Prepare for the worst

In May, new legislation in the US was introduced to crack down on tax avoidance, with an onus on the tax preparers, not the taxpayers.
As a prominent West Coast lawyer explains, tax preparers are now subject to new rules which require them, before they sign the tax return form, to state a level of personal confidence with respect to each and every issue on the tax return that the positions being taken are more likely than not to succeed if challenged. As the lawyer says: “The IRS [Internal Revenue Service] has essentially outsourced its enforcement to preparers.”
An income tax return preparer is defined as any person who prepares taxes for compensation, or who employs other people to prepare for compensation, all or a substantial portion of an income tax return or claim refund. Under the present law, the definition does not include a person preparing non-income tax returns, such as estate and gift, excise or employment tax returns. But the new law has broadened the scope of the present preparer penalties to include those categories which were formerly excluded.
For any position that doesn’t meet the test, tax preparers are required to attach a disclosure statement, typically using IRS Form 8275. Private equity partnerships, which use mazes of tax vehicles, are worried that preparers are now incentivized to raise red flags without good reason.
One general partner admitted that the new legislation has hit the West Coast venture capital firm in a “big way.” Experts advise private equity partners to consult with tax preparers early so there will be no unpleasant surprises come March 30.
One area the industry should look out for, says the lawyer, has to do with interest-free loans. Preparers who fail to make proper disclosures on this and other issues face stiff penalties. The new provision increases the first-tier penalty from $250 to the greater of $1,000 or half of the preparer’s total fee, whichever is larger. Second-tier penalty has been increased from $1,000 to the greater of $5,000 or half the preparer’s total fee, whichever is larger.
What that means for private equity is twofold. One, it is likely to lead to more paperwork and higher fees for some taxpayers. Two, expect a more conservative stance from tax preparers. A tax lawyer says: “My experience is tax preparers can be worse than the IRS. It’s almost like your audit happens but you have to clear the preparer hurdle, it’s smooth sailing from thereon out. Some people are bringing in preparers up front to sniff at this before it goes out because preparers are generally very, very conservative.”