In a Field Attorney Advice 20223301F, the IRS Chief Counsel's Office determined that a penalty should be assessed against a tax preparer who advised their client that a reserve for estimated liabilities could be excluded from income.
Generally, federal tax rules prohibit a taxpayer from using reserves to offset gross revenue. Instead, those rules require that liabilities be "fixed" before becoming deductible under the "all events test" in Code Sec. 461. During the tax year at issue, reserves were treated differently for financial statement purposes.
The parent of a consolidated group that had undergone a "technical termination" during a reorganization was advised by the firm preparing its tax return that it could employ the reserve method of accounting for tax purposes and include income items net of its reserves (e.g., the estimated cost of its anticipated discounts and disputed claims
According to the Chief Counsel's Office, the return position the preparer advised the taxpayer to take ran contrary to settled law applicable to the facts and circumstances. The IRS should therefore assess the preparer penalty for willful or reckless conduct under Code Sec. 6694(b).
The Chief Counsel's Office determined that the penalty under Code Sec. 6694(b) was proper because all of the tax professionals involved in giving the taxpayer advice had to have been aware of Code Sec. 461 and its corresponding regulations when providing the advice.
They knew the taxpayer couldn't use book accounting to exclude or deduct estimated liabilities for tax reporting, so their written advice that the taxpayer should do just that intentionally disregarded the rules and regulations.
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