Tax Preparer Penalties for Unreasonable Positions (IRC §6694)

Under IRC §6694, a paid tax return preparer who causes an understatement of a client’s tax liability through an unreasonable position owes a personal penalty of the greater of $1,000 or 50 percent of the fee earned on that return. If the conduct was willful or reckless, the penalty rises to the greater of $5,000 or 75 percent of the fee.¹ The penalty falls on the preparer, not the taxpayer, and it applies separately to each return, so a flawed position repeated across a client base compounds quickly. A willful-conduct finding also triggers a mandatory referral to the IRS Office of Professional Responsibility, which can suspend or disbar you from practice.

Who the Penalty Can Reach

Section 7701(a)(36) defines a tax return preparer as anyone who prepares a federal return or refund claim for compensation, including anyone who handles a substantial portion of it.² That covers both the signing preparer and any nonsigning preparer who advises on a specific entry making up a meaningful part of the filing.

Whether an entry is a “substantial portion” turns on its size and complexity relative to the taxpayer’s gross income and on the size of any understatement compared to total tax liability. Nonsigning preparers get a de minimis safe harbor: items under $10,000, or items under $400,000 that also represent less than 20 percent of gross income, fall below the threshold. That safe harbor does not protect signing preparers, and smaller items get aggregated before the test is applied.³ People providing only mechanical or typing help, employees preparing their own employer’s returns, and fiduciaries preparing returns for those they represent are excluded.

Within a firm, only one individual is treated as primarily responsible for each problem position. The signing preparer is presumed responsible unless credible information points to a nonsigning preparer who actually drove the position. The IRS can assess against either one, but not both, for the same position on the same return.⁴

The Standard Your Position Has to Meet

Section 6694 sets a tiered standard depending on whether the position is disclosed and whether it involves a tax shelter or reportable transaction. Getting the tier wrong is where most preparer penalties originate.

Undisclosed Positions: Substantial Authority

For a position not separately disclosed to the IRS, you need substantial authority, generally understood as roughly a 40 percent confidence level. The standard is met when the weight of legal authorities supporting the position is substantial relative to those pointing the other way.¹

The IRS recognizes a specific list of what counts as authority for this analysis: the Code, Treasury regulations, revenue rulings and procedures, court cases, tax treaties, congressional committee reports, Joint Committee on Taxation Blue Book explanations, and certain IRS administrative pronouncements. Private letter rulings and technical advice memoranda issued after October 31, 1976 also qualify, though their weight varies. Legal treatises, law review articles, and professional tax opinions are not authorities, though the sources they rely on may be.⁵

Disclosed Positions: Reasonable Basis

A position that lacks substantial authority can still avoid penalty territory if you properly disclose it and it has at least a reasonable basis, roughly a 20 to 25 percent likelihood of being upheld. It must rest on at least one recognized authority from the list above, and you must attach the disclosure forms described below.

Tax Shelters and Reportable Transactions: More Likely Than Not

When a position involves a tax shelter or a reportable transaction subject to §6662A, neither substantial authority nor disclosure with reasonable basis will save you. You must reasonably believe the position would more likely than not be sustained on its merits, meaning a greater than 50 percent chance of success. Disclosure provides no safe harbor here.¹

How the Two Penalty Tiers Work

Section 6694 has two subsections, each calculated as the greater of a flat dollar amount or a percentage of the preparer’s fee for that specific return.

Under §6694(a), when an understatement results from a position that fails the applicable standard and you knew or reasonably should have known about the problem, the penalty is the greater of $1,000 or 50 percent of the income you earned or expected to earn from that return.¹ On a $500 fee, the $1,000 floor applies. On a $10,000 fee for a complex business return, the percentage takes over at $5,000. These amounts are fixed in the statute and are not adjusted for inflation.

Under §6694(b), if the understatement stems from willful intent to understate liability or reckless disregard for tax rules, the penalty jumps to the greater of $5,000 or 75 percent of your income from the return. Reckless disregard does not require deliberate fraud; it includes preparing a return without making a reasonable effort to determine whether a position is correct.

You cannot be hit with both penalties in full for the same return. If the IRS initially assesses under (a) and later upgrades to (b), the amount already paid reduces the (b) penalty dollar for dollar. The penalties are assessed per return, though, so a preparer who applied the same problematic position across ten client returns faces up to ten separate assessments.

Defenses to a §6694 Assessment

The §6694(a) penalty for unreasonable positions has an affirmative defense: no penalty applies if you can show reasonable cause for the understatement and that you acted in good faith. This exception does not apply to §6694(b) willful or reckless conduct. Willfulness and good faith cannot coexist.

Relying on What the Client Tells You

You can generally rely in good faith on information a client provides without independently auditing or verifying it. There is no duty to examine books, records, or business documents to confirm what the client says. The same rule applies to information and advice received from other preparers or advisors, including colleagues within the same firm.⁶

The protection has real limits. You cannot ignore the implications of information you already know. If something a client provides looks wrong or incomplete, you must ask follow-up questions. And where the Code requires specific facts to exist before a deduction or credit can be claimed, such as maintenance of certain records, you must ask enough questions to confirm those facts exist. You do not have to audit your client, but you cannot close your eyes when the numbers do not add up.

