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5 Potential Defenses in IRS Tax Preparer Investigations

April 23, 2024


Just like taxpayers, tax preparers have an obligation to comply with the Internal Revenue Code (IRC). Several provisions in the IRC speak specifically to the tax preparer’s role in preparing and submitting fraudulent returns—and tax preparers can face both civil and criminal penalties for aiding and abetting federal tax law violations. For tax preparers who are under investigation, working with an experienced Texas tax defense lawyer is critical. While there are several potential defenses available, choosing the right defenses is essential for avoiding unnecessary penalties.

Here are five examples of potential defenses in IRS tax preparer investigations:

1. A “Reasonable Basis” for the Taxpayer’s Position

Not every miscalculation of a taxpayer’s federal liability warrants civil or criminal enforcement. The IRC and U.S. Treasury Regulations recognize that this is the case, and they provide that tax preparers are not subject to penalties if there is a “reasonable basis” for a position disclosed on a taxpayer’s behalf. In defining what constitutes a “reasonable basis,” Treasury Regulation 1.6662-3(b)(3) states:

“Reasonable basis is a relatively high standard of tax reporting . . . . The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim. If a return position is reasonably based on one or more of the authorities set forth in Treas. Reg. 1.6662-4(d)(3)(iii) (taking into account the relevance and persuasiveness of the authorities, and subsequent developments), the return position will generally satisfy the reasonable basis standard.”

Working with high-income and high-net-worth taxpayers often involves implementing complex tax strategies—many of which the IRS has identified as potential “red flags” for tax evasion and tax fraud. As a result, investigations are not uncommon. Tax preparers who have thoroughly documented the “reasonable basis” for their recommendations should be able to withstand the IRS’s scrutiny with the help of an experienced Texas tax defense lawyer in most cases.

2. “Substantial Authority” for the Taxpayer’s Position

When investigations target positions not disclosed, tax preparers can avoid civil or criminal culpability by demonstrating “substantial authority” for the position taken. As the IRS explains:

“The substantial authority standard is less stringent than the more likely than not standard (the standard is met when there is a greater than 50 percent likelihood of the position being upheld), but more stringent than the reasonable basis standard as defined in Treas. Reg. 1.6662-3(b)(3).”

Similar to the “reasonable basis” defense, asserting a defense based on “substantial authority” requires thorough documentation. If a tax preparer, working with his or her defense counsel can clearly demonstrate that an undisclosed position is based on substantial authority, then the tax preparer should be able to avoid both civil tax preparer penalties and criminal prosecution for aiding and abetting tax fraud.

3. Taxpayer Compliance

While tax preparers can use the “reasonable basis” and “substantial authority” defenses to avoid liability for improper tax positions, tax preparers do not need to rely on these defenses when their clients’ returns comply with the law. The fact that the IRS is investigating doesn’t necessarily mean that the position in question is unlawful. With this in mind, when facing allegations that a position taken on a client’s behalf violates the IRC (or another law, such as the Bank Secrecy Act (BSA) or Foreign Account Tax Compliance Act (FATCA)), a tax preparer’s first step should be to engage experienced tax counsel to independently assess whether the position in question is violative. If it isn’t violative, then executing a successful defense will likely involve demonstrating how the position complies with all relevant statutory requirements and prohibitions.

4. Good-Faith Reliance on the Taxpayer’s Representations

The IRS requires tax preparers to perform sufficient due diligence when they have reason to question information that a client provides. However, what is necessary in terms of due diligence depends on the circumstances involved. If a tax preparer relies on a client’s representations in good faith, then the tax preparer generally is not responsible for preparing returns based on these representations—even if they turn out not to be true.

Here, too, documentation can be critical for successfully defending against an IRS tax preparer investigation. Generally speaking, the more sophisticated and complicated the return, the more documentation is required. But, if a tax preparer (or the tax preparer’s counsel) can clearly demonstrate that the tax preparer asked the necessary questions and requested (and obtained) the necessary substantiating documentation, then civil and criminal penalties will be unwarranted in most cases.

5. Good-Faith Reliance on Tax Counsel

Tax preparers can also defend against civil and criminal liability in IRS investigations by demonstrating good-faith reliance on the advice of tax counsel. If a taxpayer’s counsel provides an opinion stating that a position has a “reasonable basis” or “substantial authority,” or if a tax preparer otherwise relies on tax counsel’s advice when making decisions with respect to a client’s returns, then the tax preparer generally should not bear responsibility—provided that the tax preparer did not have reason to question tax counsel’s opinion and was not otherwise obligated to exercise independent judgment.

Regardless of the defense (or defenses) a tax preparer has available, favorably resolving an IRS investigation requires a proactive and strategic approach. IRS tax preparer investigations can move quickly, and they can often be extremely broad in scope. Informed decision-making is key; and, to ensure that they are making the right decisions, tax preparers who are facing scrutiny from the IRS should engage experienced defense counsel promptly.

Contact Us to Request an Appointment with a Texas Tax Defense Lawyer at Brown Tax P.C.

With offices in Fort Worth, we represent tax preparers throughout Texas and nationwide during IRS investigations. If you are facing scrutiny related to a position you took on a high-income or high-net-worth taxpayer’s return (or that you took on multiple clients’ returns), we can help you make informed decisions about your next steps. To request an appointment with a Texas tax defense lawyer at Brown Tax P.C., please call 888-870-0025 or contact us confidentially online today.

Taxpreparer Investigations