IRC §6694 tax preparer penalty: the unreasonable position framework, willful or reckless conduct tier, and how the standards actually work in practice

If you sign a return as a paid preparer and the IRS later determines the return contained an understatement of tax liability attributable to an unreasonable position, IRC §6694 is the provision they will reach for. The statute has two tiers: an unreasonable position penalty for negligent positions and a heavier penalty for willful or reckless conduct. Both apply per return and stack with other preparer-focused provisions in subtitle F.

This is a preparer penalty, not a taxpayer penalty. The two analyses are connected but not coextensive.

What are the two IRC §6694 penalty tiers?

IRC §6694 imposes two penalty tiers on tax preparers. The §6694(a) penalty for unreasonable positions is the greater of $1,000 or 50% of income derived from the return. The §6694(b) penalty for willful or reckless conduct is the greater of $5,000 or 75% of income derived. Only one tier applies per return.

The §6694(a) penalty applies when you prepare a return or refund claim, the return contains an understatement of liability, the understatement is due to a position taken on the return, the position lacks the required level of support, and you knew or reasonably should have known of the position. The penalty is the greater of $1,000 or 50% of the income derived (or to be derived) with respect to the return.

The §6694(b) penalty applies when the conduct rises to 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 income derived. Under §6694(b)(3), if both apply to the same return, the (b) penalty is reduced by the (a) penalty actually paid; you do not stack the two against each other on the same conduct.

"Income derived" means the gross fee for the engagement, not net of overhead. For a $2,000 return, the §6694(a) penalty is $1,000; for a $3,000 return, it is $1,500.

What standard of authority does §6694 require for a tax position?

Whether a position triggers the §6694(a) penalty depends on the level of authority supporting it and whether the preparer disclosed it. Three standards apply in ascending order: reasonable basis (roughly 20% likelihood), substantial authority (roughly 40%), and more likely than not (greater than 50%). Disclosure on Form 8275 lowers the required standard for non-shelter positions.

Whether a position is "unreasonable" under §6694(a)(2) depends on the level of authority supporting it and whether you disclosed the position to the IRS. There are three principal standards, in ascending order of strength:

Reasonable basis (roughly a 20% likelihood of being sustained on the merits) is the default standard for undisclosed positions on most ordinary returns. A position has a reasonable basis if it is based on one or more authorities in the §1.6662-4(d)(3)(iii) hierarchy. Reasonable basis is more than non-frivolous and more than colorable; it is a real argument supported by a real authority. The Code, regulations, revenue rulings, published guidance, well-reasoned treatises, and court decisions all qualify; client memory and your own intuition do not.

Substantial authority (roughly 40%) is the standard for undisclosed positions on most returns where the taxpayer would be subject to substantial understatement penalties under §6662(d)(2)(B). The same authority hierarchy applies; the question is whether the weight of authorities supporting the position is substantial in relation to the weight of authorities supporting contrary treatment.

More likely than not (greater than 50%) is required for positions on tax shelters as defined in §6662(d)(2)(C) and for reportable transactions under §6707A. For these, even disclosure does not lower the standard.

Disclosure on Form 8275 (or Form 8275-R for positions contrary to a regulation) drops the required standard for non-shelter, non-reportable positions from substantial authority to reasonable basis. This is the practical lever you have for aggressive but defensible positions: disclose, document, and the standard you have to meet is lower.

How does the §6694(a)(3) reasonable cause defense work?

A preparer avoids the §6694(a) penalty by demonstrating reasonable cause for the position and good faith conduct. Treas. Reg. §1.6694-2(e) evaluates factors including normal office practice, reliance on client information, reliance on another professional's advice, error frequency, and materiality. The defense requires affirmative documentation, not merely the absence of bad intent.

The §6694(a) penalty is not imposed if the preparer can show there was reasonable cause for the position and the preparer acted in good faith. Treas. Reg. §1.6694-2(e) lists the factors:

• The nature of the error causing the understatement
• The frequency of errors of the same type
• The materiality of the position
• The preparer's normal office practice (procedures designed to identify errors, supervision of staff, training)
• Reliance on advice from another tax professional
• Reliance on information furnished by the taxpayer

Reliance on the client is the most contested factor. You can rely in good faith on information the taxpayer provides without independent verification, but you cannot ignore information that contradicts what the client told you, and you cannot accept obviously incomplete or inconsistent information without follow-up. The standard is what a competent preparer would do, not what would minimize your engagement time.

Reliance on another tax professional's advice generally requires that the other professional be competent in the area, have all relevant facts, and provide advice you actually relied on (not just consulted and overrode). A second opinion is not a shield if you did not follow it.

How does §6694 coordinate with other preparer penalty provisions?

