Definition
Section 6694 penalizes preparers of federal tax returns and refund claims. Under 6694(a), when an understatement results from a position without substantial authority, or, if disclosed, without a reasonable basis, the penalty is the greater of $1,000 or 50 percent of the income the preparer derived from the return, unless there was reasonable cause and good faith. Under 6694(b), for willful or reckless conduct, it is the greater of $5,000 or 75 percent of the income derived. Amounts paid under (a) reduce the amount owed under (b). Tax shelters and reportable transactions face a higher standard.
Why it matters in an audit or review
Firms that prepare returns as well as perform attest services must meet these standards without compromising independence. The standards also frame what a firm expects of preparers who support the tax provision, and unresolved penalty exposure belongs in the firm's risk assessment.
Example
Illustrative: a preparer earned $900 from a return with an understated tax caused by an undisclosed position lacking substantial authority. The 6694(a) penalty is the greater of $1,000 and 50% x $900 = $450, which is $1,000.
Common mistakes
- Assuming disclosure on the return protects any position.
- Relying on client information without making reasonable inquiries.
Sources
- Internal Revenue Code section 6694: https://www.law.cornell.edu/uscode/text/26/6694
- Treasury Department Circular No. 230, 31 CFR Part 10, sections 10.34 and 10.22
- Treas. Reg. 1.6694-1 through 1.6694-4
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error