American Institute of Certified Public Accountants v. Internal Revenue Service  —  A Contrary Perspective

Last week we discussed the IRS victory in AICPA v IRS. Today we welcome back guest blogger Stu Bassin who offers a different take on the case and critiques the underlying merits of IRS oversight over unenrolled preparers.  Les

The D.C. Circuit’s recent decision in AICPA v. Internal Revenue Service  allowed the Service to continue its voluntary Annual Filing Season Program—a program which grants unlicensed tax return preparers with limited rights to represent taxpayers during audits if they satisfy continuing professional education requirements and pass a competency examination.  In a recent post, Professor Book heralded the decision as a “major victory” for the Service and urged Congress to enact legislation providing the Service with greater authority to regulate unregistered return preparers.  I offer a different perspective.

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First, some background. About ten years ago, the Service responded to concerns that incompetent and unscrupulous tax return preparers were taking advantage of taxpayers and producing a disproportionate number of “problem” tax returns.  It  promulgated rules which required all return preparers who are compensated for preparing returns (e.g., attorneys, accountants, and unlicensed preparers) to qualify for and obtain Preparer Tax Identification Numbers (PTINs).  The regulations required preparers to pass a competency examination and complete required continuing professional education as a condition to obtaining a PTIN, although other provisions of the regulations largely exempted attorneys and CPAs from these requirements.

Unlicensed preparers, concerned that the new requirements would increase their cost of operating and possibly put them out of business, filed suit challenging the Service’s authority to regulate preparers who did nothing more than prepare returns [Personal aside. My father was a part-time unlicensed preparer who provided excellent service to taxpayers and used the fees he earned to pay for his children’s college education.  He gave up his practice when he learned of the additional costs and burdens that the new requirements would impose].  In Loving v. Internal Revenue Service, the D.C. Circuit ruled that the Service did not have statutory authority to regulate preparers whose activities were limited to preparing returns for other taxpayers.  In subsequent years, the Service has sought legislation providing it with authority to regulate these unlicensed preparers, although Congress has not granted the Service the requested regulatory authority.

The Service developed its Annual Filing Season Program in response to Loving, offering unlicensed preparers the opportunity to obtain a certificate of completion and limited rights to represent taxpayers during audits if they completed the continuing education requirements and passed the competency examination.  The program is voluntary—unlicensed preparers can continue to prepare returns without participating in the program–although the Service has made substantial efforts to sell the program to unlicensed preparers.   The most recent data suggests that relatively few of the unlicensed return preparers have elected to participate in the program.

Almost from the outset, the AICPA challenged the legality of the program.  After extensive wrangling over standing issues and two trips to the court of appeals, the D.C. Circuit upheld the validity of the program.  The key to the court’s ruling was its characterization of the program as voluntary and, therefore, not subject to the legal analysis developed in Loving.   This post does not address the legal merits of the ruling, but instead focuses upon the contentions of Professor Book and others that the result should be applauded from a policy perspective and that the experience with the Annual Filing Season Program demonstrates that Congress should grant the Service authority to regulate unlicensed preparers.

My analysis begins by accepting the proposition that policies which protect the public from unethical and incompetent preparers by putting them out of business should be applauded. But, has the voluntary Annual Filing Season Program contributed to that effort?  Less than 15% of the unlicensed preparers volunteered to fulfill the education requirements and take the competency examination required by the program. Presumably, these were primarily the most competent, ethical, and professional unlicensed preparers in the marketplace.  Conversely, the Service’s voluntary program did nothing to prevent the unethical and incompetent (along with the “ghost” preparers who prepare returns but do not sign the return as a paid preparer) from continuing to practice as they have in the past.  Ultimately, the question arises is whether the chronically understaffed Service has obtained a significant improvement in the quality and honesty of the preparer community from the resources it has invested in the voluntary program.

A recent report of the Treasury Inspector General for Tax Administration (TIGTA) provides disturbing evidence that the Service has misdirected its resources. The report began by summarizing the surprisingly wide array of penalties and other tools currently available to the Service to police preparer misconduct.  Notwithstanding these tools, TIGTA found—

  •  More than 1.3 million PTINs have been issued, most without any investigation of whether the applicant had a criminal background, a history of defrauding taxpayers, or any record of identity theft.  Once a PTIN is issued, it is only revoked if the holder is incarcerated or legally enjoined from return preparation.
  • More than 26,000 applicants for PTINs stated on their PTIN applications that they were not in compliance with their tax obligations.  The Service has taken no action to closely monitor the conduct of those preparers.
  • During Processing Year 2016, 72,590 preparers with inactive PTINs filed 2.7 million returns, yet the Service assessed penalties against 215 of these preparers.
  • The Service identified 4200 leads during one quarter relating to “ghost preparers” who prepared returns for compensation, but did not sign the returns.  In prior years, the Return Preparer Office referred an average of less than 65 cases for examination.
  • During calendar years 2012-2015, the Service collected only 15 percent of the penalties assessed against individual return preparers.
  • The Service did not identify a single instance where a return preparer audit was instigated based upon an issue which arose through the Annual Filing Season Program.

