Paid Tax Return Preparers
In a Limited Study, Chain Preparers Made Serious Errors Gao ID: GAO-06-563T April 4, 2006Despite the importance of paid tax return preparers in helping taxpayers fulfill their obligations, little data exist on the quality of services they provide. Paid preparers include, for example, enrolled agents, who are approved by the Internal Revenue Service (IRS) once they pass an examination on tax matters or demonstrate past IRS employment experience, and unenrolled preparers, who include self-employed individuals and people employed by commercial tax preparation chains. GAO was asked to determine (1) what the characteristics were of tax returns done by paid preparers, (2) what government regulation exists for paid preparers, and (3) what specific issues taxpayers might encounter in using paid preparers. To do its work, GAO analyzed IRS data, reviewed paid preparer regulatory requirements, and had tax returns prepared at 19 outlets of several tax preparation chains.
Many taxpayers choose to pay others to prepare their tax returns rather than prepare their own returns. According to the most recent reliable data, about 56 percent of all the individual tax returns filed for tax year 2002 used a paid preparer, with higher paid preparer usage among taxpayers with more complicated returns such as those claiming the earned income credit (EIC). All paid preparers are subject to some IRS regulations and may be penalized if they fail to follow them. For example, all paid preparers must identify themselves on the returns they prepare and must not deliberately understate a taxpayer's tax liability. When the EIC is involved, paid preparers must also ask specific questions to determine a taxpayer's eligibility for the credit. In GAO visits to commercial preparers, paid preparers often prepared returns that were incorrect, with tax consequences that were sometimes significant. Their work resulted in unwarranted extra refunds of up to almost $2,000 in 5 instances, while in 2 cases they cost the taxpayer over $1,500. Some of the most serious problems involved preparers not reporting business income in 10 of 19 cases; not asking about where a child lived or ignoring GAO's answer to the question and, therefore, claiming an ineligible child for the EIC in 5 out of the 10 applicable cases; failing to take the most advantageous postsecondary education tax benefit in 3 out of the 9 applicable cases; and failing to itemize deductions at all or failing to claim all available deductions in 7 out of the 9 applicable cases. GAO discussed these findings with IRS and referred to it problems that were found. Had these problems been discovered by IRS on real returns, IRS officials said that many of the preparers would have been subject to penalties for such things as negligence and willful or reckless disregard of tax rules.
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Testimony:
Before the Committee on Finance, U.S. Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EDT:
Tuesday, April 4, 2006:
Paid Tax Return Preparers:
In a Limited Study, Chain Preparers Made Serious Errors:
Statement of Michael Brostek, Director, Strategic Issues:
GAO-06-563T:
GAO Highlights:
Highlights of GAO-06-563T, a statement before the Committee on Finance,
U.S. Senate:
Why GAO Did This Study:
Despite the importance of paid tax return preparers in helping
taxpayers fulfill their obligations, little data exist on the quality
of services they provide. Paid preparers include, for example, enrolled
agents, who are approved by the Internal Revenue Service (IRS) once
they pass an examination on tax matters or demonstrate past IRS
employment experience, and unenrolled preparers, who include self-
employed individuals and people employed by commercial tax preparation
chains.
GAO was asked to determine (1) what the characteristics were of tax
returns done by paid preparers, (2) what government regulation exists
for paid preparers, and (3) what specific issues taxpayers might
encounter in using paid preparers. To do its work, GAO analyzed IRS
data, reviewed paid preparer regulatory requirements, and had tax
returns prepared at 19 outlets of several tax preparation chains.
What GAO Found:
Many taxpayers choose to pay others to prepare their tax returns rather
than prepare their own returns. According to the most recent reliable
data, about 56 percent of all the individual tax returns filed for tax
year 2002 used a paid preparer, with higher paid preparer usage among
taxpayers with more complicated returns such as those claiming the
earned income credit (EIC).
All paid preparers are subject to some IRS regulations and may be
penalized if they fail to follow them. For example, all paid preparers
must identify themselves on the returns they prepare and must not
deliberately understate a taxpayer‘s tax liability. When the EIC is
involved, paid preparers must also ask specific questions to determine
a taxpayer‘s eligibility for the credit.
In GAO visits to commercial preparers, paid preparers often prepared
returns that were incorrect, with tax consequences that were sometimes
significant. Their work resulted in unwarranted extra refunds of up to
almost $2,000 in 5 instances, while in 2 cases they cost the taxpayer
over $1,500. Some of the most serious problems involved preparers
* not reporting business income in 10 of 19 cases;
* not asking about where a child lived or ignoring GAO‘s answer to the
question and, therefore, claiming an ineligible child for the EIC in 5
out of the 10 applicable cases;
* failing to take the most advantageous postsecondary education tax
benefit in 3 out of the 9 applicable cases; and
* failing to itemize deductions at all or failing to claim all
available deductions in 7 out of the 9 applicable cases.
GAO discussed these findings with IRS and referred to it problems that
were found. Had these problems been discovered by IRS on real returns,
IRS officials said that many of the preparers would have been subject
to penalties for such things as negligence and willful or reckless
disregard of tax rules.
