District Court Strikes Down IRS’s User Fees for PTINs

Readers may be aware of last week’s Steele v US district court opinion that upheld the IRS’s requirement that preparers obtain a PTIN but struck down the IRS’s requirement that preparers pay a user fee to get the PTIN. In light of the Steele opinion, IRS announced it is suspending PTIN renewal and registration.

This is another big setback to the IRS’s approach to gain oversight over tax return preparer community and may result in the IRS refunding millions of dollars in previously collected PTIN fees. The opinion conflicts with Brannen v US, a 2012 11th Circuit opinion that held that the IRS’s PTIN user fee regime passed muster, and is yet another in the ripples following the DC Circuit’s invalidating the IRS’ plan to regulate unlicensed preparers a few years ago in the Loving case.

I will excerpt the parties’ positions and the way the court resolved the dispute, and offer some observations as to why I think the court’s approach is misguided.

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The Steele district court opinion turns on the Independent Offices Appropriation Act of 1952 (IOAA) codified at 31 USC § 9701. The IOAA provides broad authority to assess user fees or charges on identifiable beneficiaries by administrative regulation. User fees assessed under IOAA authority must be (1) fair and (2) based on costs to the government, the value of the service or thing to the recipient, public policy or interest serviced, and other relevant facts.

Essentially the plaintiffs argued that the user fee scheme provided no value to preparers in light of the DC Circuit’s Loving opinion:

 [P]laintiffs argue that because Congress did not grant the IRS licensing authority—as found by Loving—tax return preparers receive no special benefit in exchange for the fees, rendering them unlawful under the IOAA. In other words, plaintiffs argue that the IRS originally created a licensing scheme that would limit tax return preparers to those certain people who could meet eligibility criteria. But, because Loving found that Congress did not authorize a license requirement for tax return preparers, there are now no restrictions on who may obtain a PTIN and therefore it is no longer true that only a specific set of people may receive PTINs and the “special benefit” of being able to prepare tax returns for compensation. The only beneficiary of the PTIN system is therefore the IRS.

The IRS, looking to the approach of the 11th Circuit in Brannen, distinguished the PTIN rules from the ill-fated regulatory regime that the DC Circuit struck down in Loving:

The government argues that the PTIN and user fee regulations are separate from the regulations imposing eligibility requirements on registered tax return preparers. It argues that the PTIN requirements are not arbitrary and capricious because they make it easier to identify tax return preparers and the returns they prepare, which is a critical step in tax administration, and because PTINs protect social security numbers from disclosure. In support of its position that it may charge fees for PTINs, the IRS states that PTINs are a service or thing of value because the ability to prepare tax returns for compensation is a special benefit provided only to those people who obtain PTINs, who are distinct from the general public. Individuals without PTINs cannot prepare tax returns for compensation. In addition, the IRS argues that PTINs protect the confidentiality of tax return preparers’ social security numbers, and that protection itself is a service or thing of value.

The district court opinion adopted the view that the PTIN rules were part and parcel of the overall regulatory regime:

The Court finds that PTINs do not pass muster as a “service or thing of value” under the government’s rationale. First, the argument that the registered tax return preparer regulations regarding testing and eligibility requirements and the PTIN regulations are completely separate and distinct is a stretch at best. While it is true that they were issued separately and at different times, they are clearly interrelated. The RTRP regulations specifically mention the PTIN requirements and state that PTINs are part of the eligibility requirements for becoming a registered tax return preparer. See Regulations Governing Practice Before the Internal Revenue Service, 76 Fed. Reg. at 32287–89; 26 C.F.R. § 1.6109-2(d) (“[T]o obtain a [PTIN] or other prescribed identifying number, a tax return preparer must be an attorney, certified public accountant, enrolled agent, or registered tax return preparer authorized to practice before the Internal Revenue Service under 31 U.S.C. 330 and the regulations thereunder.”). Furthermore, the overarching objectives named in the PTIN regulations indicate a connection to the RTRP regulations. They were 1) “to provide some assurance to taxpayers that a tax return was prepared by an individual who has passed a minimum competency examination to practice before the IRS as a tax return preparer, has undergone certain suitability checks, and is subject to enforceable rules of practice;” and 2) “to further the interests of tax administration by improving the accuracy of tax returns and claims for refund and by increasing overall tax compliance.” Furnishing Identifying Number of Tax Return Preparer, 75 Fed. Reg. at 60310. The first objective clearly relates to the RTRP regulations regarding eligibility requirements for tax return preparers. The second objective is less explicit, but it does not stretch common sense to conclude that the accuracy of tax returns would be improved by requiring tax return preparers to meet certain education requirements.

