In 2023 alone, the IRS assessed over $13 million in civil penalties against tax return preparers. Many candidates see those figures and assume the exam is about memorizing penalty amounts, but that's the number one reason they fail these questions. The real trap isn't forgetting if a penalty is $65 or $630; it's failing to distinguish the preparer's conduct that triggers a $1,120 penalty versus the conduct that triggers a $5,590 penalty for the exact same tax understatement.
Preparer penalties and due diligence are tested on EA SEE Part 3, covering sanctions for tax preparers under IRC §§6694, 6695, and Circular 230. Mastery requires applying the correct penalty based on the preparer's conduct, such as an unreasonable position versus willful disregard of rules.
Key facts
- Relevant Exam Section: SEE Part 3 (Representation, Practices, and Procedures)
- Primary Governing Rules: IRC §§6694, 6695; Treasury Dept. Circular 230
- Key Penalty (Unreasonable Position): Greater of $1,120 or 50% of preparer's fee (IRC §6694(a) for 2026)
- Key Penalty (Willful Conduct): Greater of $5,590 or 75% of preparer's fee (IRC §6694(b) for 2026)
- Due Diligence Penalty (EITC, etc.): $630 per failure, per credit (IRC §6695(g) for 2026)
- Official Body: Internal Revenue Service (IRS)
What Are the Core Preparer Penalties on the EA Exam?
The core preparer penalties are monetary sanctions the IRS can impose on tax return preparers for specific failures ranging from simple administrative errors to intentional fraud. These rules, primarily found in Internal Revenue Code sections 6694 and 6695, are heavily tested on SEE Part 3 because they form the legal backbone of an Enrolled Agent's professional responsibility. Your ability to correctly identify the violation and apply the corresponding penalty is crucial.
The exam requires you to differentiate between three main categories of penalties. Understanding this framework is the first step.
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- Understatement Penalties (IRC §6694): These are the most complex and heavily tested. They apply when a preparer's action (or inaction) leads to an understatement of the client's tax liability. The penalty amount depends entirely on the preparer's level of fault.
- Due Diligence & Administrative Penalties (IRC §6695): These are generally fixed-dollar penalties for specific procedural failures, like forgetting to sign a return or not keeping required records. The penalty for failing to meet due diligence requirements for certain tax credits falls here and is a major focus area.
- Ethical Sanctions (Circular 230): While not a monetary penalty from the IRC, violations can lead to sanctions from the IRS Office of Professional Responsibility, including censure, suspension, or disbarment from practice.
Here is a quick-reference table summarizing the key distinctions you must know for the exam.
| Penalty Category | Triggering Conduct | Key Standard / Rule | 2026 Penalty Amount |
|---|---|---|---|
| Unreasonable Position | Taking a tax position without substantial authority (if undisclosed) or reasonable basis (if disclosed). | IRC §6694(a) | Greater of $1,120 or 50% of the preparer's fee. |
| Willful/Reckless Conduct | Intentionally disregarding rules or being reckless in an attempt to understate tax liability. | IRC §6694(b) | Greater of $5,590 or 75% of the preparer's fee. |
| Due Diligence Failure | Failing to meet knowledge, documentation, or checklist requirements for EITC, CTC, AOTC, etc. | IRC §6695(g) | $630 per failure, per credit, per return. |
| Administrative Failures | Failing to sign the return, provide a copy to the taxpayer, or include PTIN. | IRC §6695(a-d) | $65 per failure (max caps apply). |
Before you get lost in the details, try VoraPrep's free EA practice questions to see how these concepts are presented in exam-style scenarios. For a comprehensive overview of what it takes to become an EA, explore our guide on EA exam requirements and eligibility.
How Does the IRS Define and Penalize Understatements? (IRC §6694)
The penalties under IRC §6694 are the most challenging because they require you to analyze a fact pattern and judge the preparer's state of mind. Mastering this nuanced application is key to improving your EA exam pass rates, which typically range from 60-70%. Understanding the core differences between these penalties is a critical component of building your expertise as an Enrolled Agent.
The "Unreasonable Position" Penalty (IRC §6694(a))
A preparer is penalized under §6694(a) if they take a position on a return that results in a tax understatement and they did not have a realistic possibility of being sustained on its merits. The key is understanding the hierarchy of standards required to avoid this penalty.
