It comes as no surprise that people cheat on their taxes. There is a rich literature discussing tax noncompliance, analyzing its causes and discussing ways that the government can deter, detect and if necessary sanction those who would cheat or help others cheat. I too have contributed to the discussion, primarily considering the role that commercial preparers play in decisions to comply with our tax laws in research reports commissioned by the Taxpayer Advocate Service and made part of the National Taxpayer Advocate Reports to Congress in 2007 and 2008.
read more...I and others have been trying to draw on how insights from social science can help IRS and Congress seek to reduce the incidence of cheating on taxes.
Consider the following widely known social scientist experiment that is nicely summarized in an NPR story (the study is from a 1976 article in the Journal of Personality and Social Psychology by Researchers Diener, Fraser, Beaman, & Kelem, called Effects of Deindividuation Variables on Stealing Among Halloween Trick-or-Treaters). Researchers selected a group of children to visit staged homes on Halloween. The experiment involved children, dressed in costumes hiding their identity. The children went trick or treating at 27 different houses, and were greeted by different adults who showed them to a room containing two bowls, one filled with candy, and the other coins. The adults, who were in on the experiment, if asked about the money, told the kids that coins were for a charity and were going to be picked up soon. The adult then left the room. What happened next was that the kids stole. They stole candy. They stole money. They sometimes overturned the bowls and took the whole stash. It didn’t matter if an adult asked a child to act as an anonymous leader to ensure that the kids only took their fair share; the group still robbed the candy and coin bowls. The results changed dramatically if the adults knew the identity of the group of children or even the leader charged to ensure ethical behavior. When anonymity was breached, people stole less. A lot less.
This experiment (and others from social science literature I will discuss in later entries) emphasize that the opportunity to cheat without visibility is a critical factor in a taxpayer’s decision to take a position she knows is either wrong or aggressive enough that if detected the Internal Revenue Service would challenge the position.
The implications of this are far-reaching. Enhanced information reporting is one obvious byproduct, and the research supports the connection between information reporting and tax compliance. The most recent IRS research on the tax gap tells us as much; for items subject to information reporting and no withholding, correct tax reporting is about 92%; for items subject to information reporting and withholding the correct level of tax reporting is about 99%.
It is not just information reporting though that enhances visibility and accountability. Expanding and enhancing due diligence requirements can be effective. In addition, visibility is a crucial underpinning of the IRS’s Return Preparer Strategy that is currently the subject of litigation in the case of Loving v IRS. In Loving, earlier this year, the DC district court invalidated the IRS’s testing and education requirements for previously unlicensed preparers. Prior to implementing Return Preparer Strategy, the IRS literally had no idea who was preparing millions of tax returns. Disparate identification requirements, a lack of a uniform approach to communication, and no meaningful research looking at the way preparers interacted with taxpayers contributed greatly to the sense among preparers and taxpayers using those preparers that they operated in relative anonymity.
I do not want to overstate the point and say that the IRS’s approach to regulating return preparers is a panacea. There will always be unscrupulous preparers. There will be some who are incompetent, and other preparers who turn a blind eye to likely taxpayer lies (more on willful blindness in an upcoming entry). Nonetheless, I believe that the IRS’s approach to the return preparer issue, with uniform identification requirements, reasonable competency testing and ongoing education requirements, will greatly enhance visibility in the return preparation process. It can, with proper implementation, be a valuable tool in the IRS’s arsenal of trying to control errors, especially on returns claiming a refundable credit, which tend to have relatively high error rates and draw an even higher percentage of commercial preparers than other tax returns. IRS needs to understand who is preparing returns; it needs to speak to and correspond with preparers to ensure that preparers cannot hide behind a cloak of invisibility to help facilitate errors or ignore likely taxpayer misstatements. Registration, testing and ongoing education are a useful way to change the dynamics and inject a compliance norm in the multi-billion dollar tax preparation business.