Refund Amounts over or under Correct Amount in 19 Cases:
[See PDF for image]
[End of figure]
What GAO Recommends:
GAO recommends that the Commissioner of Internal Revenue conduct
necessary research to determine the extent to which paid preparers live
up to their responsibility to file accurate and complete tax returns
based on information they obtain from their customers.
www.gao.gov/cgi-bin/getrpt?GAO-06-563T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Michael Brostek at (202)
512-9110 or brostekm@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
I appreciate the opportunity to testify on the services offered by paid
tax return preparers. Every year tens of millions of taxpayers pay
someone to prepare their tax returns. According to Internal Revenue
Service (IRS) officials, several hundred thousand certified public
accountants (CPA) and attorneys were authorized to practice before it
as of March 2006, and there were about 41,000 active enrolled agents.
Enrolled agents are approved by IRS once the agents pass an examination
on tax matters or demonstrate past IRS employment experience. In 2003,
the National Taxpayer Advocate said the number of unenrolled preparers-
-those not enrolled with IRS--ranged from 300,000 to 600,000. On the
basis of scanning major preparation company Web sites, we know the
major preparation companies have thousands of offices nationwide.
Despite the importance of paid tax return preparers in helping
taxpayers fulfill their obligations, little data exist on the quality
of services they provide.
In most states, anyone can be a paid preparer regardless of education,
training, or licensure. However, there are different types of
preparers. Paid preparers who hold professional certification include
CPAs and attorneys. CPAs and attorneys are licensed through state
agencies, although licensure is not focused on their role as tax
preparers. CPAs, attorneys, and enrolled agents are referred to
collectively as practitioners. Other preparers are called unenrolled
preparers. This population of preparers is very diverse, ranging from
many of the individuals employed by commercial tax preparation
companies to those who are self-employed. Some have extensive training
and experience and others do not.
In 2003, we reported to this Committee that while many taxpayers who
used paid preparers believed they benefited from doing so, some were
poorly served. We said that the available evidence did not allow a
precise estimate of the percentage of taxpayers affected, but none of
it suggested that the percentage was large. We reported that preparer
mistakes can cause taxpayers to over-or underpay their taxes, and that
taxpayers may pay for certain services, such as short-term loans called
Refund Anticipation Loans (RAL), without understanding their costs and
benefits.[Footnote 1] In an April 2003 hearing of this Committee, we
testified that taxpayers can take common sense steps when choosing or
working with a paid preparer, such as:
* when searching for a preparer, obtain recommendations from people you
trust;
* check out your preparer's qualifications;
* make sure you understand the services you will be getting, how much
they cost, and how they will benefit you;
* make sure your preparer understands your personal circumstances and
reviews your official tax documents; and:
* review your completed return before you sign it.[Footnote 2]
Although taxpayers should take these common sense steps, IRS also notes
on its Web site under "Tips for Choosing a Tax Preparer" that no matter
who prepares a tax return, the taxpayer is legally responsible for all
of the information on that tax return.
My statement today is based on recent work we have done at the request
of the Committee. Our objectives were to determine (1) what the
characteristics were of tax returns done by paid preparers, (2) what
government regulation exists for paid tax return preparers, and (3)
what specific issues taxpayers might encounter in using paid preparers.
In preparing this statement, we did the following work:
* We analyzed IRS's Statistics of Income (SOI) individual taxpayer
database for tax year 2002, the most recent reliable data available, to
determine the income levels of users of paid preparers and
characteristics of the tax returns that these users filed.[Footnote 3]
* We reviewed laws, regulations, and other guidance and interviewed IRS
officials to determine regulatory requirements that apply to different
types of paid preparers.
* We had tax returns prepared for us at 19 outlets of several
commercial chain preparers scattered throughout a major metropolitan
area. We chose a large metropolitan area in which several chain
preparers were represented so that we could do our investigation in
different sections of the area. Our staff posed as taxpayers and asked
the paid preparers to prepare, but allow us to file, our federal tax
returns under two scenarios. In one scenario, a plumber and his wife,
with one of their children in college, derived almost all of their
income from his job, some work on the side, and a mutual fund. They had
enough deductions of various kinds to make it advantageous for them to
itemize tax deductions using Schedule A. We had 9 returns prepared for
this scenario. In the second scenario, a low-income single mother was a
retail sales worker who had side income from babysitting. She had one
child who lived with her and one who did not. We had 10 returns
prepared for this scenario. In general, we used each scenario twice
when visiting individual chain preparers but at different outlets. Our
19 site visits cannot be used to generalize our findings to the retail
tax preparation community. We did not visit any law firms, CPA firms,
or single-office tax return preparation businesses.
To arrive at correct returns for the two scenarios, our staff and staff
from the Senate Committee on Finance and the Joint Committee on
Taxation (JCT) completed the tax returns and agreed on (1) what should
and should not be reported on the returns and (2) the correct refund
amount for each scenario. For each of the 19 visits, we then compared
the tax returns produced with the consensus mock returns. In doing its
mock returns, JCT noted that it relied on the facts we provided and
discussions in which we participated. JCT cautioned that a paid
preparer might reach a reasonable conclusion different from JCT's on
certain issues or on the basis of actual questions asked or answers
given during a site visit. To minimize any potential for preparers to
have legitimately different results from our returns, we trained our
staff to answer preparers' questions consistently with the facts we
used in preparing our mock returns. Although we are defining the mock
returns as correct, we recognize that the final determination of the
accuracy of a return is subject to IRS and court interpretation.
