Background of Rules under 7216
Progressive firms are increasingly using advanced technology to comply with the volume of regulations imposed by 7216. Regardless of how a firm plans on complying with 7216, and before we discuss potential technological solutions, it is important to have at least a broad understanding of the rules under 7216.
The fact that 7216 is a criminal statute is important in two respects:
•The penalties imposed may include jail time, as each violation of 7216 is a misdemeanor and could result in a fine of up to $1,000 (in addition to the costs of prosecution) or one-year imprisonment, or both.
•Since 7216 is a criminal statute, the Internal Revenue Service is extremely limited in the type of interpretation and guidance it may issue. As a result, Private Letter Rulings and similar guidance are not available to address 7216 issues and provide clarity for practitioners.
Practitioners need to follow a three-step analysis to determine whether they are subject to the regulations:
1. Are they a tax return preparer? 7216 only applies to “tax return preparers,” who can be broadly defined as “any person who is engaged in the business of preparing or assisting in preparing tax returns; or who are otherwise compensated in connection with the preparation of a tax return.” This category is extremely comprehensive, and includes all types of individuals associated with the preparation and processing of tax returns. However, the IRS has published a list of people who (under certain circumstances) are not considered tax return preparers, most notably fee-based financial planners, and bank employees who review tax returns in connection with loan applications.
2. Do they possess tax return information? Once practitioners have determined that they are tax return preparers subject to the 7216 regulations, they next need to determine if what they possess is “tax return information.” Fortunately, determining the answer to that question is easy. Tax return information means any information, including, but not limited to, a taxpayer's name, address or identifying number, which is furnished in connection with the preparation of a tax return of the taxpayer.
3. Are they committing an unauthorized “use or disclosure” of that information?
When practitioners have established that they fit the first two definitions, they need consider whether their use or disclosure of that information is prohibited. Unless an exception applies or consent is obtained the IRS rules essentially prohibit any type of use or disclosure of tax return information other than for the purposes of preparing a tax return.
Under the IRS rules, there are several ways that a practitioner can “use” and/or “disclose” tax return information without first obtaining explicit written consent. As you will note, there is a significant distinction between “use” and “disclosure” of tax return information.
There are almost 20 exceptions to the 7216 rules, so we will not cover all of them here, but it is helpful to get a brief look at some of what most consider the “major” exceptions:
•Disclosure to members of the same firm for the purposes of preparing the client’s tax return, or providing other legal or accounting services to the client is expressly permitted under the 7216 regulations. Note that this does not permit disclosure to affiliate firms, and does not permit disclosure to members who are located outside of the United States (even if they are part of the same firm).
•Use of tax return information to provide other legal or accounting services to the taxpayer is permitted without consent. This exception is important because it could conceivably cover many services performed by attorneys and accountants, such as (1) the preparation of books and records, working papers, or accounting statements or reports for the taxpayer; (2) making the tax return information available to third parties, including stockholders, management, suppliers, or lenders, consistent with the applicable legal and ethical responsibilities, unless the taxpayer directs otherwise; and (3) estate planning or administration, or preparation of trial briefs or trust instruments, for the taxpayer or the estate of the taxpayer.
•The IRS rules permit use but not disclosure of the taxpayer’s information to send the taxpayer additional tax information or offer additional tax return preparation services to the taxpayer. Unfortunately, the term “tax information” is not defined in the IRS regulations and it is an open question as to how broad this exception may be.
One rule of thumb for 7216 issues is, when in doubt, obtain consent from the taxpayer prior to making a use or disclosure. Unfortunately, obtaining consent under the 7216 regulations is not as straightforward as it sounds. The IRS rules set forth complex requirements for obtaining consent that can be incredibly detailed. For example, a specific format (81/2-by-11 in. page size, 12-point font) is required for 1040 series filers, while consent for non-1040 series filers can be in any format (including an engagement letter), so long as the required information is obtained. Consent can also be obtained electronically, provided the (very specific) requirements of the IRS rules are satisfied.
Finally, there are two important things to note about consent.
1. Consent cannot be retroactive and the tax return preparer must obtain consent before use or disclosure.
2. If not otherwise specified in the consent, the duration of consent is for one year.
Compliance Challenges:
As illustrated, the various mandates set forth in 7216 are complex and demand significant investment of time. Tech-savvy firms realize that technology is the answer to streamlining the compliance process and are starting to transition from traditional, manual processes to a technology-driven approach.
And though some firms have put forward notable effort to comply with the 7216 “disclosure” rules, many have yet to implement a system to manage 7216 to the full letter of the law. However, disclosure regarding third-party entities is just one small slice of the 7216 pie. It’s the far bigger and more complex “use” to use piece that demands the most attention.
Under the use rules, firms must obtain the client’s permission to use their tax information for any purpose outside of preparing and filing the return. This not only includes providing data to outside institutions such as banks or mortgage companies, but also relates to sending clients information, such as educational articles or marketing literature for services that are not tax-related.
To understand the complexity of complying with use rules, consider the following example:
A firm sends out a monthly newsletter (print or digital) to all tax-only clients. Articles provide clients with information on estate planning, IRA & 401(k) investment tips, and other small business accounting guidance. Because the mailing list is comprised of the firm’s tax-only clients, consent forms are required from each client to send non tax-related articles. Additionally, consent forms need to be obtained to send information about the firm or marketing notices about firm services.
Without a system to track and monitor this activity, firms face an administrative nightmare!
Technology Solution:
Progressive firms are applying powerful applications to handle 7216 efficiently. Leading compliance systems provide a sophisticated, paperless solution to manage 7216 use and disclosure issues. These solutions also offer Form Builder technology to create custom consent forms. This technology allows firms to embed forms within a personalized email and send to clients in minutes. Clients electronically sign forms, complete with a time stamp and press a submit button.
These top-of-the-line systems provide pre-written IRS-required text that can easily be inserted into forms—as well as handle non-7216 compliance tasks, such as when approval is required to send any type of information at a client's behest (e.g., financial statements to banks or tax return copies to other CPAs, banks or mortgage brokers).
Leading firms are using the most advanced technologies to operate at peak efficiency. Beyond automating tax and accounting workflows, these firms are also adopting technology to streamline compliance tasks—saving hours of manual work and mitigating the potential for criminal sanctions and civil fines due to non-compliance. If you have not yet, it may be time look at automated Compliance Center solutions to easily manage 7216.