Let’s hope as a policy matter that the Court of Appeals in the DC Circuit reverses the District Court and allows the IRS to continue with its sensible approach to the issue of regulating tax return preparers.
About Leslie Book
Regulation in defense of the Treasury is no vice. But moderation in the pursuit of tax fraud is a virtue. I look forward to opinions on this blog concerning the IRS requirement that lawyers who prepare tax returns and want to use electronic filing, must agree to random audit of office procedures, including random inspection of client files. (We must also agree to any future rules IRS may choose to implement.) What are the ethical implications of my consent? Why should electronic filers be treated differently from those who simply “prepare” returns, rather than “file” them for clients? When states require that all returns be filed electronically through the IRS system, why should surveillance be limited to tax practitioners? Why not those who file court documents in, for example, divorce and probate cases?
The RTRP licensing scheme that was struck down by the district court in Loving had nothing to do with tax fraud. The only requirements challenged (and struck down) in Loving were the examination and continuing education requirements for previously unenrolled tax-return preparers. But dishonest tax-return preparers can pass exams & take continuing education courses just as well (if not better, given that they’re dishonest) than honest tax-return preparers.
Notably, the Loving case did not challenge the IRS’s PTIN regulations, which require tax-return preparers to register for and obtain a unique identification number (similar to a social security number). Thus, the concerns voiced about how the IRS might identify tax-return preparers are a non sequitur. The PTIN regulations were passed by separate regulations under the authority of an entirely different statute. Nothing about the Loving case impairs the IRS’s ability to use PTINs to identify tax-return preparers and which returns they’ve prepared, nor to use algorithms or other software profiling technology to detect likely occurrences of tax fraud. If any aspect of the IRS’s Return Preparer Strategy would reduce tax fraud, it would be the PTIN identification number requirement, not the RTRP licensing scheme.
In addition, the IRS has long had the authority to prosecute fraudulent tax-return preparers (or seek injunctions against their continued preparation of tax returns) under the Internal Revenue Code, and the Loving case did nothing to change this. The Loving case also had no effect on the existing Title 26 statutory scheme that regulates the conduct of tax-return preparers, and imposes (often severe) civil and criminal penalties for violations ranging from failing to include one’s name or identification number on a tax return one has prepared to outright tax fraud.
Thus, even after Loving, the IRS still has the ability to “understand who is preparing returns [and] speak to and correspond with preparers to ensure that preparers cannot hide behind a cloak of invisibility.” There is no cloak of invisibility; all tax-return preparers must have valid PTINs (registration for a PTIN includes providing one’s email, phone number, and street address) and they must include their name and PTIN number on every return they prepare or be subject to penalties under Title 26. Therefore, the claim that the Loving ruling did anything to interfere with the ability of the IRS to know who is preparing tax returns, and which ones, is simply unsupported by both the facts and the relevant laws & regulations.
I think many at IRS would disagree with the statement that the RTRP regime had nothing to do with tax fraud, but the point you make that the cloak of invisibility is punctured by the PTIN regime is forceful. It is not clear whether more touches and contacts would contribute to lesser fraud (or unintentional errors for that matter); whether it would drive taxpayers to self-prepare, to VITA; etc. The additional touch necessitated by education and testing facilitates greater communication between the IRS and preparers; by no means is it necessary for those requirements to be in place to generate greater visibility and accountability. There are some interesting empirical questions underlying what I believe to be the rationale for the IRS’s efforts ; the research, or at least what I am familiar with, is not conclusive. I think reasonable people can differ as to what conclusion or policy choices an agency should make, especially when the costs are direct and the benefits are somewhat unclear or at least not yet proven.
I look forward to continuing this discussion at the Shachoy symposium at Villanova, where we are lucky to have you as a panelist.
Yes, I look forward to continuing this discussion at the Villanova symposium.