* We analyzed IRS's National Research Program (NRP) database to compare
the compliance found on returns that used paid preparers and returns
that did not.[Footnote 4]
We did our work in February and March 2006 in accordance with generally
accepted government auditing standards and the quality standards for
investigations as set forth by the President's Council on Integrity and
Efficiency.
My statement today will make the following points:
* Many taxpayers choose to pay others to prepare their tax returns
rather than prepare their own returns. About 56 percent of about 130
million individual tax returns filed for tax year 2002 used a paid
preparer, with higher paid preparer usage among taxpayers with more
complicated returns, that is, those using the Form 1040 as opposed to
the Form 1040EZ, those claiming itemized deductions and not the
standard deduction, and those claiming the earned income credit (EIC).
* All paid preparers are subject to some IRS regulations and may be
penalized if they fail to follow them. For example, all paid preparers
must identify themselves on the returns they prepare and must not
deliberately understate a taxpayer's tax liability. When the EIC is
involved, paid preparers must also ask specific questions to determine
a taxpayer's eligibility for the credit. Lawyers, certified public
accountants, and certain tax professionals are also subject to
additional requirements.
* In our site visits, paid preparers often prepared returns that were
incorrect, with tax consequences that were sometimes significant. Their
work resulted in unwarranted extra refunds of up to almost $2,000 in 5
instances, while in 2 cases they cost the taxpayer over $1,500. Some of
the most serious problems involved preparers:
* not reporting side income in 10 of 19 cases;
* not asking about where a child lived or ignoring our answer to the
question and claiming an ineligible child for the EIC in 5 out of the
10 applicable cases;
* failing to take the most advantageous postsecondary education tax
benefit in 3 out of the 9 applicable cases; and:
* failing to itemize deductions at all or failing to claim all
available deductions in 7 out of the 9 applicable cases.
We discussed these issues with IRS. Had these problems been discovered
by IRS on real returns, IRS officials said that many of the preparers
would have been subject to penalties for such things as negligence and
willful or reckless disregard of tax rules. We have referred matters we
encountered to IRS so that any appropriate follow-up actions can be
taken.
More than Half of Taxpayers Used a Paid Preparer, but Use Varied by Tax
Return Complexity and Often Involved Larger Refunds:
As shown in table 1, according to SOI data, somewhat over half of the
approximately 130 million individual tax returns filed for tax year
2002 were done by a paid preparer. This filing breakdown was true for
all income levels we analyzed, although the income level exceeding
$100,000 had the highest percentage--64 percent.[Footnote 5] As not all
paid preparers provide preparer information on returns they prepare,
the percentages of returns that actually were prepared by another
person for pay is probably somewhat higher.
Table 1: Estimated Percentage of Individual Taxpayers' Returns Prepared
by a Paid Preparer for Tax Year 2002, by Adjusted Gross Income Level:
Adjusted gross income level: $0-20,000;
Estimate (percent): 53.
Adjusted gross income level: $20,001-40,000;
Estimate (percent): 56.
Adjusted gross income level: $40,001-60,000;
Estimate (percent): 57.
Adjusted gross income level: $60,001-80,000;
Estimate (percent): 58.
Adjusted gross income level: $80,001-100,000;
Estimate (percent): 55.
Adjusted gross income level: Over 100,000;
Estimate (percent): 64.
Adjusted gross income level: All adjusted gross income levels;
Estimate (percent): 56.
Source: GAO analysis of IRS SOI data.
[End of table]
As table 2 shows, this consistency of use did not hold for other
groupings of individual tax returns prepared by paid preparers. Use of
paid preparers differed among different types of returns, taxpayers of
different filing statuses, filers taking different types of deductions,
and claimants and nonclaimants of the earned income tax credit.
According to the breakdown in table 2, one-third of taxpayers filing
the simplest individual tax form--the Form 1040EZ--used a paid preparer
for tax year 2002, and two-thirds of a low-income working group--those
claiming the EIC--paid someone to prepare their tax returns.
Table 2: Estimated Percentage of Individual Taxpayers Using a Paid
Preparer for Tax Year 2002, by Various Groupings:
Grouping and subgrouping: Type of return: Form 1040EZ;
Estimate (percent): 33.
Grouping and subgrouping: Type of return: Form 1040A;
Estimate (percent): 50.
Grouping and subgrouping: Type of return: Form 1040;
Estimate (percent): 64.
Grouping and subgrouping: Filing status: Single;
Estimate (percent): 48.
Grouping and subgrouping: Filing status: Married filing jointly;
Estimate (percent): 61.
Grouping and subgrouping: Filing status: Head of household;
Estimate (percent): 65.
Grouping and subgrouping: Type of deductions: Itemized;
Estimate (percent): 62.
Grouping and subgrouping: Type of deductions: Standard;
Estimate (percent): 52.
Grouping and subgrouping: Earned income credit: Claimed;
Estimate (percent): 67.
Grouping and subgrouping: Earned income credit: Not claimed;
Estimate (percent): 54.
