for compliance action and assigned a unique tracking code.


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