Once it functionally equated the PTIN regime to the testing and eligibility requirements Loving struck down, the Steele opinion concluded that the benefit that the IRS was supposedly conferring for the user fee was in fact the functional equivalent of regulating the practice of preparing returns, with my emphasis below on the key part of the Steele opinion’s discussion:

Having concluded the inter-connectedness of the regulations, the government’s argument begins to break down. The Loving court concluded that the IRS does not have the authority to regulate tax return preparers. Loving, 742 F.3d at 1015. It cannot impose a licensing regime with eligibility requirements on such people as it tried to do in the regulations at issue. Although the IRS may require the use of PTINs, it may not charge fees for PTINs because this would be equivalent to imposing a regulatory licensing scheme and the IRS does not have such regulatory authority. Granting the ability to prepare tax return for others for compensation—the IRS’s proposed special benefit—is functionally equivalent to granting the ability to practice before the IRS. The D.C. Circuit has already held, however, that the IRS does not have the authority to regulate the practice of tax return preparers. See id. In coming to its conclusion, the Circuit considered the statutory language that the Secretary may “regulate the practice of representatives of persons before the Department of the Treasury.” Id. at 1017–18 (quoting 31 U.S.C. § 330(a)(1)). The court found that the IRS improperly expanded the definition of “practice . . . before the Department of Treasury” to include “preparing and signing tax returns” because to “practice before” an agency “ordinarily refers to practice during an investigation, adversarial hearing, or other adjudicative proceeding.” Id. at 1018. The Loving court concluded that “[t]hat is quite different from the process of filing a tax return” in which “the tax-return preparer is not invited to present any arguments or advocacy in support of the taxpayer’s position . . . [and] the IRS conducts its own ex parte, non-adversarial assessment of the taxpayer’s liability.” Id. The ability to prepare tax returns is the “practice” identified by the IRS in Loving, but the court found that such an activity does not qualify as practicing before the IRS. Therefore, it appears to this Court that the IRS is attempting to grant a benefit that it is not allowed to grant, and charge fees for granting such a benefit.

Parting Thoughts

There are over  700,000 PTIN holders, and I have seen estimates that IRS has collected anywhere between $175 and 300 million since the PTIN program started in 2011. One aspect of the opinion is that by deciding the case in this manner (i.e, IRS has no authority to charge fees for PTINs), the court did not address the plaintiffs’ alternate argument that fees the IRS charged were excessive. (IRS reduced the PTIN fee to $50 from $64 a few years ago).

This is obviously a major setback for the IRS. I am surprised by the court’s narrow view of the benefits associated with PTINs. I recall a decade or so ago the many challenges IRS had in assessing the quality of return preparers in a pre-PTIN required world. When discussing IRS efforts to unify the identification requirement under a single identifying number, GAO noted that past practices made it very difficult for IRS to get a sense of the overall preparer community, let alone associate individual preparers and the returns they prepared. While of course the IRS benefits from the uniformity of identifying requirements, so does the public, and, by extension, so do preparers.

It is in the interest of competent and honest preparers to ensure that the public has confidence in the work that they do. The visibility and accountability associated with a uniform identifying requirement benefits the tax system generally. While the impact of Steele is by no means as far-reaching as Loving, it is a major defeat and is further reason why Congress needs to step in and legislate that IRS has the ability to regulate this important aspect of tax administration.

TIGTA Report on PTINs Finds IRS Not Fully Using its PTIN Powers

While IRS lost the battle in Loving to impose mandatory education and testing requirements over paid preparers, it still holds the keys to allowing paid preparers access to earning money though its oversight of the e-file program and the requirement that all preparers register for a Preparer Tax Identification Number (PTIN). Last month TIGTA released a report reviewing the IRS’s administration of the PTIN program, and its study reveals that IRS has failed to revoke PTINs for preparers who themselves were not compliant with tax return filing or payment obligations.

The following highlights parts of the TIGTA report I found interesting.

