Practices and Procedures · Rules and penalties

Types of penalties a preparer faces

Preparer penalties divide cleanly. Section 6694 punishes getting the position wrong, and is measured against the fee earned. Section 6695 punishes getting the paperwork wrong, and is a flat amount per failure. Knowing which family a notice belongs to tells you both what the exposure is and what argument answers it.

The rule

Unreasonable positions. A preparer who prepares a return or claim with an understatement due to an unreasonable position, and who knew or reasonably should have known of the position, pays the greater of $1,000 or 50% of the income derived or to be derived from the return or claim^TY2026 (IRC § 6694(a)(1)). What makes a position unreasonable depends on how it was handled: a position is unreasonable unless there is substantial authority for it; if it was disclosed it is unreasonable unless there is a reasonable basis; and for tax shelters and reportable transactions the standard is higher still (IRC § 6694(a)(2)).

Willful or reckless conduct. Where the understatement is due to a willful attempt to understate liability, or reckless or intentional disregard of rules or regulations, the penalty is the greater of $5,000 or 75% of the income derived or to be derived from the return or claim^TY2026 (IRC § 6694(b)).

The paperwork penalties. Section 6695 imposes $65 per return or claim, capped at $33,000^TY2026 for failing to furnish a copy of the return to the taxpayer, failing to sign, failing to furnish an identifying number, failing to retain a copy or list, and failing to file correct information returns. Negotiating a taxpayer’s refund check costs $665 per check, no cap^TY2026, and each failure to be diligent in determining eligibility for head of household filing status, the child tax credit, the American Opportunity credit, or the earned income credit costs $665 per failure, no cap^TY2026.

Aiding and abetting. Anyone who aids, assists in, procures, or advises on the preparation of a return, affidavit, claim, or other document, knowing it will be used in a material matter and knowing it would understate another person’s tax, pays $1,000 per document, and only one penalty per person per taxpayer per taxable period^TY2026 — or $10,000 per document where the document relates to a corporation's tax liability^TY2026 (IRC § 6701(a), (b)). The penalty does not require that the person be a preparer, or that the document be signed, or even that it be filed.

Disclosure and use of client information. Knowing or reckless disclosure of return information, or use of it for anything other than preparing the return, is criminal: a misdemeanor: a fine of up to $1,000, imprisonment of up to one year, or both, plus costs of prosecution^TY2026 (IRC § 7216(a)). The same conduct without the mental state carries the civil penalty of $250 per disclosure or use, capped at $10,000 per calendar year^TY2026 (IRC § 6713(a)). Both have exceptions for disclosures made under another provision of Title 26 or under court order (IRC § 7216(b)).

Frivolous submissions. A purported return that gives no basis for judging the correctness of the self-assessment, or that is substantially incorrect on its face, draws $5,000 per frivolous return or specified frivolous submission^TY2026 where the conduct rests on a position the Secretary has identified as frivolous or reflects a desire to delay or impede administration (IRC § 6702(a)). The same amount applies to a specified frivolous submission — a collection due process request, installment agreement application, offer in compromise, or taxpayer assistance order request on the same footing (IRC § 6702(b)).

The taxpayer-side categories a preparer must recognise. The accuracy-related penalty applies to, among others, negligence or disregard of rules or regulations, any substantial understatement of income tax, and substantial valuation misstatements (IRC § 6662(b)). These matter to a preparer because the same positions that expose a client under § 6662 expose the preparer under § 6694. An understatement is substantial when it exceeds an understatement exceeding the greater of 10% of the tax required to be shown or $5,000 (corporations: the lesser of the greater of 10% or $10,000, or $10,000,000)^TY2026 (IRC § 6662(d)(1)). A valuation misstatement is graded by how far the claimed figure sits from the correct one — substantial at 150% or more of the correct value or adjusted basis; gross at 200% or more^TY2026 (IRC § 6662(e)(1)(A), § 6662(h)(2)(A)) — and at the gross level the rate doubles to 40% of the underpayment attributable to a gross valuation misstatement^TY2026 (IRC § 6662(h)(1)).

Current figures

How it works in practice

The § 6694(a) standards are a ladder, and disclosure is the rung that moves you down it. With substantial authority, an undisclosed position is safe from the penalty. Without it, disclosure drops the requirement to reasonable basis — a materially lower bar. A preparer who is unsure of a position has a decision to make at the time of filing, not after the notice arrives.

