In the first few months of each year, Americans turn for vital help to a group of 350,000 professionals whose work goes virtually unregulated: tax preparers. Following a court decision that struck down an Internal Revenue Service (IRS) rule that would impose licensing requirements on tax preparers, Congress is considering whether to pass new licensing regulations through legislation.
Currently, the IRS requires tax preparers to obtain an identification number that their clients must submit with their tax returns. This enables the agency to identify preparers who consistently file improper returns. However, the federal government does not otherwise regulate tax preparers, such as by imposing licensing requirements.
Earlier this year, the U.S. Government Accountability Office (GAO) conducted an investigation of tax preparers and found pervasive mistakes. For example, 30% of the tax preparers advised clients to claim ineligible children for the Earned Income Tax Credit (EITC). Sixty-three percent suggested not reporting cash tips.
The IRS has not been blind to these concerns, which have long preceded the GAO’s recent report. In 2011, it issued a rule creating a licensing system for tax preparers, with exams, fees, and continuing education requirements. The IRS claimed authority to promulgate the rule under a 130-year old statute that authorizes the federal government to “regulate the practice of representatives of persons before the Department of Treasury.”
In addition to concerns about fraud and incompetence, the IRS also justified its rule by citing the need for uniformity. Four states had general tax preparer regulation, while the others did not. Admittedly, professional associations have strict regulations on attorneys and accountants who often help their clients file returns, but many other tax preparers practice outside those professions.
In 2012, the libertarian Institute for Justice challenged the IRS rule in court. It argued that the IRS lacked authority to issue its rule because the underlying statute was meant only to cover those who would appear before the IRS in audit proceedings. Most tax preparers merely assist taxpayers and never appear before the IRS.
In 2013, a federal district judge agreed with the Institute and invalidated the IRS regulation, and earlier this year, the D.C. Court of Appeals upheld the lower court’s decision. In a unanimous opinion by Judge Brett Kavanaugh, the appeals court held that the IRS rule exceeded the agency’s statutory authority. It considered the word “representative” to involve an agency relationship, as did some other IRS regulations. The court also found that the phrase “practice…before the Department of Treasury” implied that a representative needed to make arguments or engage in advocacy on behalf of a client’s case.
In the wake of this appellate court decision, President Obama included language in his proposed 2015 budget legislation that would grant the IRS authority to regulate all tax preparers and increase penalties on preparers who willfully or recklessly misrepresent tax returns.
The Senate Finance Committee held a hearing on tax preparers earlier this spring. IRS Commissioner John Koskinen testified that failure to adopt legislation would result in “increased collection costs, reduced revenues, the burden placed on taxpayers by the submission of incorrect returns on their behalf, and a reduction in taxpayers’ confidence in the integrity of the tax system.”
Committee Chair Ron Wyden (D-OR) called the D.C. Circuit’s decision “baffling” and supported national legislation. He pointed to a GAO study, which found that taxpayers in Oregon, the state with the strictest tax preparer licensing laws, were 72% more likely to file an error-free return than the national average.
However, Dan Alban of the Institute for Justice pointed out that an IRS study found California, which also has tax preparer licensing laws, has the third highest error rate in the nation. (The GAO’s most recent report acknowledges this, but argues that Oregon’s laws are stricter.)
Alban contended that tax preparer regulation is anti-competitive because “licensing burdens usually fall hardest on the little guys.” He pointed out that large tax preparers like H&R Block support increased regulations. He also quoted a Wall Street Journal editorial that argued that “big tax preparers…are only too happy to see the feds swoop in to put their mom-and pop seasonal competitors out of business.” He said that the IRS could respond to concerns about fraud by increasing criminal enforcement against the “bad apples” rather than enacting new regulations.
Senator Orin Hatch (R-UT), the ranking Republican on the committee, was more equivocal. He acknowledged the problem of “incompetent and unethical” tax preparers, but argued that they were a symptom of the complex and burdensome tax code. Instead of regulation, he advocated for a “fair and simple tax system that dramatically reduces [taxpayer] dependence on paid return preparers.” However, absent tax reform, he was open to “different ideas” to “minimize the damage” of bad tax preparers.
In an editorial arguing in favor of regulation, the New York Times suggested earlier this year that Republicans concerned with tax-related fraud might join with Democrats on this issue.
Charles Boustany (R-LA), a member of the House committee, has stated that, while he broadly supports the idea of the IRS regulating tax preparers, he doubts the House would pass any such legislation this year.