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Penalty notices shine light on shady tax preparers

FTB mailed Notices of Tax Preparer Penalty Due to unscrupulous tax preparers in August 2006. The notices are formal demands for payment, and the balance is due immediately to FTB.

Issuing the notices is another step we are taking to address the tax gap and ensure taxpayers pay the correct amount of tax - no more nor less than what is due. Tax professionals play a key role in helping taxpayers comply with the tax laws.

FTB auditors identify suspicious trends and patterns on tax returns, including those in:

  • Credits, such as the Child and Dependent Care Expenses Credit.
  • Overstated deductions on Schedules A and C.

Auditors then examine returns with potential understated tax liabilities, and underreported income, and taxpayers are assessed additional tax as appropriate. FTB also assesses a penalty on tax preparers who submit multiple excessive or abusive returns.

Penalty amounts

California's Revenue and Taxation Code Section 19166 generally conforms to Internal Revenue Code (IRC) Section 6694, which establishes the tax preparer penalty as:

$250 per return or claim if:

  • The tax liability understatement is due to a position that does not have a realistic possibility of being sustained on its merits.
  • The preparer knew or should have known of the unrealistic position.
  • The position was not adequately disclosed or was frivolous.

    A position is considered to have a realistic possibility of being sustained on its merits when a reasonable, and well-informed analysis by a knowledgeable person concludes that the position has approximately a one in three chance (or greater) of being sustained on its merits (Treasury Regulation 1.6694-2(b)(1)).

    $1,000 federal penalty per return or claim if the understated tax liability is due to willful or reckless conduct by the preparer.
    • For California, this penalty amount is $5,000.

    In addition, if the California tax liability understatement is from an inadequately disclosed reportable transaction, a listed transaction, or a gross misstatement:

    • The $250 penalty is increased to $1,000.
    • The standards change from a realistic possibility of being sustained, to a reasonable belief that the tax treatment in that position was more than likely not the proper treatment.

For any return or claim, the penalty under Subsection 6694(b) must be reduced by the amount of the penalty paid under Subsection 6694(a).

Contesting the penalty

The law contains no provision allowing tax preparers to protest the penalty if they disagree with it. However, a preparer may file a court action within 30 days after FTB denies the refund claim, or the claim is deemed denied (whichever is earlier), if both of the following are true. The preparer:

  • Makes a payment of at least 15 percent of the penalty within 30 days of the notice.
  • Files a claim for refund before the statute of limitations period expires.

The penalty continues to accrue interest until it is paid in full, or until the dispute is resolved.

  • The penalty will not be imposed if the facts and circumstances show that the understatement was due to reasonable cause, and that the preparer acted in good faith (see Treasury Regulation 1.6694-2(d) for evaluation criteria on imposing the penalty).