Interestingly, most of TIGTA’s recommendations concerned basic steps that the Service should have taken years ago to enforce of existing laws to police dishonest preparers, but had failed to take.

The basic question arising from this data is whether the Service’s Annual Filing Season Program has represented a wise investment of the Service’s scarce resources.  We know that the vast majority of the return preparers in the marketplace are honest and competent, yet the Service’s Annual Filing Season Program focuses on them, burdens them with added paperwork filing requirements, and expends a substantial amount of the Service’s resources in administering a program directed at honest and competent preparers.  The program, however, does not require dishonest and incompetent preparers to participate, take the continuing education courses, or pass the competency examination.  Indeed, it appears that the Service does little to enforce existing laws which could be employed to put dishonest preparers out of business.  More startling, as TIGTA reported, even when the data currently collected by the Service identified preparers filing returns using inactive PTINs or as ghosts, the Service rarely proceeded with investigations or other action against these miscreants.  And, the Service cannot excuse this inaction based upon the lack of resources—the Return Preparer Office alone employs nearly 200 employees. Rather, those resources are being directed toward administering an Annual Filing Season Program focused upon collecting forms from honest preparers.

All of this brings us back to the basic question of whether the Service should be granted more regulatory authority over unregistered preparers.  While Professor Book says it should, I believe that new legislation and expanded regulatory authority is the wrong idea.  All agree that the principal problem is dishonest and incompetent return preparers. The record developed by TIGTA shows that the Service focuses its efforts on collecting forms and data from honest preparers who choose to participate in the Annual Filing Season Program.  It does little, however, to enforce the rules already on the books to police miscreants by investigating preparers it already knows are using inactive PTINs or have their own unpaid tax liabilities. Increasing the Service’s authority to impose additional requirements upon return preparers will not alter the conduct of these wrongdoers.  Unfortunately, it seems that they will continue to flout any new rules (and the existing rules) with little risk that the Service will act against them.

In sum, I believe that giving the Service additional statutory authority to regulate several hundred thousand more unregistered preparers is a bad idea.  Additional regulatory authority will impose substantial compliance burdens and costs upon reputable preparers while devoting more of the Service’s resources to managing even more forms and data relating to honest preparers.  Yet, the Service does not employ the data and legal authority it currently has to identify and weed out wrongdoers.  Expanding its regulatory authority over unregistered preparers will channel more of the Service’s resources into managing regulation of the honest, not using existing law to address misconduct by the disreputable, inept, and unethical. That is hardly good public policy.  Rather, the orientation of the Service and the Congress should be to devoting the Service’s resources to aggressive enforcement of the existing rules against the unethical and incompetent.  That is the better route to removing the bad apples from the system.

In Major Victory for IRS DC Circuit Upholds IRS Annual Filing Program

In a major victory for IRS, in AICPA v IRS, the DC Circuit upheld the voluntary annual filing season program. The annual program allows unenrolled preparers to take a competency test and satisfy continuing education requirements in exchange for limited representation rights before Exam and publication in the IRS’s database of preparers, along with enrolled agents, CPAs and attorneys. The opinion reaches the merits of the IRS’s authority to create the annual program. In a prior opinion, the district court had found that AICPA did not have standing to bring the action that challenged the program. The DC Circuit, by reaching the merits of AICPA’s challenge, analyzed the reach of Loving and whether the program was a legislative rule that should have been issued via regulations rather than via a revenue procedure.

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To get to the merits of the dispute the DC Circuit reversed the lower court on statutory standing.  The lower court held that AICPA did not have standing to bring the challenge. The DC Circuit felt that the additional supervisory responsibilities of CPAs and other licensed preparers, and the concomitant possibility that failing to supervise those preparers may bring sanctions under Circular 230, meant that AICPA had enough skin in the game to challenge the program.

The real importance of this decision is twofold:  first, the majority opinion takes a somewhat limited read of Loving, and second, in finding that the program is not a legislative rule for APA purposes and thus was not required to be issued under the APA notice and comment regime, the opinion provides cover for other IRS actions that the IRS may argue are merely interpretive and thus not subject to notice and comment.