§6694 is the primary preparer penalty, but several other Code sections and administrative regimes can apply to the same conduct. These include §6700 (abusive shelter promotion), §6701 (aiding and abetting understatement), §6713 and §7216 (unauthorized disclosure), and Circular 230 sanctions. Each has distinct elements, penalties, and scope.

§6694 is the headline preparer penalty but several others can apply to the same conduct:

§6700 penalizes promoting abusive tax shelters and is the relevant provision when the issue is shelter promotion rather than preparation. Penalty: the lesser of $1,000 per activity or 100% of gross income derived.

§6701 penalizes aiding and abetting an understatement: knowing that a document will be used in connection with a tax matter, knowing that a portion of the document will be used in a tax return, and knowing that the portion will result in understatement. Penalty: $1,000 per document ($10,000 for corporate-related conduct). Unlike §6694, §6701 reaches anyone who participates in the preparation, not just the signing preparer.

§6713 penalizes unauthorized disclosure or use of taxpayer information at $250 per disclosure, capped at $10,000 per year. §7216 makes knowing or reckless disclosure a criminal misdemeanor.

Circular 230 standards apply to attorneys, CPAs, Enrolled Agents, and other Office of Professional Responsibility (OPR) practitioners. OPR sanctions (censure, suspension, disbarment) are distinct from the monetary penalties under §6694 and can be imposed for conduct that does not involve a specific return.

§6751(b) requires written supervisory approval of penalty assessment. The Tax Court and several circuits have held that failure to obtain timely approval is grounds to invalidate the penalty; it is a procedural defense worth raising routinely.

What is the procedural path for contesting a §6694 penalty?

Preparer penalties under §6694 follow a distinct procedural track. There is no statutory notice of deficiency and no Tax Court jurisdiction. A preparer can seek IRS Appeals review before payment, or pay 15% of the penalty and file a refund suit in federal district court or the Court of Federal Claims under §6694(c)(2).

The IRS assesses preparer penalties under a procedure that differs from taxpayer deficiencies. There is no statutory notice of deficiency; the penalty is assessed and a notice and demand for payment issues. From there:

You can request IRS Appeals review before paying. Appeals will evaluate hazards of litigation, which often produces compromise. This is the cheapest path to engagement on the merits.

If you cannot resolve the matter in Appeals (or want to skip it), you pay 15% of the penalty, file a refund claim, and if the claim is denied you have 30 days to file a refund suit in federal district court or the Court of Federal Claims under §6694(c)(2). The 15% prepayment is the entry ticket to district court litigation; the remaining 85% is stayed during the suit if you pay timely.

The full Tax Court deficiency procedure under §6213 does not apply to preparer penalties. This is one of the main procedural differences from a §6651 or §6662 taxpayer penalty.

How can tax preparers manage §6694 penalty risk?

Most §6694 exposure is preventable through disciplined documentation and disclosure practices. The key steps are: document the legal authority for every non-obvious position before signing, disclose on Form 8275 when authority is uncertain, verify client information that appears inconsistent, and raise §6751(b) supervisory approval as a procedural defense if a penalty is proposed.

Most §6694 exposure is preventable with disciplined process. The patterns that produce penalties are not exotic positions; they are routine returns where corners were cut.

Document the authority for any position that is not the IRS's preferred treatment. If you take a position on classification, deduction, credit eligibility, or entity treatment that you would have to defend if asked, write down the authority that supports it before you sign. The contemporaneous note is reasonable cause documentation.

Disclose on Form 8275 when in doubt. Disclosure costs nothing and drops the standard you have to meet. The taxpayer may resist disclosure for non-tax reasons (audit risk perception); the engagement letter and the conversation about disclosure are themselves reasonable cause documentation.

Verify information that does not add up. A K-1 that does not match the prior year by a substantial amount, a Schedule C with no documented expenses despite a substantial business, foreign accounts the client mentions but cannot describe, these are the points where reliance on the client stops being good faith.

Coordinate with reasonable cause framework documentation for the taxpayer. If your client is facing §6662 exposure, your file and the client's reasonable cause file are interconnected. The same documentation tends to help both.

Watch §6751(b) supervisor approval timing in any penalty notice. If the IRS did not obtain written supervisory approval before the first communication proposing the penalty, the penalty may be invalid on procedural grounds regardless of the merits.

Preparer penalties are not catastrophic in isolation: $1,000 to $5,000 per return is a manageable exposure for an established practice. They become problematic in two situations: when they accumulate across many returns in a pattern audit, and when OPR action follows under Circular 230 and your practice license is on the table. The defense strategy for both starts with the same documentation discipline, and both reward early engagement of qualified controversy counsel rather than waiting for the matter to escalate.