Ask the Tax Editor, October 2: Questions for Tax Preparers

Each week in our Ask the Tax Editor series, Joy Taylor, The Kiplinger Tax Letter editor, answers questions on topics submitted by readers. This week, she's looking at four tax questions from readers who are paid tax return preparers. (Get a free issue of The Kiplinger Tax Letter or subscribe.)

1. How much can you rely on the IRS's frequently asked questions?

Question: It seems that for the past several years, the IRS has issued lots of its tax law guidance quickly in the form of frequently asked questions (FAQ). Can my clients rely on the agency's FAQs to avoid penalties if the IRS audits them?

Joy Taylor: In many cases, yes. Although the IRS's FAQ guidance does not rise to the level of legal authority and cannot be cited as precedent to support the merits of a taxpayer's position, taxpayers can rely on them to escape accuracy-related penalties. Taxpayers who can show that they relied on the FAQs in good faith and that such reliance was reasonable based on all the facts and circumstances have a valid reasonable-cause defense and won't be subject to the negligence penalty or other accuracy-related penalties.

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The IRS includes the following language in each of its FAQ guidance documents:

"These FAQs are being issued to provide general information to taxpayers and tax professionals as expeditiously as possible. Accordingly, these FAQs may not address any particular taxpayer’s specific facts and circumstances, and they may be updated or modified upon further review. Because these FAQs have not been published in the Internal Revenue Bulletin, they will not be relied on or used by the IRS to resolve a case. Similarly, if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer’s case, the law will control the taxpayer’s tax liability. Nonetheless, a taxpayer who reasonably and in good faith relies on these FAQs will not be subject to a penalty that provides a reasonable cause standard for relief, including a negligence penalty or other accuracy-related penalty, to the extent that reliance results in an underpayment of tax. Any later updates or modifications to these FAQs will be dated to enable taxpayers to confirm the date on which any changes to the FAQs were made. Additionally, prior versions of these FAQs will be maintained on IRS.gov to ensure that taxpayers, who may have relied on a prior version, can locate that version if they later need to do so."

2. Do paid preparers need a data security plan?

Question: I am a self-employed tax return preparer. I heard that the IRS requires all paid preparers to have a data security plan. Is this true?

Joy Taylor: Yes. Having a data security plan is mandatory for paid tax return preparers. In part, that's because preparers are a frequent target of cyberthieves, who prey on them in their quest for taxpayer personal information.

Anyone who prepares or assists in preparing federal tax returns for compensation must have a preparer tax identification number (PTIN) from the IRS that they renew each year. The form that preparers use to apply for or renew their PTIN requires them to check yes or no to the following statement: "I am aware that paid tax return preparers are required by law to create and maintain a written information security plan that provides data and system security protections for all taxpayer information."

IRS provides help for preparers who need to create a written information security plan. IRS Publication 5708 includes a template of a written information security plan (or WISP) that preparers can use as a starting point and amend according to their own situation.

3. IRS regulation of unenrolled preparers

Question: I am a tax return preparer. I am not a CPA, enrolled agent or lawyer. I heard that Congress wants to make it harder for me to get a preparer tax identification number (PTIN) each year. Can you explain exactly what Congress is proposing for tax return preparers?

Joy Taylor: In late September, the Senate approved a bipartisan bill called "The Taxpayer Assistance and Service Act" that has over 60 proposals covering 10 broad topics:

• Tax administration and customer service
• U.S. citizens who live abroad
• Streamlining judicial review for filers who challenge IRS in court
• Tax return preparers
• IRS's Taxpayer Advocate's office
• IRS's appeals office
• Whistle-blowers
• U.S. citizens held hostage overseas
• Small businesses
• Miscellaneous provisions

One of the sections in this bill would let the IRS regulate unenrolled paid tax return preparers. An unenrolled preparer is someone who prepares tax returns for money but is not a CPA, lawyer, enrolled agent or a comparable state-licensed holder.

Under the bill, unenrolled preparers would have to meet various requirements in order to apply for or renew a PTIN each year. These preparers must provide information about their competence and character, pass criminal background and tax compliance checks, and take up to 18 hours of continuing education courses. Importantly, the proposal does not require unenrolled preparers to pass a competency exam. Under the proposal, the IRS would be able to deny, revoke or suspend PTINs for unenrolled preparers who don't comply with the rules.

Giving the IRS power to regulate unenrolled preparers has been tried before. Since 2014, after an appeals court struck down the IRS's administrative oversight rules for unenrolled preparers, the IRS's National Taxpayer Advocate, Treasury inspectors, government auditors and tax practitioner groups have pleaded with Congress to let the IRS regulate unenrolled preparers. But this has always faced a wall of naysayers in the House and Senate, mainly Republicans, with added pressure from key free-market groups that oppose giving the IRS more statutory authority to regulate preparers.

But some tax professionals say this time could be different. The current language in the bipartisan Senate bill is more modest when compared with prior proposals. Democrats have made preparer oversight a top priority. And it is well-documented that unenrolled preparers make more errors with their clients' refundable credits and certain other tax breaks, when compared with filers who do their own returns, CPAs, enrolled agents, attorneys, and volunteers with tax-filing assistance programs.

Now that the Senate has approved the Taxpayer Assistance and Service Act, the ball is in the House's court. Maybe we will see the House act on the bill in the short time period after the midterm elections and before lawmakers head home again for the December holidays. There are many factors that will determine this, including which party comes out ahead in the midterms, other items on the House's plate, and the determination of legislators to focus on taxes.

4. What are the electronic filing rules for client returns

Question: I am a part-time, self-employed tax return preparer. On average, I prepare about 15 Form 1040 tax returns each filing season for my clients. I prepare the returns on paper and give them to my clients to file. Someone told me that I have to file my clients' returns electronically each year. Is this accurate?

Joy Taylor: The rules for tax preparers on electronic filing of client tax returns are thorny, but I'll try to explain them as simply as I can.

The preparer e-filing rules have been around since 2011. As a general rule, preparers who expect to file more than 10 Forms 1040, 1040-SR, 1040-NR or 1041, or any combination of these during the year, must electronically file them with the IRS.

There are three escape hatches to this general rule:
First, your clients can opt out of e-filing. Returns that clients mail to the IRS themselves are not treated as filed by the preparer and do not count against the 10-return cap. Clients must opt for this in writing. Preparers must keep a copy of the clients' signed statements in their file and attach the IRS Form 8948 to the tax return that the client mails to the IRS. Note that you can provide filing instructions, addressed envelopes, stamps, etc., as long as the client actually mails the return.

Second, preparers who don't e-file returns can request a hardship waiver using IRS Form 8944. To seek a hardship waiver, you must generally send the 8944 to the IRS by February 15 of the year for which the waiver is sought. Note that the IRS is sometimes a bit stingy in granting these waivers. Also, the waivers are valid for one calendar year.

Third, there are a few very narrow administrative exemptions. For example, one is for preparers who are members of certain religious groups who oppose e-filing.

About Ask the Editor, Tax Edition

Subscribers of The Kiplinger Tax Letter, The Kiplinger Letter and The Kiplinger Retirement Report can ask Joy questions about tax topics. You'll find full details of how to submit questions in each publication. Subscribe to The Kiplinger Tax Letter, The Kiplinger Letter or The Kiplinger Retirement Report.

We have already received many questions from readers on topics related to tax changes in the One Big Beautiful Bill, retirement accounts and more. We will continue to answer these in future Ask the Editor roundups. So keep those questions coming!

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