As to the AICPA view that the annual program was a backdoor way to avoid Loving and regulate return preparation, the court disagreed, emphasizing that the rules allow for establishing competence in representing taxpayers in the exam process rather than regulate return prep per se:

We see nothing in the Program that attempts to resurrect regulations of the type enjoined in the Loving decisions. Unenrolled tax preparers who participate in the program “consent to be subject to the duties and restrictions relating to practice before the IRS in [certain sections of] Circular 230,”id. § 4.05(4); they do not consent to be governed by Circular 230 insofar as they are engaged in the business of tax preparation.

The Program also ties violations of Circular 230 to the limited practice right, not to the preparation of tax returns: Record of Completion holders “who violate Circular 230 during the course of [their] representation [before the IRS]will have their Record of Completion and ability to represent a taxpayer before the IRS under this revenue procedure revoked.” Id. § 7.01(2). When seen in this light, it is clear that the participants’ commitment to follow Circular 230 is coextensive with the IRS’s authority under § 330(a) to regulate practice before it.

The issue that generated a spirited dissent was whether the program required notice and comment. This case is another in a line of cases where courts (mostly in the nontax context) have struggled to define what in fact is a legislative rule which, under the APA, requires notice and comment, as compared to an interpretive rule that is not required to be issued through notice and comment. Here, that was a crucial issue because the IRS served up these rules via a revenue procedure, rather than via regulations. AICPA argued that the program was in fact a legislative rule and the IRS failure to comply with notice and comment meant that it was improperly established.

The majority’s view that the rules were not legislative stemmed mostly from the voluntary nature of the program:

In this case the Revenue Procedure and associated Program do not bind unenrolled preparers at all; the Program merely provides an opportunity for those unenrolled preparers who both choose to participate and satisfy its requirements.

As to the argument that the rules imposed new burdens on supervisors (more akin to a legislative rule), the majority noted that supervisors had responsibilities under Circular 230 prior to the program, and that the opt in to Circular 230 for the unlicensed preparers who take the annual program does not extend to additional supervisory responsibilities pertaining to return preparation:

Nor does it impose any new or different requirement upon supervisors or unenrolled agents; Circular 230 bound supervisors and unenrolled agents before the Program took effect and continues to bind them now. [note omitted]

In further finding that the rule was interpretive, the majority took a dig at IRS for not being clearer in its revenue procedure that it meant to illustrate the meaning of the statutory term competence:

The AICPA also argues the Revenue Procedure cannot be an interpretive rule, and in its view therefore must be a legislative rule, because it “contains not a word of the reasoned statutory interpretation … that typifies an interpretative rule.” We disagree, although we acknowledge the agency could have been more clear. By clarifying how an unenrolled preparer seeking to practice before the IRS may “demonstrate … necessary qualifications … and competency” within the meaning of § 330(a), the Revenue Procedure “reflects an agency’s construction of a statute that has been entrusted to the agency to administer.” Syncor Int’l Corp. v. Shalala, 127 F.3d 90, 94 (D.C. Cir. 1997); see Interport Inc. v. Magaw, 135 F.3d 826, 828-29 (D.C. Cir. 1998) (holding a rule interpretive where “it explains more specifically what is meant” in another authority, in that case a legislative rule). As stated above, the Program requires unenrolled preparers who want to participate to complete a set number of hours of instruction, on specific topics, and pass a test before gaining the limited practice right. See REV. PROC. 2014-42 §§ 4, 6. Those requirements are the agency’s interpretation of what § 330(a) means by “competency” and the other criteria it lists. [footnote omitted]

The dissent focused on two main issues: first, it noted that the IRS power to allow unenrolled preparers limited rights in examinations initially arose via regulations that were issued with notice and comment, and changes to those rules likewise had to follow from notice and comment. Second, it argued that the majority opinion failed to appreciate the reach of Circular 230 and its possible imposition of monetary sanctions for violations of the annual program.

Practitioners and academics will be digging in deeper on the spirited disagreement between the dissent and majority on whether the program is in fact the product of a legislative rule. The disagreement between the majority and dissent over the reach of Circular 230 (and whether the program imposes the possibility of newer sanctions on supervisors)  reminded me of Karen Hawkins’ insightful 2017 Griswold lecture, where she discussed how “because it has not been amended to reflect current case law, legislation or clarifications….” parts of Circular 230 have “become vague, ambiguous, outdated and, in some instances unadministrable.”

My quick takeaway of the case is that there is significant uncertainty in the reach of Circular 230 and the contours as to what is a legislative rule. IRS should tread carefully when establishing new programs as significant as this. IRS could have benefitted from the input that notice and comment provides, as well as perhaps given it more time to think through how the program could be more effectively administered.

TIGTA Criticizes IRS Efforts at Curbing Preparer Misconduct

TIGTA reports are, by their nature, often critical of IRS performance. IRS Lacks a Coordinated Strategy to Address Unregulated Return Preparer Misconduct details TIGTA’s view that IRS is not doing enough to curb preparer misconduct.