I would also note that the costs to be considered should certainly include the cost of creating regulatory barriers to entry for small, independent tax-return preparers who are not part of a large corporate firm, as well as the increased costs of tax-return preparation to consumer-taxpayers that would result from costly regulations & reduced competition. These substantial costs are too often ignored.
The Economist noted that these new IRS regulations “threaten to crush . . . small, local” tax preparers and are “likely to push mom and pop into another line of work.” http://www.economist.com/node/21551052
Indeed, the IRS’s own data has shown a dramatic drop in the number of tax preparers following the implementation of the RTRP regulations – a loss of over 200,000 preparers from 2010 to 2012, coupled with a sharp uptick in the number of returns prepared per preparer. In addition, the regs hit smaller preparers hardest, driving more out of the market. Preparers who prepared between 1-20 returns decreased from 66% of all preparers in 2004 to 58% of all preparers in 2010 and were just 46% of all preparers in 2012. Meanwhile, preparers who prepared over 100 returns increased from 17% of all preparers in 2004 to 22% in 2010 and made up 30% of all preparers in 2012. See http://www.taxpolicycenter.org/events/upload/1-2-Vigil.pdf
This large reduction in the number of tax preparers is expected to drive up the prices Americans pay for tax-return preparation, as Accounting Today noted in an article entitled _Tax Preparer Shortage on the Way_. “This new requirement will cause an exodus of tax preparers who will stop practicing rather than take the test and complete annual education,” said Chuck McCabe, chief executive of The Income Tax School. “The result will be a shortage of qualified tax preparers and, consequently, a bidding war. A high percentage of the industry’s most experienced tax preparers are elderly and rather than take the exam, many will retire.” http://www.accountingtoday.com/news/tax-preparer-shortage-63903-1.html?taxpro
This is no accident. The reduction in competition and the corresponding higher profit-per-return are precisely why large, corporate tax-preparation firms such as H&R Block, Jackson Hewitt and Intuit (makers of TurboTax, which is not even subject to the RTRP regs) lobbied for these licensing regulations in the first place, and why TurboTax was the first entity to express outrage when the regulations were struck down. As the Wall Street Journal noted, “Cheering the new regulations are big tax preparers like H&R Block, who are only too happy to see the feds swoop in to put their mom-and-pop seasonal competitors out of business.” http://online.wsj.com/article/SB10001424052748703436504574640572196836150.html
Indeed, not only did former H&R Block CEO Mark Ernst supervise the drafting of the new RTRP licensing rules, but a “A 2010 analysis by investment bank UBS concluded the rules ‘should help Block’ for many reasons, including ‘add[ing] barriers to entry (or continuation) for small preparers.'”
http://washingtonexaminer.com/tim-carney-hr-block-turbotax-and-obamas-irs-lose-in-effort-to-regulate-small-tax-preparers-out-of-business/article/2521169
Unsurprisingly, Reuters reported that the big losers of the Loving decision (aside from the IRS itself) were the large corporate tax firms: “The court ruling could hurt institutional tax-preparation providers such as H&R Block and Jackson Hewitt by reopening the market to small competitors that the IRS program had been
expected to squeeze out, said [investment analyst Gil] Luria, who covers the industry.” http://articles.chicagotribune.com/2013-01-22/news/sns-rt-usa-taxpreparer-update-1l1n0aremb-20130122_1_tax-preparers-jackson-hewitt-irs-program
It is easy to overlook the crony capitalism and rent-seeking at issue here by (wrongly) assuming that big business almost always opposes regulation, and so any regulations supported by large industry players must be objectively good for the industry. And it can also easy to forget that federal agencies are often captured by the industries they’re supposed to be regulating; many assume they must have consumers best interests in mind, even when they are passing regulations that will reduce consumer choice & drive up prices. Instead, look at who benefits, and who loses. And be very skeptical when large corporate interests lobby for regulations that would restrict market entry and/or drive out smaller competitors, as was the case with the RTRP regulations.
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