Substantial Authority

[solomon]

From Title III of HR 6049 passed by the Senate yesterday.

Subtitle C: Modification of Penalty on Understatement of Taxpayer's Liability by Tax Return Preparer - (Sec. 321) Modifies the standards for imposing penalties on tax return preparers for understatements of tax to require: (1) substantial authority for a position with respect to an item on a tax return if such position was not disclosed with the return; and (2) a reasonable basis for a position that was disclosed with the return.

Among other things, the AMT patch and extenders are included.

[erchess]

OK now I am confused

I thought the IRS was considering going to the requirement for "substantial authority" and then they backed off. Is anyone else surprised to see this coming from Congress?

Furthermore, can anyone explain to me the difference between having Substantial Authority and having Reasonable Basis? I think we all know what Substantial Authority is - the code or an authoritative interpretation of it such as certain things the IRS puts out including Pubs and Rev Procs and Rev Rulings as well as court decisions provided in all cases that a higher court has not ruled to the contrary. Most of the time if we can find the Facts and Circumstances the Law is known. But can someone give me a set of facts and an action under those facts that would have Reasonable Basis but not Substantial Authority? I think we all agreed in another thread that there is no authority for deducting the cost of a breathalyzer the taxpayer puts on his car as part of a sentence for repeatedly driving drunk.

[BHoffman]

I think we all agreed in another thread that there is no authority for deducting the cost of a breathalyzer the taxpayer puts on his car as part of a sentence for repeatedly driving drunk.

We can look forward to authority if the taxpayer is a member of Congress.

[solomon]

Furthermore, can anyone explain to me the difference between having Substantial Authority and having Reasonable Basis?

From Notice 2008-13.

For purposes of determining whether the tax return preparer has a reasonable
basis for a position, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer, as provided in § 1.6694-1(e).

In addition, a tax return preparer may rely in good faith and without verification upon information furnished by another tax return preparer or other third party. Thus, a tax return preparer is not required to independently verify or review the items reported on tax returns, schedules or other third party documents to determine if the items meet the standard requiring a reasonable basis for a position.

The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known to the tax return preparer. The tax return preparer also must make reasonable inquiries if the information furnished by another tax return preparer or a third party appears to be incorrect or incomplete.

Substantial Authority is defined in Reg. 1.6662-4(d)(3)(iii).

Here is a link: http://ecfr.gpoaccess.gov/cgi/t/text...16.251&idno=26

[New York Enrolled Agent]

Furthermore, can anyone explain to me the difference between having Substantial Authority and having Reasonable Basis? I think we all know what Substantial Authority is - the code or an authoritative interpretation of it such as certain things the IRS puts out including Pubs and Rev Procs and Rev Rulings as well as court decisions provided in all cases that a higher court has not ruled to the contrary.

Erchess

It's too bad the IRS Tax Forums are over. NAEA did a CPE session on these standards. I am going to disagree with you on one item - most preparers do NOT understand what substantial authority is.

Reasonable basis and substantial authority are terms of art and not terms of science. Every preparer should print out Reg §1.6662-3(b)(3) where reasonable basis is "defined" and also Reg §1.6662-4(d) where substantial authority is "defined" and discussed. BTW, IRS publications do NOT constitute authority.

To determine a tax preparation standard for taking a position on a tax return, you must perform an analysis as described in §1.6662-4(d)(3)(ii) of the regulations. You weigh the authorities in supporting your position versus the authorities against your position. Not all authorities have the same weight.

Over the years, tax commentators have come to a fairly accepted conclusion that you have substantial authority if your analysis leads you to conclude that you have a 40% confidence level that your position would be sustained. Likewise, you have reached a reasonable basis for your position if you come to an approximately 20% confidence level that your position would be sustained. The current standard, of course, in §6694 is more likely than not. This requires that you come to the conclusion that you have a more than 50% confidence level.

The regs say that substantial authority is an objective standard. Clearly, I think subjective is a more appropriate word to use. All preparers absolutely NEED to read Reg §1.6662-4(d)(3) [all parts] to get a hold on this.