Source: GAO analysis of IRS SOI data.
[End of table]
Table 3 shows that whether taxpayers prepared their own returns or paid
a preparer, their tax returns showed a median of hundreds of dollars in
tax refunds for tax year 2002.[Footnote 6] However, overall and at the
four lowest income categories, those using paid preparers had a higher
median at statistically significant levels.
Table 3: Estimated Median Tax Year 2002 Refunds on Returns Filed by
Individual Taxpayers Using Paid Preparers and Those Preparing Their Own
Returns:
Income level: $0-20,000;
Using a paid preparer: $751;
Preparing own return: $365.
Income level: $20,001-40,000;
Using a paid preparer: $1,324;
Preparing own return: $846.
Income level: $40,001-60,000;
Using a paid preparer: $1,436;
Preparing own return: $1,224.
Income level: $60,001-80,000;
Using a paid preparer: $1,611;
Preparing own return: $1,359.
Income level: All adjusted gross income groups;
Using a paid preparer: $1,118;
Preparing own return: $674.
Source: GAO analysis of IRS SOI data.
[End of table]
At the $0-20,000 income level, a major part of the reason why refunds
are so different for those who used paid preparers versus those who
prepared their own returns appears to be the EIC. As table 4 shows,
those who claimed the EIC and used a paid preparer had tax returns
showing a median more than $900 higher in refunds than those who
claimed the EIC and prepared their own returns.
Table 4: Estimated Median Tax Year 2002 Refunds on Returns Filed by Low-
income Individual Taxpayers Using Paid Preparers and Those Preparing
Their Own Returns, by Whether They Claimed the EIC:
Taxpayer category: All taxpayers;
Using a paid preparer: $751;
Preparing own return: $365.
Taxpayer category: Taxpayers claiming the EIC;
Using a paid preparer: $2,675;
Preparing own return: $1,754[A].
Taxpayer category: Taxpayers not claiming the EIC;
Using a paid preparer: $367;
Preparing own return: $273.
Source: GAO analysis of IRS SOI data.
[A] The 95 percent confidence interval surrounding this estimate ranges
from $1,596 to $1,944.
[End of table]
Regulation of Tax Preparers Varies by Type of Preparer:
Different types of paid preparers are governed by different
regulations. All are subject to Internal Revenue Code (IRC) penalties,
and all paid preparers who choose to file electronically are subject to
IRS Electronic Return Originator (ERO) rules. However, only paid
preparers who choose to represent taxpayers before IRS are governed by
IRS Circular No. 230 regulations.[Footnote 7] In addition, California
and Oregon have their own regulations that apply to all paid preparers.
Table 5 summarizes how different types of paid preparers are covered by
different regulations.
Table 5: Summary of Paid Preparer Regulation:
Regulation: IRC penalties;
Preparers covered: Practitioners;
Preparers covered: Unenrolled preparers;
Description of regulation: Address such areas as fraud, negligence, due
diligence, and unauthorized disclosure.
Regulation: ERO rules;
Preparers covered: Practitioners;
Preparers covered: Unenrolled preparers;
Description of regulation: Apply to all entities in IRS's e-file
program and their principals and responsible officials and include
application requirements and rules for participating in electronic
filing.
Regulation: Circular 230;
Preparers covered: Practitioners;
Description of regulation: Applies to CPAs, attorneys, and enrolled
agents and governs duties and restrictions, sanctions, and disciplinary
proceedings.
Regulation: State regulations;
Preparers covered: Practitioners;
Description of regulation: Contain licensing and usually continuing
education requirements for CPAs and attorneys with only California and
Oregon having these requirements for unenrolled tax preparers.
Source: GAO.
[End of table]
Some Regulations Apply to All Paid Preparers:
All paid preparers are subject to IRC penalties and the regulations
that implement them. According to the Internal Revenue Manual,
penalties are IRS's key tools against noncompliant preparers. Table 6
lists civil penalties that apply specifically to preparers and some of
the criminal penalties (sections 7206, 7207, and 7216) that apply to
paid preparers.
Table 6: Internal Revenue Code Penalties:
Code section: 6694(a);
Description: Understatement of taxpayer's liability due to an
unrealistic position;
Penalty: $250 per return.
Code section: 6694(b);
Description: Understatement of taxpayer's liability due to willful or
reckless conduct;
Penalty: $1,000 per return.
Code section: 6695(a);
Description: Failure to provide copy of return to taxpayer;
Penalty: $50 per failure.
Code section: 6695(b);
Description: Failure to sign return;
Penalty: $50 per failure.
Code section: 6695(c);
Description: Failure to furnish identifying number;
Penalty: $50 per failure.
Code section: 6695(d);
Description: Failure to retain a copy or list of returns filed;
Penalty: $50 per failure.
Code section: 6695(e);
Description: Failure of employers to file correct information on each
tax preparer employed;
Penalty: $50 per failure.
Code section: 6695(f);
Description: Negotiation of taxpayer's refund check;
Penalty: $500 per check.
Code section: 6695(g);
Description: Failure to be diligent in determining earned income tax
credit eligibility;
Penalty: $100 per failure.
Code section: 6701;
Description: Aiding and abetting understatement of tax liability;
Penalty: $1,000.