There is a lot in this report. It lays out the recent history of IRS efforts; starting in 2009 with the ill-fated plan to regulate unlicensed preparers via compliance and background checks, qualifying examinations and continuing education requirements. When Loving struck down the 2009 rules, IRS pivoted and the TIGTA report discusses in detail the IRS procedures at SB/SE for examining preparers and the sanctions that IRS can bring on unscrupulous or incompetent preparers even in the absence of the direct oversight.

The main takeaway from the report is that IRS does not have a consistent national return preparer strategy. As the report details, IRS stated that its “overall strategy for addressing preparer misconduct was generally to use the tools at the IRS’s disposal as effectively as possible within resource constraints to improve tax compliance by increasing the accuracy of tax returns and holding tax return preparers accountable for misconduct.” Post-Loving, IRS has shifted resources to a relatively undersubscribed voluntary program for unenrolled preparers while the vast majority of unenrolled preparers continues to operate outside direct oversight.

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TIGTA takes direct issue with IRS claims to address the issue “as effectively as possible.” Starting from a macro perspective, TIGTA notes that there is no evidence of a coordinated IRS strategy; and little in writing that could serve as a blueprint for efforts to address unenrolled preparers. While SB/SE has the main responsibility for addressing preparer misconduct, its Business Performance Review documentation in recent years barely mentions the Return Preparer Coordinator functions in the seven main geographic areas; it also has little discussion of Lead Development Centers, which are the hubs for reviewing referrals of preparer misconduct.

The report goes into great detail as to how this lack of strategy manifests itself in particular problems. Here are some of the highlights:

Limited Priority in Exams: TIGTA notes the relative scarcity of focused preparer examinations (called PACS, or Program Action Cases) in recent years; for example in FY 2016 there were only 140 developed PACs compared to Criminal Investigation’s 248 investigations and 204 indictments in the same period.  As TIGTA notes, the lesser number of civil cases “is unexpected given the respective resources of these two IRS functions, as well as the intensive nature of criminal investigations versus civil penalty cases. The SB/SE Division Examination function has approximately 6,500 revenue agents and tax compliance officers compared to Criminal Investigation’s nearly 2,200 special agents.”

Inconsistent Criteria and Limited Impact For PAC Referrals: TIGTA criticized the differing approaches to focused preparer examinations in the seven geographical areas, with some areas focusing on high refund rates and others looking to numbers of taxpayers connected to a preparer. That contributes to a lack of a national approach to the issue of preparer oversight.Furthermore, TIGTA noted that the preparer exam impact  is often limited as IRS often failed to examine all of the identified preparer’s tax returns.

Assessment of Penalties Not Maximized: The report examines the failure to assess penalties when conduct may have warranted them. For example, it discusses a lack of PTIN penalty enforcement. TIGTA notes that “if penalties had been proposed when the invalid PTINs were identified, more than $122,747,250 could have been assessed, yet only 215 penalties were assessed for all of I.R.C. § 6695(a)-(e) penalties, inclusive of § 6695(c) penalties, totaling $1,572,055 which is 1 percent of the potential penalty assessment for just one of the possible violations.”  Of course, assessing more penalties against a group such as bad preparers in no way guarantees collection of the penalties assessed as discussed in the next section.

Collection of Preparer Penalties is Minimal: TIGTA notes that IRS no longer prioritizes collection of return preparer penalties. TIGTA notes that from CY 2012 to CY 2015, the IRS collected just $46.3 million (15 percent) of the $317.2 million of penalties assessed on individual return preparers; the numbers are even worse for penalties assessed against preparers failing to put a PTIN on returns, with IRS collecting just 8% of those penalties in 2016.  Prioritizing collection from this group would not necessarily ensure a higher return.  Collection may have directed their limited resources to persons more likely to have the ability to pay.

RPO Doing Little to Combat Unregulated Preparer Misconduct:The report discusses the efforts of the IRS Return Preparer Office following Loving. It is not a pretty picture.

The Return Preparer Office, which was originally established to lead the now defunct regulatory effort, is still in existence but now primarily focuses its efforts on tax professionals and those few tax return preparers who volunteer to be subject to certain annual training. The Return Preparer Office checks tax compliance for tax professionals but not for most unregulated preparers. More than 26,000 Preparer Tax Identification Number recipients acknowledged being tax noncompliant. Additionally, while preparing tax returns without a Preparer Tax Identification Number is subject to a penalty, the penalties are assessed on a limited ad hoc basis. In Processing Year 2016, the IRS failed to assess $121,175,195 in Preparer Tax Identification Number penalties.