[Edsel]

Digging Deep

[QUOTE=New York Enrolled Agent;66059]Over the years, tax commentators have come to a fairly accepted conclusion that you have substantial authority if your analysis leads you to conclude that you have a 40% confidence level that your position would be sustained. Likewise, you have reached a reasonable basis for your position if you come to an approximately 20% confidence level that your position would be sustained. The current standard, of course, in §6694 is more likely than not. This requires that you come to the conclusion that you have a more than 50% confidence level.
QUOTE]

That's just great! How is someone supposed to calculate the difference between a 40% probability and a 20% probability when we don't even know what the probabilities are to begin with?

I can just see defending myself in court:

IRS: Mr. Edsel, the position you maintain for your client requires a 40% confidence level or better, and it simply does not exist.
EDSEL: How can you be sure?
IRS: Our best calculations tell us that your position is sustainable only 36.82% of the time. This is less than 40%.
EDSEL: What about the old 20% rule?
IRS: You're supposed to know when we change our mind. After all we issue opinions and revenue rulings.
EDSEL: How can you be sure about the 36.82%.
IRS: I dunno. Doesn't matter anyway, we don't have to. The burden of proof is on you.


Wonder how this ridiculous scenario would play out in a court of appeals?

[JohnH]

You could try this approach:

IRS: How did you arrive at the 40% confidence level?
EDSEL: Easy, I subtracted 60% from 100%.
IRS: How did you arrive at the 60%?
EDSEL: Easy, I subtracted 40% from 100%
IRS: Why did you subtract 40%?
EDSEL: Easy, because 100% minus 60% equals 40%.
IRS: Why did you subtract 60% from 100%
EDSEL: Easy, because 100% minus 40% equals 60%, and that's really my confidence level but I'm giving you guys the benefit of the doubt and reducing it to 40% just to be on the safe side.
IRS: As a general rule, how likely are you to use this method to calculate your confidence level?
EDSEL: More likely than not.

[erchess]

Thank You Everyone

This has been and I am sure will continue to be an entertaining and informative thread.

I now understand that there are three well established degrees of confidence that I am right. Currently I am supposed to reasonably believe that what I do on a tax return is "more likely than not" to be upheld if it gets thoroughly litigated. I thought there was the possibility that I could avoid preparer penalties if I properly disclosed what I was doing even if I didn't meet that standard but I didn't see that in this thread. I personally plan to stick pretty close to this standard most of the time because most of my clients want to avoid trouble with the IRS in most cases. I expect most users of this board will do the same because most of the questions we have about our clients' returns involve differences in tax that are not worth the various costs of an audit much less a court fight with the IRS.

I "get" the point that IRS Pubs are not Authorities but can't you make the Service go along with their own Pubs if you ever need or want to? The only audits I have been involved in that hinged on law rather than facts I won by having the examiner read Pubs.

Anyway apparently there is a bill in Congress that would let me get by with doing something on a return without disclosure if I reasonably believe that the weight of the authorities on my side is substantial compared to the weight of the authorities going against me. This apparently translates into a 40% chance of winning if the case were thoroughly litigated. There is also apparently the provision in the bill that if I properly disclose what I am doing I can get away with having reasonable basis, which translates to only a 20% chance of winning it the case got litigated.

[solomon]

I "get" the point that IRS Pubs are not Authorities but can't you make the Service go along with their own Pubs if you ever need or want to?.

Good Luck!

[ChEAr$]

Actually

there are more than just three degrees of confidence - 101 degrees, from 0 through 100%.

I won't disagree with NYEA in that we should all take the time to read 6662, however when
push comes to shove, I imagine most of us will use the S O P rule;
seat of (one's) pants.

[solomon]

there are more than just three degrees of confidence - 101 degrees, from 0 through 100%.

I won't disagree with NYEA in that we should all take the time to read 6662, however when
push comes to shove, I imagine most of us will use the S O P rule;
seat of (one's) pants.

Yeah. A tax attorney (tried many cases in court), said the so called percentages are wives' tales.

[erchess]

okay

That would explain why my cousin who is a regular attorney (not a tax attorney) always gets uncomfortable when I ask her what percentage of the time a given set of facts would lead to a particular outcome if the case were thoroughly litigated