Code section: 6713;
Description: Improper disclosure or use of return information;
Penalty: $250 per disclosure, up to a maximum of $10,000.
Code section: 7206;
Description: Willful preparation of a false or fraudulent return or
other document;
Penalty: Up to $100,000, 3 years imprisonment, or both.
Code section: 7207;
Description: Knowingly providing fraudulent returns or other documents
to IRS;
Penalty: Up to $10,000, 1 year imprisonment, or both.
Code section: 7216;
Description: Knowingly or recklessly disclosing or using return
information;
Penalty: Up to $1,000, 1 year imprisonment, or both.
Code section: 7407;
Description: Authority to enjoin income tax preparers.
Source: Internal Revenue Code.
[End of table]
Some civil penalties for preparers who engage in improper conduct are
found in IRC sections 6694 and 6701. These include a $1,000 per return
penalty if the understatement of the taxpayer's liability was due to
the preparer's willful attempt to understate liability or reckless or
intentional disregard for the rules. They also include a $1,000 penalty
on preparers who help taxpayers understate their liability. In
addition, they include a $250 per return penalty if the preparer knew
or reasonably should have known that the understatement of a taxpayer's
liability was due to a position that had no realistic possibility of
being sustained.
IRC section 6695 contains many identification penalties that apply to
preparers. For instance, a preparer must sign the return after it is
completed but before the taxpayer signs it and provide the taxpayer a
copy of the return. The preparer must also put his or her social
security number or other number issued by IRS on the return. The
penalty for failing to meet these requirements is $50 per failure but
cannot annually exceed $25,000 per person for each type of failure.
Most penalties in this section are not to be assessed if the preparer
shows that the violation was due to reasonable cause or not due to
willful neglect. All penalties in this section can be assessed in
conjunction with other penalties.
IRC section 6695 includes requirements specific to the EIC. It requires
paid preparers to take certain actions in determining the taxpayer's
eligibility for the EIC and the amount of EIC claimed. For instance,
preparers are required to complete an eligibility checklist to
determine if a child is a "qualifying child" by meeting residency, age,
and relationship requirements. Of particular importance in our
investigation, a qualifying child must have lived with the taxpayer for
over half of the year.
Preparers are also subject to criminal sanctions arising from improper
conduct. Civil and criminal penalties can be imposed for the same
violation. Preparers who help taxpayers prepare false or fraudulent
returns may be liable and could receive a prison term and a fine of up
to $100,000.
Other penalties, both civil and criminal, protect taxpayers from paid
preparers improperly disclosing the information they provide for their
tax return. Section 6713 imposes a civil penalty on preparers who
improperly use or disclose taxpayer information. Section 7216 imposes a
criminal penalty on preparers who knowingly or recklessly disclose or
use return information.
IRS's Small Business/Self Employed Division has responsibility for
assessing and collecting monetary penalties against any paid preparers
who do not comply with civil tax laws when filing returns. Under
section 7407, IRS may also bring a civil action in District Court to
seek an injunction prohibiting preparers from preparing taxes. IRS's
Criminal Investigation Division investigates paid preparers suspected
of violating criminal tax laws. In fiscal year 2005, Criminal
Investigation conducted 248 investigations under its Return Preparer
Program, with 140 of these resulting in recommended prosecutions.
Additional Regulations Apply Only to Some Paid Preparers:
Some IRS rules and regulations apply only to paid preparers in certain
circumstances. For example, ERO rules apply to preparers who are EROs-
-entities that IRS has approved to file electronic returns. EROs may or
may not be preparers. ERO rules also apply to ERO principals and
responsible officials. Circular 230 regulations apply to enrolled
agents, attorneys, and CPAs.
IRS has broad authority to monitor and sanction any paid preparer who
is authorized to file tax returns electronically. To participate in the
IRS e-file program, applicants must pass an IRS suitability check that
may include a background check, a credit history check, a tax
compliance check, and a check for prior e-file noncompliance. An IRS
official told us that although some EROs do not provide preparation
services, most do.
IRS monitors EROs to ensure compliance with revenue procedures and
publications that govern IRS's e-file program. For instance, according
to an IRS official, IRS continues to see if program participants are
suitable to participate. It also suggests that EROs verify the identity
and taxpayer identification number of taxpayers to protect the e-file
program from fraud and abuse. Violation of provisions in either a
revenue procedure or an IRS publication could lead to sanctions. IRS
sanctions range from a letter of reprimand for a relatively minor
infraction to expulsion from the e-file program for more severe
infractions. According to IRS, in 2005 it conducted 1,104 monitoring
visits for the e-file program resulting in 322 sanctions or proposed
sanctions.
Circular 230 imposes standards on enrolled agents, attorneys, and CPAs.
According to the Circular, in general, only practitioners may represent
taxpayers before IRS; however, unenrolled preparers may represent
taxpayers in certain situations.[Footnote 8] An attorney or CPA may
represent taxpayers before IRS by filing a written declaration with IRS
that he or she is licensed as either an attorney or a CPA. Under
Circular 230, tax preparers who are not attorneys or CPAs but who wish
to have the unrestricted privilege of representing taxpayers must be
approved as enrolled agents with IRS. Enrolled agent applicants must
either pass an examination on tax matters or have past IRS employment
experience. They are also required to meet continuing education
requirements.