TIGTA notes that a main part of RPO, the Suitability Office, produces limited benefits:

The resources used by the Suitability Office to conduct credentials research are not commensurate with the benefits realized. At best, preparers who have misrepresented themselves will stop after being notified by the Suitability Office. However, if the preparers continue with the behavior, the IRS is not taking additional steps to address it. The Suitability Office takes no further action if the preparer is unregulated. Even when cases are referred to the OPR, nearly all of them are closed upon receipt because the preparers are not currently practicing before the IRS and therefore, the OPR lacks jurisdiction. The appropriate function to report unregulated preparers misrepresenting themselves as tax professionals is TIGTA’s Office of Investigations.

The report notes that “an even more significant problem is that the Suitability Office no longer devotes any resources to unregulated preparers. Ensuring the tax compliance of tax preparers yields benefits to tax administration; however, the Suitability Office is only checking the status of the relatively small number of tax professionals and volunteers for the AFSP, e.g., those who present the least risk to tax administration.”

IRS Failing to Use Its Information: One of the key benefits of a uniform preparer identification number is the greater ease that the number affords the IRS to track preparer behavior. The report notes that PTINs “allow the IRS to keep track of preparers’ behavior, such as the number of returns they prepare and file, the number of returns by filing method (paper or electronically filed), returns filed with refunds, and returns filed with balances due.”

All of the IRS’ information on preparers is consolidated in the Return Preparer Database. Despite the presence of the information, TIGTA notes that IRS has failed to maximize its potential:

IRS has not yet taken full advantage of its capabilities. Much of the analyses and resulting corrective actions could be performed systemically, with minimal need for employees’ direct involvement. Expansion of the database’s capabilities could allow the IRS to identify and deter additional preparer misconduct, while also freeing employees who are currently performing manual tasks that could be performed systemically by the database.

Given the resources reductions over the past several years, it is particularly important for the IRS to continue developing and taking full advantage of its available systemic capabilities.

Conclusion

No doubt the IRS could improve its police role for return preparers.  Many of the recommendations presented by TIGTA could assist the IRS in improving this role.  The IRS has continued to push for a legislative fix to Loving – a fix that would have come quickly in past decades but not in the Congress since 2010.  The hope for a legislative fix that would allow the IRS to go back to the strategy it had finally decided to employ coupled with the diminution of resources may have something to do with the sluggish action TIGTA perceives coming out of the IRS.  Collection from bad preparers will never be easy.  The IRS will not fix the problem of bad preparers by assessing more penalties.  It needs strong tools to stop them from preparing.  Getting the return right at the outset saves the IRS and taxpayers from time consuming efforts to reconstruct a correct tax assessment.  TIGTA is right to keep reviewing IRS efforts on this important issue.  The IRS is right to keep pushing for legislation to allow it to robustly regulate preparers.  While waiting for Congressional approval, the IRS should look carefully at those suggestions from TIGTA that will allow it to shut down bad tax preparers and pay little attention to the suggestions that cause it to assess large amounts of penalties it will struggle to collect and that may not stop the bad action.

 

 

 

 

 

 

When Can An Entity Be Subject to Return Preparer Penalties?

I have been reading a lot of opinions discussing misbehaving tax return preparers. The IRS has a heavy arsenal it can deploy against those preparers short of criminal sanctions: civil penalties, injunctions and disgorgement are the main tools, all of which we have discussed from time to time. A recent email advice that the IRS released  explores when an entity that employs a return preparer can also be subject to return preparer penalties.

One way to think about the uptick in actions against return preparers is that the IRS has taken Judge Boasberg and others to heart when IRS lost the Loving case a few years ago.

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Part of the reason Judge Boasberg (later affirmed by the DC Circuit) tossed the IRS return preparer scheme out was that the IRS approach to including return preparation within 31 USC § 330 (which authorizes the Secretary to regulate “the practice of representatives of persons before the Department of the Treasury” )seemed to disregard or minimize the existing powers the IRS had to combat bad egg preparers:

Two aspects of § 330’s statutory context prove especially important here. Both relate to § 330(b), which allows the IRS to penalize and disbar practicing representatives. First, statutes scattered across Title 26 of the U.S. Code create a careful, regimented schedule of penalties for misdeeds by tax-return preparers. If the IRS had open-ended discretion under § 330(b) to impose a range of monetary penalties on tax-return preparers for almost any conduct the IRS chooses to regulate, those Title 26 statutes would be eclipsed. Second, if the IRS could “disbar” misbehaving tax-return preparers under § 330(b), a federal statute meant to address precisely those malefactors—26 U.S.C. § 7407—would lose all relevance.

