With the release of the recently proposed IRS rules, many tax groups are urging Congress to modify a provision it approved that has resulted in a fundamental change in the role of tax return preparers and, ultimately will cause an increase in preparer fees for taxpayers.

In May 2007, Congress passed the Small Business and Work Opportunity Tax Act of 2007 (H.R. 1591) as part of the supplemental appropriation bill. Tax provisions included various incentives for small businesses, such as the expansion of expensing, the work opportunity tax credit, child care grants, and provisions favoring family businesses and S corporations. However, one tax provision found in section 8246 has proven to be controversial especially among tax preparers.

Specifically, section 8246 increased the tax return reporting standards applicable to tax return preparers under section 6694 of the Internal Revenue Code for undisclosed, non-tax avoidance items, from the "realistic possibility of success" standard to the "more likely than not" standard. As under prior law, if that reporting standard cannot be satisfied and the preparer wants protection from the possible imposition of an understatement penalty, a disclosure of the item on the return is necessary.

Section 8246 is a major change in tax policy, according to some. Prior to the bill's enactment, section 6694 of the code applied only to "income tax return preparers." Now it applies to all "tax return preparers", including those who prepare estate and gift tax returns. Prior to enactment, the penalty under the section was $1,000. It has been increased to $5,000 or 50 percent of the income derived in respect of preparing the return.

The change most troublesome to preparers is the new "more likely than not" standard. Prior law permitted preparers to recommend undisclosed return positions that merely enjoyed a "realistic possibility of success on the merits". Meaning that a preparer would face no penalty for recommending a tax position on a return even if the preparer thought the position might have only about a one in three possibility of success on the merits—without regard to the possibility of audit or detection on audit.

Under the legislative change, a preparer faces penalty for "unreasonable positions", defined as a position of which the preparer knew or reasonably should have known for which there was not a "reasonable belief" that the position was "more likely than not" to be sustained on the merits and the position was not disclosed or, if disclosed, there was not a reasonable basis for the position. This "more likely than not" standard requires a more than 50 percent confidence level for undisclosed positions and a "reasonable basis" confidence level for disclosed positions.

While Congress claims to have put the new preparer standards in place to make tax preparers more accountable to their clients, some claim the rules will allow preparers to be less accountable by changing the meaning of disclosure in a way Congress may not have intended. Because it also raises the standard for tax preparers to a level above the standard for taxpayers, it creates the potential for conflicts of interest between preparers and their clients, and consequently affects the nature of taxpayers' representation. Return preparation fees could increase because more research will be required for tax preparers to feel secure that the "more likely than not" standard is satisfied.

These new provisions have been disconcerting for many attorneys, certified public accountants, and tax preparers and were discussed in depth at an August 18 IRS hearing on the proposed rules.

Meanwhile, the Treasury Department and the IRS have argued that tax amendments, together with the changes in existing business practices and the increased complexity of the federal tax law, have created an increased need for specialization which has required the new type of rules.