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The IRS created the Return Preparer Office in 2010 in part to administer the PTIN rules. Part of that responsibility includes reviewing applicants and renewals for suitability. As TIGTA explains,  “a fully completed suitability check includes the IRS matching the preparers in the [Tax Professional PTIN System] to lists of individuals who may be unsuitable for the PTIN program, researching and contacting the preparer, and using judgment to decide which action to take on each case. ”

While the report redacts a portion describing exactly what goes into suitability determinations, that appears to focus on a preparer’s tax compliance history. The suitability review generally occurs after IRS doles out the numbers in applications or renewals. According to TIGTA it does so after issuing PTINS  because “IRS does not want to prevent tax return preparers from completing tax returns during this process.”

There are about 700,000 preparers with PTINS; about 406,000 PTIN holders (or 58%) are unlicensed professionals. Only about 50,000 PTIN holders are enrolled agents and the rest, about 240,000, are licensed professionals like CPAs.

On the positive side, TIGTA found RPO had done a good job administering rules relating to the post-Loving voluntary testing and education program for unlicensed preparers as well as ensuring that preparers met certain minimum requirements, such as being at least 18:

Our review identified that the Return Preparer Office (RPO) has established processes and procedures to ensure that individuals assigned a PTIN were at least 18 years of age, were not using identifying information associated with a deceased individual, and correctly reported professional credentials.

In addition, the RPO ensured that individuals participating in the new Annual Filing Season Program met educational requirements and consented to be subject to the duties and restrictions of practicing before the IRS under Treasury Department Circular 230.

In its main criticism TIGTA found IRS and RPO failed to “revoke PTINs of tax return preparers who were not compliant with their tax filing and payment obligations.” In addition,  TIGTA found that RPO failed to assess suitability of preparers who self-reported felonies or ensure that preparers who had been previously enjoined no longer had PTINs. For an illustration of the extent of preparers with tax compliance issues, TIGTA elaborates:

For example, in January 2015, the RPO identified 19,496 preparers with PTINs that were potentially noncompliant with tax filings and payments. These preparers have over $367.6 million in total taxes due as of January 26, 2015. The RPO also identified 3,055 preparers who failed to file required tax returns for one (2,374 preparers) or more (681 preparers) tax years; eight tax return preparers who failed to file required tax returns for five years, and one tax return preparer who failed to file required tax returns for six years. While the RPO has a process to identify noncompliant return preparers, no actions were taken by the RPO to resolve these cases.

TIGTA connects the preparers’ lack of compliance to extra risk that the returns those preparers prepare are likely to have compliance problems (“[t]hese tax return preparers can negatively affect taxpayers as well as tax revenue if the tax returns they prepare are incorrect or fraudulent.”), though there is no research that I am aware of that TIGTA or IRS has done on that point.

In addition to the findings, TIGTA discussed Section 6109 and the regs under 6109 which contain the underlying PTIN rules and the compliance requirement for preparers. Here is the background on the issue as TIGTA frames it:

Treasury Regulation Section 1.6109-2(f) grants the IRS the authority to conduct tax compliance checks for tax return preparers, stating that the IRS may conduct a Federal tax compliance check on a tax return preparer who applies for or renews a PTIN or other prescribed identifying number. The IRS’s decision to not fully complete tax compliance checks and revoke PTINs as warranted allows some preparers to maintain their PTIN even though they are not in compliance with Internal Revenue laws.

Consistent with the regulatory authority, IRS established tax compliance as a suitability requirement in Notice 2011-6; 2011-1 C.B. 315, Implementation of Rules Governing Tax Return Preparers. The notice states:

Until further guidance is issued, the IRS, in accordance with the authority to provide exceptions to the PTIN rules under section 1.6109-2 (h), will permit any individual eighteen years or older to pay the applicable user fee and obtain a PTIN permitting the individual to prepare, or assist in the preparation of, all or substantially all of a tax return or claim for refund for compensation if: the individual passes the requisite tax compliance check and suitability check (when available).

TIGTA elaborated on IRS views with respect to suitability and compliance checks, including the process within the IRS’s Return Preparer Office and IRS’s views that Section 7803 also provides statutory background for IRS authority to impose requirements on those seeking to obtain or retain PTINS

In May 2011, IRS Chief Counsel issued a memorandum to the Director of the RPO stating that “[n]either section 6109 nor the PTIN regulations provide specific suitability requirements to be satisfied before an individual receives a PTIN other than a Federal tax compliance check.” This memorandum also indicates that the IRS has the authority, under both Internal Revenue Code section 6109 and its general tax administration powers under Internal Revenue Code section 7803, to deny PTINs to certain individuals or classes of individuals when the issuance of PTINs to those individuals or classes of individuals would be inconsistent with the sound administration of Internal Revenue laws. However, the IRS assigns or allows an individual to renew a PTIN prior to performing suitability checks to avoid delays for the tax return preparers and to promote the use of PTINs by tax return preparers. After the PTIN is issued or renewed, the RPO Suitability function performs suitability and other checks to determine if the PTIN holder should retain the PTIN. This process was developed to allow tax return preparers to continue to prepare tax returns while the suitability checks are being completed.