As Judge Boasberg flagged, a key aspect of the IRS power to police return preparers is civil penalties under Title 26. Section 6694(b) provides a penalty for a preparer’s willful or reckless misconduct in preparing a tax return or refund claim; the penalty is the greater of $5,000 or 75% of the income derived by the tax return preparer from the bad return/claim.

The recent email advice from the National Office explored the Service’s view on whether the IRS can impose a 6694 penalty on the entity that employs a misbehaving return preparer as well as the individual return preparer who was up to no good.  The advice works its way through the statutory and regulatory definitions of return preparer under Section 6694(f), which cross references Section 7701(a)(36) for the definition of “tax return preparer.”

Section 7701(a)(36) provides that “tax return preparer” means any person who prepares for compensation, or who employs one or more persons to prepare for compensation, tax returns or refund claims.

The regs under Section 6694 tease this out a bit. Treasury Regulation § 1.6694-1(b) provides the following:

For the purposes of this section, ‘tax return preparer’ means any person who is a tax return preparer within the meaning of section 7701(a)(36) and § 301.7701-15 of this chapter. An individual is a tax return preparer subject to section 6694 if the individual is primarily responsible for the position(s) on the return or claim for refund giving rise to an understatement. See § 301.7701-15(b)(3). There is only one individual within a firm who is primarily responsible for each position on the return or claim for refund giving rise to an understatement. … In some circumstances, there may be more than one tax return preparer who is primarily responsible for the position(s) giving rise to an understatement if multiple tax return preparers are employed by, or associated with, different firms.

Drilling deeper the advice also flags Reg § 1.6694-3(a)(2), which sets out when someone other than the actual return preparer may also be on the hook for the 6694 penalty:

  1. One or more members of the principal management (or principal officers) of the firm or a branch office participated in or knew of the conduct proscribed by section 6694(b);
  2. The corporation, partnership, or other firm entity failed to provide reasonable and appropriate procedures for review of the position for which the penalty is imposed; OR
  3.   The corporation, partnership, or other firm entity disregarded its reasonable and appropriate review procedures though willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) in the formulation of the advice, or the preparation of the return or claim for refund, that included the position for which the penalty is imposed.

In the email, the Counsel attorney points to the above reg for the conclusion that  its “interpretation of Treasury regulation § 1.6694-3(a)(2) is that generally, the entity (corporation, partnership, or other firm entity) that employs a tax return preparer will simultaneously be subject to the penalty under section 6694(b) only if the specific conditions set forth in the regulation are met. Otherwise, only the individual(s) that is primarily responsible for the position(s) on the return or claim for refund that gives rise to the understatement will be subject to the penalty.”

The email does refer to a district court opinion case (affirmed by the Sixth Circuit) from a few years ago, US v Elsass, where the court found that the owner of an entity was a “tax return preparer” for the purposes of the return preparer penalty provisions. In that case, the owner was the sole owner and personally prepared a substantial number of the returns at issue and was in its view the moving force on the positions (a theft loss/refund scheme).

The upshot of the advice is that absent circumstances similar to Elsass, or the presence of conditions 1 and either 2 or 3 above in Reg 6694-3(a)(2), an entity that employs return preparers itself is likely not subject to penalties. That conclusion suggests that return preparers should be careful to document and review procedures that are in place to ensure that an employed preparer has supervision and, of course, to make sure that management follows those procedures.

Government Seeks Reversal of District Court Decision That Invalidated PTIN User Fees

One of the more interesting cases from last year was Steele v US, where a DC district court upheld regulations imposing a PTIN requirement for preparers but held that the IRS did not have authority to require preparers to pay a user fee for obtaining or renewing a PTIN. In Steele, the District Court in invalidating the fees largely relied on the reasoning in Loving, and applied the Independent Offices Appropriations Act (IOAA) which authorizes agencies to charge fees for “a service or thing of value provided by the agency.” The lower court essentially held that the IRS’s fees were a backdoor attempt at regulating return preparers, stating that IRS “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” after Loving.

The government appealed, and it just filed its opening brief.

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The main argument that the government makes on appeal is that the district court failed to appreciate the service and value associated with obtaining a PTIN:

The PTIN provides a special benefit to tax return preparers because, as even the District Court held, it is required by statute and regulation to lawfully prepare returns for compensation. If a return preparer does not obtain a PTIN and provide it on returns he or she prepares, the preparer is subject to penalties of up to $25,000 per year, I.R.C. § 6695(c), as well as to being enjoined from preparing returns, I.R.C. § 7407. Return preparers comprise only a tiny fraction of the U.S. population, and the members of the general public who are not preparers have no occasion to request PTINs and receive no direct benefit from their issuance to those individuals who are return preparers. The issuance of PTINs thus provides a special benefit to the recipients of the PTINs, and therefore the IOAA authorizes the IRS to charge a user fee for PTINs.

