Senator Feinstein, while noting that there is nothing inherently wrong with preparers selling financial products, observes that for lower-income and vulnerable taxpayers it may dilute federal benefits and not be accompanied by sufficient information describing the products. 

To help understand the scope of the practice as well as properly evaluate the costs and benefits, Senator Feinstein asked for responses to the following questions within 60-days:

1. What is the quality of information available about the extent to which high-cost financial products are being purchased by taxpayers, the characteristics of those who are most likely to sell and purchase such products, and whether the use of such products is growing or decreasing? How many complaints has the Bureau received about such products?
2. To what extent are tax preparers making the costs of high-cost financial products tied to tax preparation and tax refunds clear and easily understandable? Is the CFPB considering any actions to improve the ease with which consumers can understand these costs
3. For its 2006 report on paid tax preparers, the Government Accountability Office sent staff posing as taxpayers to visit tax preparers to see how they operated under two scenarios. Similarly, a 2015 report from the National Consumer Law Center involved sending “mystery shoppers” to paid tax preparers in Florida and North Carolina to check error rates. Would a similar approach be productive for the CFPB to gather additional information about financial products offered by tax preparers?
4. Is there any evidence that companies that offer high-cost financial products have offered them in conjunction with assisting people in applying for other forms of government aid? If so, is the CFPB taking or considering actions to address these situations? If not, what safeguards are in place in case such companies do so in the future?
5. The COVID-19 pandemic and the extra responsibilities Congress has conferred on the Internal Revenue Service (IRS) in response have caused substantial delays in tax processing. Is the CFPB concerned that potential delays in processing 2021 tax returns — such as the IRS having to reconcile child tax credit and economic impact payments — will lead to significant accrual or compounding of interest or other charges for taxpayers who have purchased refund advance loans or similar financial products? Has the Bureau received complaints about this?
6. The CFPB has provided advice and information for taxpayers, including on refund advance loans and checks. Do you have evidence on whether the Bureau’s educational activities in this area have been effective?

Some Quick Observations

Through pandemic relief and expanded child-related tax benefits, millions of people who had no or little exposure to the federal income tax system now must file tax returns. Current House-passed legislation is pushing the IRS to consider what a true IRS-hosted online return platform would look like.  A recent Politico piece by Brian Faler, Democrats hope to get a foot in the door for free tax-filing by the IRS, [paywall], discusses the proposed legislative initiative, as well as possible Byrd-rule problems with the proposal and opposition from anti-tax activist Grover Norquist, who heads Americans for Tax Reform. As reconciliation packages must focus on fiscal matters, the Byrd-rule limits proposals that have budgetary effects that are only incidental. Norquist is a well known opponent of pretty much any substantive tax increase or proposal that would expand IRS capabilities.

There are many reasons related to tax administration to support the IRS developing its own platform, especially for lower income and vulnerable taxpayers.  To be sure, there are also reasons to oppose it. For a point/counterpoint see Professors Joe Bankman and Jim Maule squaring off in the ABA Tax Times Perspectives on Two Proposals for Tax Filing Simplification, which discusses the merits of a pro-forma and data retrieval proposals. The Biden Administration’s Executive Order from earlier this week Transforming Federal Customer Experience and Service Delivery to Rebuild Trust in Government explicitly calls on Treasury to consider expanded e-filing options (Sec 4(b)).

Even if IRS were to create a true public option for e-filing that minimized taxpayer burdens, there will be taxpayers who choose to engage private practitioners. A few years ago when I worked at TAS we produced a report with recommendations on improving the administration of refundable credits. One of our proposals was legislation to require all paid return preparers to provide a fee disclosure statement to taxpayers prior to providing tax preparation and filing service. Senator Feinstein’s letter highlights that policymakers should consider the costs (and possible benefits too) of products that are not directly related to return preparation, especially when millions of lower-income and less sophisticated taxpayers pay to file returns.

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.

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:

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 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.