The reference to Section 7803 is interesting, as that provides the Commissioner of Internal Revenue with “the power to administer, manage, conduct, direct, and supervise the execution and application of the internal revenue laws or related statutes and tax conventions to which the United States is a party.” IRC 7803(a)(2)(A). There has been some controversy regarding the powers that are associated with the general provision. For example, AICPA in its criticism and lawsuit over the IRS’s voluntary testing and education program has taken aim at the substantive reach of 7803(a)(2)(A) and whether it provides cover for IRS’s attempt to provide more oversight over unlicensed preparers (see e.g., last year’s AICPA letter on IRS Regulation of Tax Return Preparers After the Loving Decision).

As a related aside, the issue of how much room Title 26 provisions give IRS to oversee unlicensed preparers has been getting some additional attention recently.  Astute tax administration observer (and guest PT poster) Professor Bryan Camp in a recent Tax Notes article How the IRS Can Regulate Return Preparers Without New Law makes a compelling policy case for additional oversight of unlicensed preparers. In that article, Professor Camp explores how IRS may be able to use Title 26 itself to regulate the submission of tax returns as way to expand oversight over unenrolled preparers in light of IRS losses in Loving and Ridgley (the case striking down Circular 230 limits on contingent fees). He explains as follows: “if Treasury has the ability to regulate all returns [looking to Sections 6001, 6011 and 7805], it may also have the ability to respond to the concerns about the unreliability of [unenrolled return preparer] returns with regulations directed at all return preparers, including CPAs, attorneys, and enrolled agents.”

We hope to have more on Professor Camp’s article soon, but bringing it back to PTINs, despite IRS’s own view that Section 6109 allows it to conduct compliance checks on unlicensed preparers,  it appears that IRS does not revoke PTINs or even make inquiries of unlicensed preparers following its compliance or suitability checks. To that end, consider TIGTA’s recommendation that IRS “should ensure that tax compliance checks are complete by timely issuing inquiry letters to preparers after identifying noncompliance with Federal tax laws and that appropriate actions are taken to revoke PTINs when warranted.”

IRS agreed, to a point:

Management’s Response: The IRS agreed with this recommendation. The RPO conducts weekly tax checks on all PTIN holders in the [Tax Professional PTIN System]. Consistent with the IRS’s existing procedures to send letters following the end of the filing season, the IRS began sending letters on June 17, 2015, to credentialed preparers (practitioners governed by Circular 230 guidelines) and preparers participating in the AFSP [voluntary education and testing program] who were noncompliant with their tax obligations. The RPO will continue sending inquiry letters annually after each filing season.

On page 9 and 10, surrounded by a redacted portion of the TIGTA report, IRS stated, however, that at the time of TIGTA’s audit it was not taking action with respect to unlicensed preparers:

After the Loving decision was upheld…management proceeded with caution and decided to not issue inquiry letters to noncompliant preparers and to not revoke the PTINs as warranted.

Parting Thoughts

In reading the TIGTA report, it seems that IRS was not fully using the powers it has at its disposal to oversee preparers and perhaps is still gunshy following Loving when it comes to unlicensed preparers. As someone who believes that additional oversight over unlicensed preparers is an important way to increase accountability and visibility in our tax system, the TIGTA report at a minimum may raise questions as to whether IRS should use its existing powers fully before having more added to its plate.

To be sure, IRS is licking its wounds over Loving and related cases, and there is no doubt that it would welcome explicit legislative cover when it comes to the largest segment of the preparer community, unlicensed preparers. In this environment, that explicit legislative authority is far from a sure thing, and taxpayers and others are testing the limits of IRS powers, including in the AICPA’s challenge to the IRS voluntary testing and education program for preparers. Perhaps IRS reticence is a resource issue, or maybe just an aversion to additional possible setbacks. In any event, the challenges associated with higher errors associated with returns prepared by unlicensed preparers remains a problem still in search of solutions.