In addition the government emphasized that the PTIN program helps “to protect preparers’ SSNs, which was Congress’s purpose in authorizing the IRS to create and mandate the use of the PTIN.”

The government on appeal attempts to separate the PTIN requirement from the regulation regime that Loving struck down. In so doing, the government emphasizes that while PTINs played a key role in that ill-fated regulatory regime (essentially only registered or licensed return preparers were eligible for a PTIN in the pre-Loving world) PTINs have a value and role that is distinct from regulating preparers.

As readers may recall, the district court’s conclusion mooted the alternative argument that the user fees IRS charged were excessive. If the government prevails on appeal, that issue will resurface.

Stay tuned.

For a prior post on Steele see here

TIGTA Releases Report on Return Preparers and Refundable Credits

Earlier this month TIGTA released a report discussing its review of compliance issues associated with refundable credit returns prepared by tax return preparers. The report is heavily redacted, but it has some interesting statistics and also provides further evidence as to how resource constraints limit IRS ability to do its job. The report also notes that IRS has not sufficiently referred egregious preparers to other functions, like Criminal Investigations or the Return Preparer Office.

Here are some of the report highlights:

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In processing year 2015 (I assume for 2014 tax returns) IRS identified 27.5 million returns with an EITC, and it approximates that 47%, or 13 million, were prepared by a return preparer. I note that EITC returns prepared by a return preparer have been decreasing, in part likely due to the growth of DIY software and also possibly due to a growth in ghost returns, where preparers fail to sign the return to avoid possible scrutiny and penalty.

Using its secret sauce scoring formula, the IRS was able to identify return preparer EITC returns that have potentially erroneous claims. TIGTA notes that IRS flagged 150,000 return preparers with characteristics that suggest they were preparing returns with errors relating to qualifying children or income misreporting, or both.

IRS has a robust tiered approach to return preparer compliance treatments; that includes phone calls, a variety of letters, “knock and talk” visits, due diligence audits, and even more severe treatment like injunctions or criminal referrals. (For a more detailed summary of IRS approach, see its EITC preparer toolkit summary.)

TIGTA notes that IRS selected 49,563 preparers for potential compliance treatments; due to resource constraints, IRS identification of a preparer needing treatment did necessarily not lead to that preparer getting treated.

In fact in FY 2016, the IRS completed various compliance treatments to address just over 24,000 return preparers identified as filing high rates of tax returns with characteristics of an erroneous EITC claim. The report breaks down the treatment and noted that IRS evaluates the success of its treatments. In part it does so by scoring the preparers’ future years’ returns and compares those to both a control group and the preparers’ past returns.

The TIGTA report not surprisingly found that a visit from an armed CID agent had a positive effect on future compliance (less so when an armed CID agent was not there); so did due diligence audits, and the audits that selected fewer returns had a similar effect as more expansive audits.

TIGTA knocked IRS for insufficiently documenting why certain preparers did not get treated; it also noted that about 39% of preparers who received a knock and talk visit or due diligence visit did not improve their compliance in the next year. TIGTA felt IRS needed a better job of putting in place written procedures discussing referrals to other functions, especially in light of the high number of preparers who apparently did not alter their behavior after the treatment; IRS pushed back a bit and said it did not think more procedures were needed but that there should be greater instances where a different function takes action.

The report also discusses the impact of letters and general contacts before the fact that were meant in a sense to nudge preparers to do the right thing. That is a topic I am keenly interested in; a paper that I and co-authors Dave Williams and Krista Holub (both of Intuit) wrote discusses possible ways that IRS can influence taxpayers and to a lesser extent preparers with behavioral economics techniques. For those with an interest, a draft is here; a final version will come out next year in the Virginia Tax Review.

I suspect that there is more work that IRS can do to examine the impact of letters and communication in general on return preparers. I am intrigued that IRS seems to have a different strategy for new preparers; it seems like reaching out and educating preparers before they develop entrenched bad practices is a good policy.

As Congress has recently expanded due diligence penalties to include CTC and AOTC, interest in preparers and compliance will likely increase. The TIGTA report is a useful reminder that IRS, while not able to regulate preparers in the way it sought before Loving, does have a variety of ways to influence and punish bad preparers. It seems IRS has a pretty good handle on finding preparers who are likely serving up erroneous returns; whether it has the resources or appetite to go after them fully is another issue.

 

Can Tax Preparer Recover Damages for Revoked EFIN

The recent decision rendered by the Court of Federal Claims in Snyder & Associates v. United States provides a stark reminder about the perils of building a business based on a government privilege or license – in this case the ability to electronically file tax returns for clients.  It also provides a reminder of the limitations of federal employees to bind the government for which they work.