Circular 230 describes the standards of conduct that practitioners must
follow to maintain the right to represent taxpayers before IRS. There
are generally three categories of misconduct covered under Circular
230: (1) misconduct while representing a taxpayer, (2) misconduct while
preparing a taxpayer's return, and (3) misconduct not directly
involving IRS representation. In terms of the second category--tax
preparation--one standard is the realistic possibility standard. This
standard restricts practitioners from signing tax returns if the
position does not have a realistic possibility of being sustained by
IRS. In addition, practitioners are required to advise taxpayers of any
noncompliance issue or omission from tax returns submitted to IRS,
advise taxpayers of the consequences of this noncompliance or omission,
and exercise due diligence to ensure accuracy in preparing tax returns.
Practitioners are also prohibited from charging contingent fees, that
is, fees based on whether the return will avoid challenge from IRS, for
some services including preparation of an original tax return. Finally,
practitioners are prohibited from making fraudulent, coercive, or
deceptive advertising statements.
IRS's Office of Professional Responsibility (OPR) administers the rules
set forth in Circular 230. OPR may censure, suspend, or disbar any
practitioner from practice before IRS if the practitioner violates any
Circular 230 regulation, is shown to be incompetent or disreputable, or
misleads or threatens a client with intent to defraud. OPR receives
complaints from taxpayers and IRS employees regarding tax preparers.
The American Jobs Creation Act of 2004[Footnote 9] added the authority
to impose a monetary penalty on a practitioner who violates Circular
230, and an employer or firm if it knew, or should have known, of the
misconduct. The act also added violations of Circular 230 to the list
of misconduct that can lead to an injunction. In fiscal year 2005, OPR
investigated 719 practitioners, resulting in 320 sanctions.
In the section on diligence as to accuracy in Circular 230, a
practitioner will have been "presumed to have exercised due diligence
for purposes of this section if the practitioner relies on the work
product of another person and the practitioner used reasonable care in
engaging, supervising, training, and evaluating the person, taking
proper account of the nature of the relationship between the
practitioner and the person."[Footnote 10] According to an IRS
official, "another person" includes an unenrolled preparer, and
enrolled agents are responsible for ensuring that unenrolled preparers
working for them do high quality work. According to the official, if
there were a problem with an unenrolled preparer's work, IRS could take
action against the employing enrolled agent.[Footnote 11]
State Regulation of Paid Preparers Focuses on Licensed Practitioners:
Although all states have licensing requirements for CPAs and attorneys,
only two states have licensing requirements for unenrolled preparers.
California and Oregon both require unenrolled paid preparers to
register with state agencies and meet continuing education
requirements. California requires that paid preparers pass a 60-hour
approved course and obtain a tax preparer bond to become registered.
California also requires 20 hours of continuing education annually. In
Oregon, tax preparers must be at least 18 years old, have a high school
degree or equivalent, complete 80 hours of income tax law education,
and pass a tax preparer examination. Oregon also requires 30 hours of
continuing education annually. While Oregon requires enrolled agents to
register, enrolled agents must meet far fewer registration requirements
than unenrolled preparers must.
In addition to state licensing requirements, tax practitioners often
belong to professional organizations such as the American Institute of
Certified Public Accountants, the American Bar Association, or the
National Association of Enrolled Agents. These organizations impose
general standards of conduct on the actions of their members, including
those who prepare tax returns.
Taxpayers Using Paid Preparers May Receive Incorrectly Completed Tax
Returns:
Taxpayers relying on paid preparers to provide them with accurate,
complete, and fully compliant tax returns may not get what they pay
for. Tax returns prepared for us in the course of our investigation
often varied widely from what we determined the returns should and
should not include, sometimes with significant consequences. Many of
the problems we identified put preparers, taxpayers, or both at risk of
IRS enforcement actions. The National Research Program's review of 2001
tax returns also found many errors on returns prepared by paid
preparers, and some of those errors were more frequent on paid prepared
returns than on self-prepared returns.
All of the Tax Return Preparer Visits We Conducted Produced Errors,
Some with Substantial Consequences:
All 19 of our visits to tax return preparers affiliated with chains
showed problems. Nearly all of the returns prepared for us were
incorrect to some degree, and several of the preparers gave us very bad
tax advice, particularly when it came to reporting non-W-2 business
income. Only 2 of 19 tax returns showed the correct refund amount, and
in both of those visits the paid preparer made mistakes that did not
affect the final refund amount. While some errors had fairly small tax
consequences, others had very large consequences. Incorrectly reported
refunds ranged from refunds overclaimed by nearly $2,000 to underclaims
of over $1,700.
Figures 1 and 2 below show how the tax return preparers we visited
completed key lines on the 1040 form, and explanations of some of these
lines follow the figures. Also, appendix I has descriptions of selected
visits we made to paid preparers, describing two example visits with
fewer issues and two with serious compliance problems.