Disclosing a Position on Form 8275 or 8275-R

Proper disclosure is what separates the substantial authority standard from the lower reasonable basis standard. A position that lacks substantial authority but has a reasonable basis avoids penalty only if you flag it for the IRS on the correct form.

Form 8275, the Disclosure Statement, flags positions not adequately disclosed elsewhere on the return. It requires a description of the item, the dollar amount, the relevant code section, and the legal reasoning supporting the position.⁷ Boilerplate defeats the purpose. The IRS needs enough detail to evaluate whether the position clears the reasonable basis threshold.

If the position contradicts a Treasury regulation, Form 8275-R (the Regulation Disclosure Statement) is required instead. Disclosure on 8275-R is the only way to make an adequate disclosure of a position contrary to a regulation.⁸ Both forms attach directly to the return or amended return when filed.

Contesting a Proposed Penalty

The IRS does not assess §6694 penalties automatically. An examiner develops the case and proposes the penalty through official correspondence, and you can agree, negotiate, or fight the assessment.

Once you receive a notice and demand, you can halt collection by paying at least 15 percent of the penalty within 30 days and filing a refund claim for the amount paid. With those two steps complete, the IRS cannot levy or file suit to collect the remaining balance until the matter is finally resolved.¹

The protection is temporary. After the refund claim is denied, or after six months pass without action, whichever comes first, you have 30 days to file suit in the appropriate U.S. district court. Miss that 30-day window and the collection stay ends the next day. The IRS can also file a counterclaim for the remaining penalty balance in the same proceeding.

On timing, the IRS has three years from the filing date of the underlying return to assess a §6694(a) penalty. For §6694(b) penalties involving willful conduct, there is no time limit. The IRS can assess at any point.⁹

What Follows a §6694 Finding

The civil penalty is often just the beginning. A §6694 finding, especially under subsection (b), can trigger consequences well beyond the dollar amount.

Circular 230 Discipline

A mandatory referral to the IRS Office of Professional Responsibility follows any finding of willful conduct under §6694(b). An isolated §6694(a) penalty does not automatically trigger a referral, but the IRS will send one if the examiner identifies a pattern of failing to meet professional standards.¹⁰

Under Circular 230, OPR sanctions include censure (a public reprimand), suspension from practice before the IRS, and disbarment. OPR can also impose monetary penalties up to the gross income you earned from the conduct at issue, on top of any §6694 amounts already assessed.¹¹ Expedited suspension procedures apply when a practitioner has lost a professional license, been convicted of a tax crime or a crime involving dishonesty, or has a pattern of failing to file their own returns.

Federal Court Injunctions

Under §7407, the IRS can ask a federal district court to enjoin a preparer from specific prohibited conduct or from acting as a tax return preparer at all. Grounds include conduct subject to §6694 or §6695 penalties, misrepresenting credentials, guaranteeing refunds, or other fraudulent behavior that interferes with tax administration. A court finding a pattern of repeated violations can permanently bar the person from preparing returns.¹²

Criminal Exposure

The most aggressive cases move beyond civil penalties. A preparer convicted of a felony tax crime faces fines up to $100,000 ($500,000 for a corporate entity), up to three years in prison, and the costs of prosecution.¹³ Criminal exposure generally requires proof of willful intent, the same kind of conduct that triggers §6694(b), and the civil and criminal tracks can run in parallel.

A Related Exposure: §6695 Administrative Penalties

Section 6694 addresses the substance of the positions you take. Section 6695 addresses administrative failures that are separate but easy to overlook. Failing to give the taxpayer a copy of the return, failing to sign the return, failing to include a PTIN, and failing to keep a copy or maintain a client list each carry a $50 penalty per failure, capped at $25,000 per year (or per return period, for the client-list rule). Endorsing or cashing a client’s refund check is $500 per check with no annual cap.¹⁴ Each carries a reasonable cause defense except the refund-check prohibition, which applies regardless of intent. Individual amounts look small, but a high-volume preparer who systematically skips one of these can hit the $25,000 cap fast.

1
Office of the Law Revision Counsel. 26 USC 6694 – Understatement of Taxpayers Liability by Tax Return Preparer
2
Legal Information Institute. 26 USC 7701(a)(36)(A) – Tax Return Preparer Definition
3
eCFR. 26 CFR 301.7701-15 – Tax Return Preparer
4
eCFR. 26 CFR 1.6694-1 – Section 6694 Penalties Applicable to Tax Return Preparers
5
GovInfo. 26 CFR 1.6662-4 – Substantial Understatement of Income Tax
6
GovInfo. 26 CFR 1.6694-1 – Section 6694 Penalties Applicable to Tax Return Preparers
7
Internal Revenue Service. Instructions for Form 8275 – Disclosure Statement
8
Internal Revenue Service. Instructions for Form 8275-R – Regulation Disclosure Statement
9
Internal Revenue Service. 8.11.3 Return Preparer Penalty Cases
10
Internal Revenue Service. Preparer Penalty Procedures for SB/SE Employment Tax
11
Internal Revenue Service. Treasury Department Circular No. 230
12
Office of the Law Revision Counsel. 26 USC 7407 – Action to Enjoin Tax Return Preparers
13
Internal Revenue Service. Tax Preparer Penalties
14
Office of the Law Revision Counsel. 26 U.S. Code 6695 – Other Assessable Penalties With Respect to the Preparation of Tax Returns for Other Persons