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Snyder & Associates engaged in return preparation in the Los Angeles area.  It had a symbiotic relationship with a lender that funded refund anticipation loans (RALs).  Even though RALs ended several years ago, at least in their first decade of the 21st Century form, this case relates back to that era.  The same person owned both the return preparation firm and the lender.  Nothing in the opinion suggests that the businesses or the owner of the businesses engaged in inappropriate activity; however, one of the associates of the business, Nancy Hilton, who prepared returns there in the capacity of an independent contractor, did engage in fraudulent activity.

Ms. Hilton approached the IRS criminal investigators and advised them of the scheme in which she participated.  The scheme used stolen identities to seek benefits through tax filing.  After she brought the scheme to the IRS, Special Agents sought to use her to set up a sting.  For the sting to work, the IRS wanted Ms. Hilton’s co-conspirators to cash the checks written as refund anticipation loans.  Cashing those checks meant pulling money out of the lender side of the business.  The owner initially balked at the plan because of concerns of losing the money.  One of the special agents directly stated or implied that the IRS would make the lender whole.  The sting went forward.  In the end, the IRS declined to make the lender whole and, to add insult to injury, it terminated the EFIN license held by Snyder & Associates – an act which effectively terminated the return preparation business.

The business sued to recover the funds lost through the sting operation and to restore its EFIN privileges.  It lost on both counts.

With respect to the money lost in the sting, the issue turned on the authority of the special agent to bind the government.  I am probably oversimplifying this, but my experience working in the federal government for over 30 years suggests that first line employees like special agents, revenue agents, revenue officers, attorneys, etc., have extremely limited ability to bind the government.  Almost everything that they do which might create a monetary liability for the government must first be approved by their supervisors.  The principle extends beyond contracting for repayment of a sting obligation or other monetary obligations to matters such as settlement authority or referral authority.  There is a fairly elaborate system of delegation orders granting authority for certain acts.  The system generally does not go lower than the front line manager and frequently does not go that low.

Snyder & Associates ran full force into this system.  The special agent who told it that the money used to pay the fraudulent RALs would be repaid to the business by the government simply did not have the authority to bind the IRS.  The Court expended little effort in denying this claim for relief because the IRS had not committed itself to repayment of losses.  Based on my experience, the special agent who made the representation will receive counseling about their scope of employment which will include a discussion about not doing this again.  Such counseling will be cold comfort to the business that has lost the money with little or no hope of recovering it from the participants in the fraudulent scheme who will also owe the IRS and whose debt to the IRS will generally have a higher priority than the debt to the business.

Having lost the money spent to support the sting, the business then sought to reobtain the right to electronically file returns which the IRS pulled at approximately the same time the business cooperated with the sting operation.  The business argued that the termination of the EFIN rights was an improper taking of a property interest.  The Court points out that the IRS did not take the business or in any way deny the business use of the business.  The termination of the EFIN certainly impacted the business but the business had “no cognizable property interest in their EFIN in the first place.”  Citing Mitchell Arms v. United States, the Court stated that “when a party receives a permit to engage in an activity ‘which, from the start, is subject to pervasive Government control,’ no cognizable property interest capable of supporting a takings claim ever arises in that permit.”

Although the Mitchell Arms case involved the import and sale of assault rifles rather than electronic filing of returns, the Court found the action of ATF in that case exactly paralleled the action of the IRS in this one.  Because no property interest attached to the EFIN, the termination of the right to electronically file could not constitute a taking under the constitution.

Conclusion

The decision here, though harsh, does not cover new ground.  The business had good reason to expect the IRS would make it whole for assisting with the sting operation based on the representations of the special agent.  Not everyone knows of the limitations governing federal employees.  The case reminds us to take care in contracting or thinking we have contracted with the federal government.  Authority is critical.  Here, the special agent did not have proper authority to bind the IRS and the actions of other IRS officials did not act to ratify the actions of the special agent.

Similarly, licenses like EFINs do not come with a guarantee or with special protections.  When a business relies on the EFIN for its financial life, it must take extreme care to avoid actions that can result in its removal.  Even though the actions here appear to be those of an independent contractor working with the business, the concern of the IRS about fraudulent return filing schemes ends up punishing the business as well as the individual perpetrator in an effort to keep the system clean.  The result here reaches a much different result for the preparer than the D.C. Circuit in Loving because of the difference in the nature of the fight.  In Loving, the IRS sought to assert its authority over a previously unregulated matter – tax return preparation.  Here, the IRS exercised control over use of its electronic filing procedures something which it has carefully regulated from the start.  The challenge was not to the IRS ability to regulate electronic filing but whether the business had a property interest in the ability to electronically file.

 

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.