Figure 1: Summary of How Paid Preparers Completed Selected Lines on the
IRS Form 1040 (page 1):
[See PDF for image]
[End of figure]
Figure 2: Summary of How Paid Preparers Completed Selected Lines on the
IRS Form 1040 (page 2):
[See PDF for image]
[End of figure]
Identifying information. Taxpayer names and social security numbers
were correctly entered on all but one of our returns, with one preparer
entering a wrong middle initial. Some preparers asked for this
information orally, and some asked us to complete information
worksheets.
Filing status. All of our prepared tax returns showed the correct
filing status for the two different scenarios we used. The plumber's
return always correctly indicated married filing jointly, and the sales
worker's return always indicated her filing status as head of
household.
Exemptions. Exemption information entered on the returns prepared for
us included some mistakes. All 9 of the plumber's returns listed the
correct number of exemptions. However, the plumber's daughter was
listed with a different last name on 1 return. Also, both of the
plumber's children were listed with first and middle names on another
return, despite the 1040 form clearly calling for dependents' first and
last names.
Of the 10 sales worker returns prepared for us, 7 incorrectly indicated
both children lived with the taxpayer in 2005. When asked where her
children lived, our staff always said that one lived with her and the
other with the child's grandmother throughout 2005. However, this
question was not always asked. In general, incorrectly reporting the
number of dependent children may have implications for other lines on a
tax return, specifically the dollar amount of personal exemptions on
line 42, the child tax credit reported on line 52, and the additional
child tax credit on Form 8812 and line 68.
Wages and investment income. Most income documented by third- party
reporting forms (Forms W-2 or 1099) was included on our returns
correctly, but not in every case. Wages shown on forms W-2 were
correctly listed on line 7 (see fig. 1) of all 19 of the tax returns
prepared for us in our investigation. Similarly, tax-exempt interest
(line 8a) and qualified dividends (line 9b) were listed on a Form 1099
from a mutual fund and were entered correctly on all 9 of the plumber's
returns. However, the same Form 1099 included ordinary dividends, but 1
preparer entered the wrong amount on line 9a. Also, the mutual fund
Form 1099 listed capital gains, but 2 returns did not include capital
gains income on line 13.
State tax refunds. State tax refunds were also shown on Forms 1099
given to the paid preparers we visited, but 8 out of 19 preparers
handled them incorrectly.[Footnote 12] In the plumber scenario, the
state tax refund should have been reported as income (line 10) on this
year's return, but this was not done on 5 of the 9 returns prepared for
him. The sales worker did not itemize deductions for 2004, so her state
tax refund was not supposed to be reported as income this time.
However, 2 of 10 preparers included her state tax refund on line 10,
and a third preparer listed the state tax refund amount from the state
Form 1099 as unemployment compensation on line 19.
Business income. Reporting "side income"--income from casual self-
employment arrangements--was very problematic in many of our visits to
paid preparers. Both of our taxpayer scenarios included self-
employment income, and we told the preparer that we had such income
whenever we were asked. Also, if the preparer did not ask about non-W-
2 business income, we still told the preparer that we had such income
before the end of the visit. Despite being told of the side income in
every case, 2 out of 9 plumber return preparers and 8 out of 10 sales
worker return preparers did not report the income as required.[Footnote
13]
Even in cases where the side income was reported, several paid
preparers gave us incorrect information. Several advised us that
reporting such income was our decision because IRS would not know of it
unless we reported it. One preparer told our investigator posing as a
sales worker that she did not have to report the income unless it was
over $3,200. Another said that her income could not be reported because
she did not have the names and the social security numbers of the
children she watched. On the other hand, the discussion of side income
with the paid preparers (when a discussion took place) often, to the
sales worker's potential benefit, included detailed probing by the
preparer to identify expenses to offset the income we described.
The amount of business income we built into our scenarios, and that
preparers often did not include on the tax returns that they prepared,
was not unusual for wage-earning taxpayers who underreported business
income for tax year 2001. According to data taken from IRS's recent NRP
efforts, for tax year 2001, about 37 percent of taxpayers with wages
and business income who underreported their business income did so by
amounts of up to $1,500, and about 65 percent underreported their
business income by up to $5,000.[Footnote 14]
Deductions. Only 2 of 9 of the plumber's returns reported the correct
amount of itemized deductions (line 40). Returns done by 2 preparers
claimed the standard deduction, even though it was about $4,000 less
than the total amount of itemized deductions we included in the
scenario. Five other preparers itemized deductions for the plumber, but
made other mistakes. These errors changed the amount of the plumber's
refund, although sometimes by fairly small amounts. One preparer,
however, missed deductions for property taxes worth about $4,000,
meaning that the claimed refund was hundreds of dollars lower than it
should have been. On the other hand, all 10 of the sales worker returns
claimed the standard deduction, which was to the taxpayer's advantage
in these cases because she had very few deductions to itemize. In 2002,
we reported that as many as 2 million taxpayers failed to minimize
their taxes by failing to itemize their deductions and that about half
of these taxpayers had returns prepared by another person.[Footnote 15]
Foreign tax credit. The plumber's Form 1099 from his mutual fund showed
a small amount of foreign taxes paid, but only 1 of the 9 preparers we
visited claimed the foreign tax credit (line 47) for which the taxpayer
was eligible.