- For undisclosed positions: The preparer must have substantial authority for the position. This is a high standard, meaning the weight of authorities supporting the treatment is substantial in relation to those opposing it.
- For disclosed positions: If the position is properly disclosed on Form 8275 or 8275-R, the standard drops to reasonable basis. This is a lower bar, but still requires more than just an arguable or colorable claim.
The penalty for 2026 is the greater of $1,120 or 50% of the income the preparer derived from the return. The penalty can be waived if the preparer can show there was reasonable cause for the understatement and they acted in good faith.
The "Willful or Reckless Conduct" Penalty (IRC §6694(b))
This is the most severe preparer penalty. It applies if an understatement is due to a preparer's willful attempt to understate tax liability or a reckless or intentional disregard of tax rules and regulations. "Willful" means a conscious, voluntary act. "Reckless" means making little to no effort to determine if a rule applies.
An exam question might describe a preparer who ignores a client's W-2 and instead uses a much lower, unsubstantiated income number the client provides verbally to maximize a credit. This is a classic example of reckless disregard.
The penalty for 2026 is the greater of $5,590 or 75% of the income the preparer derived from the return. There is no "reasonable cause" defense for this penalty.
What Are the Other Key Preparer Penalties? (IRC §6695 & Circular 230)
Beyond understatements, the IRS penalizes specific procedural and due diligence failures under IRC §6695. These are often tested as "add-on" penalties in larger scenario questions, reflecting the comprehensive nature of an Enrolled Agent's responsibilities.
Specific Due Diligence Failures (IRC §6695(g))
This is a critical, frequently tested area. For returns claiming the Earned Income Tax Credit (EITC), Child Tax Credit (CTC/ACTC/ODC), or the American Opportunity Tax Credit (AOTC), a preparer has a specific, heightened due diligence responsibility.
They must:
- Complete and submit Form 8867, Paid Preparer's Due Diligence Checklist.
- Interview the taxpayer and ask adequate questions to resolve inconsistencies.
- Retain records and documentation used to determine eligibility.
Failure to meet these requirements for each applicable credit triggers a $630 penalty (for 2026) per failure. Forgetting to complete Form 8867 for a return claiming both the EITC and CTC would result in two penalties, totaling $1,260.
Administrative Penalties (IRC §6695(a)-(f))
These are strict liability penalties for procedural oversights. For 2026, the most common are:
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- Failure to Furnish Copy to Taxpayer (§6695(a)): $65 per failure.
- Failure to Sign Return (§6695(b)): $65 per failure.
- Failure to Furnish PTIN (§6695(c)): $65 per failure.
- Failure to Retain Copy or List (§6695(d)): $65 per failure.
- Negotiation of Refund Check (§6695(f)): $590 per check. This is a severe violation also prohibited by Circular 230.
The Role of Treasury Circular 230
Circular 230 provides the broad ethical and professional standards for practicing before the IRS. While it doesn't impose its own monetary penalties, violating its standards (like the duty of due diligence in Section 10.22) is often the root cause of conduct that triggers IRC penalties. Severe or repeated violations can lead to IRS sanctions like censure, suspension, or permanent disbarment. Understanding these ethical obligations is as crucial as knowing the tax code itself, impacting everything from your daily practice to your potential Enrolled Agent salary.
Worked Example: Calculating Total Preparer Penalties (2026 Rules)
Let's apply these updated 2026 rules to a realistic exam scenario. This is how you must think to get the question right.
Scenario: Elara, an Enrolled Agent, prepared the 2025 federal income tax return for her client, Mr. Henderson. During their interview, Mr. Henderson mentioned a significant business loss from a prior year. Elara, without requesting any documentation or reviewing prior-year returns, accepted his verbal assertion of a $50,000 net operating loss (NOL) carryforward and applied it. Elara also included an Earned Income Tax Credit (EITC) on the return. She did not complete Form 8867. Due to a busy tax season, Elara forgot to sign the completed return. Her fee was $400. Question: The IRS later determines the $50,000 NOL was entirely unsubstantiated, resulting in a tax understatement. What is the total amount of preparer penalties Elara is subject to under IRC §§6694 and 6695 for the 2025 return, using 2026 penalty rates?---
Step-by-step reasoning process:- Identify the Preparer Status: Elara is an EA preparing a return for a fee. She is a "tax return preparer" and subject to all penalties.
