CPA Exam — REG (Regulation)Ethics, Professional Responsibilities, and Federal Tax ProceduresHard
A tax preparer discovers that a client has deliberately failed to report significant income for the past three years. The client insists on continuing this practice for the current year's return and refuses to amend prior returns. Under IRC Sec. 6694, what is the MOST likely penalty the preparer would face if they prepare and sign the current year's return omitting this income?
- AA penalty for an understatement due to willful or reckless conduct.
- BA penalty for failure to sign the return.
- CA penalty for an understatement due to an unreasonable position, based on a lack of reasonable basis.
- DA penalty for failure to provide a copy of the return to the client.
Show answer & explanationAnswer & explanation
Correct answer: A. A penalty for an understatement due to willful or reckless conduct.
IRC Sec. 6694(b) imposes a higher penalty on preparers for understatements due to willful or reckless conduct. Deliberately omitting significant income, knowing it's a violation of tax law, constitutes willful or reckless conduct. The penalty is the greater of $5,000 or 50% of the income derived by the preparer with respect to the return or claim.
Why the other options are wrong
- B. This is also a separate, smaller penalty (Sec. 6695) unrelated to the understatement of tax.
- C. While a lack of reasonable basis penalty (Sec. 6694(a)) would apply, willful or reckless conduct (Sec. 6694(b)) carries a significantly higher penalty and is more appropriate given the preparer's knowledge of deliberate fraud.
- D. This is a separate, much smaller penalty (Sec. 6695) unrelated to the understatement of tax.
IRC Sec. 6694(b) Willful/Reckless Conduct
IRC Sec. 6694(b) imposes significant penalties on tax preparers for understatements due to their willful or reckless conduct in preparing a return.
- Applies when preparer willfully attempts to understate tax liability.
- Also applies to reckless or intentional disregard of rules or regulations.
- Penalty is the greater of $5,000 or 50% of preparer's income from the return.
- This is a more severe penalty than for unreasonable positions without willful/reckless conduct.
Memory trick: Willful act, a hefty tax fact.