Taxpayers frequently fear getting a letter from the Internal Revenue Service (IRS). But they aren't the only ones who get worrisome IRS correspondence. Return preparers can also receive letters that signal that the IRS is looking into a return. And preparers, too, can end up paying penalties to the IRS—for failing to follow the Tax Code when preparing returns. Some believe the resource-constrained IRS seeks to turn every return preparer into an IRS employee, pre-auditing their clients' returns, and refusing to take defensible positions out of fear that they will face penalties.
We've noticed an uptick in the number of letters that preparers are receiving, so let's review the basics of why the IRS goes after return preparers and how that process begins with a “Letter 4523.”
The Significance of Investigating a Return Preparer
At a conference panel, an IRS official explained why the agency was turning up the heat on return preparers: Tax preparers have an ethical responsibility to help clients fulfill their voluntary commitments to pay taxes; therefore, they shouldn't facilitate clients' evasion. The IRS is “more and more realizing that one bad preparer could be worse than 100 bad taxpayers.”
Furthermore, there are penalties for return preparers who have committed harm against their clients or the government. Some of these wrongdoings are fairly minor; others are much more grave. But all of the following can result in penalties:
- Understating of the taxpayer's liability because of unreasonable positions
- Understating of the taxpayer's liability because of reckless or willful conduct
- Promoting abusive tax shelters
- Preparing fraudulent returns, statements, or other documents
- Knowing or reckless disclosure of the taxpayer's information
- Taking actions to limit disclosure of reportable transactions or other required actions
- Failing to follow IRS codes and regulations when preparing a return
- Failing to furnish a copy of the return to the taxpayer
- Failure to sign a return
- Failure to exercise necessary diligence when determining a client's eligibility for specific tax benefits (such as the Earned Income Tax Credit and Lifetime Learning Credit)
There will, of course, be questions as to whether the preparer unwittingly filed false returns because they relied on the client's false information.
And if the preparer did knowingly commit a wrongdoing, then the IRS will still want to know if this was done at the preparer's or the client's instigation.
Possible Penalties for a Return Preparer
When the IRS assesses penalties against a return preparer, the agency bases its calculations on the number of violations, the regulations that were violated, and the tax years involved. Additionally, the penalties vary by the inflation rates since many of the violations have no statute of limitations (i.e., it doesn't matter how many years ago the violations occurred).
For minor incidents, such as failure to send a copy of a return to a client, the initial penalty is low—$50—but since that would apply to every client missing a copy, the cumulative effect can be sizable. The IRS caps the liability for these penalties within a given year. (In 2020, the fine was capped at $26,500.)
For more significant crimes, penalties include fines as much as $1,000 or a 100% forfeit of the client's payment for the related work. For understating tax liability, preparers can pay fines of $1,000 per incorrect return—although the IRS has the option to limit these to one fine per related client per year.
If the preparer has prepared fraudulent documents, the preparer could face both fines of up to $100,000 relating to work for individuals ($500,000 for corporate work) and a prison sentence of up to three years. They can also be required to reimburse the government for the cost of their prosecution.
The Function of a Letter 4523
An IRS examiner will use Letter 4523, the “Preparer Contact Letter,” to notify a return preparer of concerns about a return they've prepared within the last three years.
In the letter, the examiner notifies the preparer that the examiner wants to schedule a “comprehensive interview” with a preparer. As with all IRS correspondence, time is of the essence. The examiner is expected to hear from the preparer within 14 days.
Significantly, the IRS can review multiple years of one client's returns, but examiners may also examine multiple clients' returns as they look for a preparer's patterns of malfeasance.
Preparing for the Comprehensive Interview
Once the letter's in hand, the preparer should get ready for the meeting with the examiner. Per IRS policy, the examiner will expect the preparer to address questions such as:
- Did the preparer have a face-to-face meeting with the taxpayer?
- Did the taxpayer complete a questionnaire?
- What documentation did the preparer receive from the taxpayer?
- Did the preparer send the taxpayer a copy of the return?
- Was the preparer compensated?
- Is the preparer aware of any errors, omissions, or mistakes on the return?
Note that the IRS will conduct comprehensive interviews with the preparer and the taxpayer to confirm they say the same information. Preparers should understand that these are not interviews that they should handle on their own, and they may be able to avoid them entirely if adequately represented. If a preparer is compelled to appear for an interview, they should be adequately prepared for it, and the best preparation comes from knowing the questions that the IRS revenue agent will ask you.
If you find yourself under a preparer examination, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.