Because § 6694 is measured against income derived from the return, the exposure scales with the fee. On a modest engagement the floor governs; on a substantial one, the percentage does, and a single return can carry a penalty far above the floor.

The § 6695 penalties look small individually and are not. They apply per return or claim, and the annual caps sit well above the individual amount, so a systemic office failure — an unsigned return template, a missing identifying number in the software profile — multiplies quickly. Two of them have no cap at all: negotiating a refund check, and the due diligence penalty, which applies per failure and can be charged more than once on a single return where several credits are in issue.

Section 6701 is the one that catches people who do not think of themselves as preparers. It reaches anyone who advises on any portion of a document, and the statute requires no signature, no compensation, and no filing — a bookkeeper who supplies figures they know to be wrong is inside it. The offsetting limit is § 6701(b)(3): one penalty per person, per taxpayer, per taxable period, no matter how many documents.

The information-handling rules are two penalties for one act, separated by state of mind. Section 7216 is a misdemeanor and needs knowing or reckless conduct; § 6713 is strict-liability civil and needs neither. A disclosure made carelessly rather than knowingly still costs, per disclosure, up to the annual cap. Both bite on the ordinary commercial temptation — using a client list to market an unrelated service — not just on leaks.

Circular 230 § 10.34 sits alongside all of this, imposing professional standards on the same conduct, so a position that draws a § 6694 penalty will often also be a Circular 230 matter for the Office of Professional Responsibility.

How this has changed

Section 6694 was rewritten in 2007, which replaced the old realistic-possibility standard with the substantial authority and reasonable basis ladder now in subsection (a)(2), raised the penalties, and tied them to income derived from the return rather than fixing them at flat amounts. The § 6695 penalties, by contrast, remain flat but are now indexed for inflation, so they creep upward annually and any figure quoted without a filing year should be checked. The due diligence penalty under § 6695(g) has expanded in coverage over successive changes, reaching beyond the earned income credit to the child tax credit, the American Opportunity credit, and head of household filing status.

Exam focus

Know the § 6694(a) ladder cold: substantial authority for an undisclosed position, reasonable basis for a disclosed one, and a higher standard for tax shelters and reportable transactions. Know that both § 6694 penalties are the greater of a dollar floor or a percentage of income derived — 50 percent for unreasonable positions, 75 percent for willful or reckless conduct. On § 6695, expect questions on which failures carry a cap and which do not, and on the per-failure operation of the due diligence penalty. Beyond those two sections, know that § 6701 turns on knowledge rather than on preparer status, that § 7216 is the criminal provision and § 6713 its civil twin, and that the accuracy-related rate doubles from 20 percent to 40 percent when a valuation misstatement is gross.

Check yourself

1. A preparer takes an undisclosed position with no substantial authority, earning a $12,000 fee, and an understatement results. The § 6694(a) penalty is: (A) The statutory floor (B) $6,000, being 50 percent of the income derived (C) $12,000 (D) 75 percent of the fee Answer: B. The penalty is the greater of the floor or 50 percent of income derived.

2. Which § 6695 penalty has no annual maximum? (A) Failure to sign the return (B) Failure to furnish a copy to the taxpayer (C) Negotiation of a taxpayer’s refund check (D) Failure to retain a copy or list Answer: C. Check negotiation and the due diligence penalty are uncapped.

3. A return claims head of household status, the child tax credit, and the earned income credit, with no due diligence performed on any. The § 6695(g) exposure is: (A) One penalty, because it is one return (B) Three penalties, one per eligibility determination (C) One penalty capped annually (D) No penalty if the return is accurate Answer: B. The penalty applies per failure.

4. A bookkeeper knowingly supplies fabricated figures used on a client’s return. The bookkeeper does not sign the return and is not paid for tax work. Which penalty applies? (A) None, because the bookkeeper is not a return preparer (B) IRC § 6694(b), for reckless conduct (C) IRC § 6701, for aiding and abetting an understatement (D) IRC § 6695(b), for failure to sign Answer: C. Section 6701 requires neither preparer status, a signature, nor compensation.

5. A preparer carelessly, but not knowingly, uses a client’s return information to market an unrelated service. The exposure is: (A) A misdemeanor under IRC § 7216 (B) The civil penalty under IRC § 6713 (C) Both, since the acts are identical (D) Neither, because marketing is not disclosure Answer: B. Section 7216 needs knowing or reckless conduct; § 6713 does not.