Tax return preparer penalties are all too real when they begin impacting your finances and reputation. Tax preparers who understate taxpayers’ liabilities may face penalties that range from $1,000 to $5,000, or 50% to 75% of the preparation fees. To steer clear of these penalties, it’s critical to understand both the penalties and their underlying standards which are based on qualitative judgments rather than clear-cut bright-line tests.
Major standards
The three standards listed below are key tools to utilize when analyzing a tax return position. They are vital when the position is slightly contrary to the usual tax law interpretation but may be somewhat validated by other authorities such as case law.
Substantial authority: Authority comes from the relevance, persuasiveness and document type: a revenue ruling has more weight than a private letter ruling, for example. The authoritative list of substantial authority is found in Reg. §1.6662-4(d)(3)(iii).
Reasonable basis: In cases where substantial authority is not met, they could still meet the reasonable basis standard. Consider a charitable deduction based on resale markets rather than thrift store value. While some case law may support the resale market position, the weight of authority in Regs §1.170A-1(c)(2) and IRS Pub. 561, Determining the Value of Donated Property, favors thrift store value. This position has reasonable basis but not substantial authority.
Adequate disclosure: Providing a detailed explanation that attaches to the return may be the remedy for a questionable position. If disclosed on Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, penalties could be avoided under the reasonable basis standard. Follow the annual disclosure list in Rev. Proc. 2024-44 for when return-level disclosure is deemed sufficient to reduce understatement exposure on 2024 forms. Watch for the 2025 Rev. Proc. update; NATP will alert you when it is available.
A breakdown of the understatement penalties
Two preparer penalties may apply in the case of tax liability understatements:
§6694(a): unreasonable position. Applies when a filed position lacks substantial authority and, if disclosed, doesn’t meet reasonable basis. Disclosure via Forms 8275 or 8275-R may mitigate the potential penalties, but only if the position clears reasonable basis, like the example above. The penalty is the greater of $1,000 or 50% of the return preparation fee.
§6694(b): willful or reckless conduct. Considered intentional rule-breaking or gross indifference to the law. Examples would be inventing dependents or manufacturing losses for a non-existent business. Intent or knowledge of the rule-breaking is the key offending factor here. The penalty is the greater of $5,000 or 75% of the return preparation fee.
Who is affected
Penalties expose both the individual preparer and the firm. The IRS typically penalizes the person “primarily responsible” for the position, but firms may also face penalties up to a percentage of the income derived from the work.
Penalty relief
Reasonable cause and good-faith procedures may qualify for relief only if backed by real systems and supervision, followed by timely corrective action (see Tracy v. Commissioner, T.C. Summ. Op. 2023-20). In Tracy, an ill and aging lawyer whose assistant withheld employment taxes was granted relief under reasonable cause, not because of the illness and age, but because systems were in place that would have prevented the trust tax abuse under normal circumstances. Mere forgetfulness or illness is insufficient; ordinary and prudent business practices that are otherwise workable attract the reasonable cause remedy.
Lesser-known penalties include:
- §6700 (abusive shelters)
- §6701 (aiding and abetting understatements)
- §6707/§6707A (reportable transactions)
- §6708 (advisee lists)
- §6713/§7216 (improper use/disclosure)
- §7206/ §7207 criminal provisions and
- §7407/§7408 injunctions
Clear steps to avoid understatement preparer penalties
- Institutionalize due diligence. Use written checklists, engagement scopes and second-review protocols. Document inquiries on dubious positions. Don’t allow clients who urge willful or unreasonable conduct to sway your professional judgment.
- Align positions to authority. Build files with current, on-point authorities; weigh them against contrary authority. If substantial authority can’t be reached, obtain reasonable basis and proper disclosure (Forms 8275 and 8275-R).
- Disclose intentionally. Using the Form 8275 series, apply the annual disclosure list found in Rev. Proc. 2024-44 for adequate disclosure on 2024 returns where it helps reduce §6694(a) exposure.
Protect your reputation and finances by avoiding penalties for unreasonable positions or reckless conduct. Allow your professional judgment to keep you and your clients on track.
Be sure to read the full How-To article on penalties in the October 2025 TAXPRO.