- Analyze the NOL Issue (IRC §6694):
- The facts state Elara accepted a large, "entirely unsubstantiated" NOL "without requesting any documentation." This is the examiner's signal for a high level of fault. It goes beyond simple negligence.
- This conduct represents a reckless disregard of the rules requiring substantiation for deductions. It is not merely an "unreasonable position" that might have a defense.
- Therefore, the penalty under IRC §6694(b) for willful or reckless conduct applies.
- The penalty is the greater of $5,590 or 75% of the preparer's fee (75% of $400 = $300).
- Penalty for the NOL issue = $5,590.
- Analyze the EITC Due Diligence Issue (IRC §6695(g)):
- Elara claimed the EITC but "did not complete Form 8867." This is a direct violation of the specific due diligence requirements.
- The penalty under IRC §6695(g) applies.
- Penalty for EITC due diligence failure = $630.
- Analyze the Signing Requirement Issue (IRC §6695(b)):
- Elara "forgot to sign the completed return." This is a straightforward administrative failure.
- The penalty under IRC §6695(b) applies.
- Penalty for failure to sign = $65.
- Calculate the Total Penalties:
- IRC §6694(b) penalty (NOL): $5,590
- IRC §6695(g) penalty (EITC): $630
- IRC §6695(b) penalty (Signing): $65
- Total Penalties = $5,590 + $630 + $65 = $6,285.
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The tempting wrong answer and why it's wrong:The most tempting wrong answer is A. $1,815. This answer results from misinterpreting the NOL issue as a lower-level "unreasonable position" under IRC §6694(a).
- How to get to $1,815: You would calculate the §6694(a) penalty (greater of $1,120 or 50% of $400 fee = $1,120), add the EITC penalty ($630), and add the failure-to-sign penalty ($65). $1,120 + $630 + $65 = $1,815.
- Why it's wrong: The keywords "entirely unsubstantiated" and "without requesting any documentation" are designed to push you toward the higher standard of reckless conduct. On the exam, you must read the facts carefully to judge the preparer's actions against the statutory language.
The correct answer is B. $6,285. Mastering these distinctions is what separates a pass from a fail, and VoraPrep's adaptive learning engine helps you practice these scenarios until they become second nature.
Test Your Knowledge: Preparer Penalty Practice Questions
Ready to test your understanding with the correct 2026 figures?
Sample Q1: Liam, a tax preparer, took an unreasonable position on a 2025 return that was not disclosed. The position lacked substantial authority and resulted in a tax understatement. Liam's fee was $300. What is the penalty Liam is subject to under IRC §6694(a)?
Sample Q2: Sarah, an Enrolled Agent, knowingly understated a client's tax liability on their 2025 return by intentionally disregarding a clear IRS regulation. The fee Sarah charged for the return was $8,000. What is the penalty Sarah is subject to under IRC §6694(b)?
Sample Q3: David, an EA, prepared a 2025 tax return for a client but forgot to sign it. He also failed to provide the client with a copy of the completed return. What is the total amount of penalties David is subject to under IRC §6695 for these two failures?
How Should You Study for Preparer Penalty Questions?
Focus your study time on application, not just memorization. Once you understand the basic rules, spend the majority of your time working through scenario-based questions. To effectively prepare, consider how long you should study for the EA exam and build a realistic study plan.
On exam day, read every fact pattern carefully. Look for the specific words the IRS uses to signal intent: "inadvertently," "reasonable cause," "good faith," "reckless," "willful," "knowingly." These words are your clues to selecting the right penalty section. A question that mentions "failure to complete Form 8867" is a direct signal for the IRC §6695(g) penalty, no matter what other facts are present.
Remember that these penalties are interconnected with Circular 230. A preparer who is reckless enough to trigger a §6694(b) penalty has certainly violated their due diligence duty under Circular 230 Section 10.22. Understanding this framework helps you see the bigger picture of professional responsibility that the exam is designed to test. For more insights on exam strategy, check out our guide on how long to study for the EA exam.
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