Child-care expenses. The sales worker had child-care expenses, but none
of the 10 preparers we visited included the credit for child-and
dependent-care expenses (line 48) for which she was eligible. Some
preparers told her that she could not claim the credit because she did
not have the social security number of her child-care provider. This
information was incorrect. The instructions for Form 2441 state that a
taxpayer who attempts to collect the social security number of his or
her child-care provider but is unsuccessful can report that fact on
Form 2441 and still claim the credit.[Footnote 16]
Education credits. In the plumber scenario, one of the taxpayer's
children was a college student in the second year of postsecondary
education, but 6 of 9 paid preparers made some sort of error in
determining the line 50 education credit--either improperly including
items in expenses, not claiming the credit most advantageous to the
taxpayer, or both. The expenses and the year in school made the Hope
education credit far more advantageous to the taxpayer than either the
tuition and fees deduction (line 23) or the Lifetime Learning credit.
Of the 9 plumber's returns, 6 included the Hope credit, but 3 of the 6
preparers involved improperly included books among the expenses,
increasing the credit by about $100 above what it should have been. One
preparer included the tuition and fees deduction instead of the Hope
credit and 2 others claimed the Lifetime Learning credit, reducing the
taxpayer's refund by hundreds of dollars. In 2005, we reported that
many tax returns, including many prepared by paid preparers, made such
suboptimal choices among the three postsecondary education tax
preferences.[Footnote 17]
Earned income credit. The EIC on line 66a was another area where paid
preparers made very significant mistakes. Of the 10 returns prepared
for the sales worker, 5 reported two children on Schedule EIC, Earned
Income Credit, instead of the one child who lived with the taxpayer in
2005 and was eligible for the EIC. IRS has estimated that incorrectly
claimed children are the largest category of errors for the EIC,
accounting for about $3 billion of the estimated $8.5 billion to $9.9
billion in EIC overclaims in tax year 1999. IRS regulations require
that paid preparers ask a series of questions to determine eligibility
for the EIC, including whether children lived with the taxpayer in the
United States for more than half of the year. We were posing as a
fairly unsophisticated taxpayer who was unaware of EIC eligibility
rules, so we did not volunteer that one of our children did not live
with us in 2005. Whenever we were asked if our children lived with us,
however, we said that one did and one did not. Only 1 preparer asked
all of the required questions. Three preparers asked about the names,
dates of birth, and social security numbers of the two children but
never asked where the children lived in 2005. Three preparers gave us a
worksheet to complete that asked most but not all of the required
questions, but 2 of these preparers still entered two children when we
wrote down that one child did not live with the sales worker at all
during the year. In 1 of these cases, another employee reviewed the
return.
Refunds. As a result of the errors described above, some claimed
refunds on line 73a on our 19 returns were either substantially higher
or lower than they should have been. Figure 3 shows the deviation from
the correct refund amount under our two scenarios. The pairs of bars
shown in the figure indicate returns prepared by employees affiliated
with the same chain. As shown in the figure, refunds reported for the
plumber were incorrect in all 9 cases--sometimes by only small amounts,
but at other times by substantial sums. Refunds reported for the sales
worker were correct in 2 cases and overstated in the other 8 cases. The
paid preparers that arrived at the refund amount that was $218 too high
ignored the sales worker's side income but reported the correct number
of children living with her when calculating the EIC. The preparers who
arrived at overclaimed refunds of $1,956 did not include the side
income and reported two children for EIC purposes.
Figure 3: Refund Amounts over or under Correct Amount:
[See PDF for image]
[End of figure]
The 19 paid preparers we visited arrived at the correct refund amount
only twice. On 5 returns, all for the plumber, they understated our
refund amount by a total of $3,465. On 12 returns (4 for the plumber
and 8 for the sales worker) they overstated the refund by a total of
$12,169--a total of $1,735 in overstated refunds for the plumber and
$10,434 for the sales worker.
Preparer's identifying information. In addition to various
computational errors, some preparers also did not include identifying
information required on the 1040 forms they completed. IRS regulations
require that paid preparers include a signature or typed name, a social
security number or "PTIN" (an IRS-issued unique identifier for paid
preparers), and the name and employer identification number of their
employer. Four of our 19 returns had no preparer signature and 2 had no
preparer social security number or PTIN. All but 1 return prepared for
us included a company name and employer identification number; that
return was missing all identifying information.
Preparer services and fees. Most paid preparers we visited offered
services besides the federal tax returns we requested. Some preparers
offered to prepare the state tax return for us. In a few cases the
preparer gave us completed state tax returns along with the federal
return and did not indicate that there was an additional charge.
Whenever asked, we said we only wanted a federal tax return. Electronic
filing was always an option. One preparer proceeded to electronically
file our return, even after we said we wanted to mail in a paper
return. In this case, the preparer did not ask us to provide a personal
identification number or ask us directly to sign a form authorizing the
electronic filing, as required by IRS regulations.
We were also usually offered ways to get our refunds more quickly than
waiting for a check mailed from IRS. Some of these options involved
RALs--short-term loans made to taxpayers and paid off with tax refunds-
-and others involved direct deposit alternatives. In some cases, what
were clearly RALs were not described as loans but as "options" or "bank
products." One preparer gave us a RAL application to sign at the start
of the visit without explaining what it was we were being asked to
sign. Another preparer told us the size of the refund we could receive
in 12 to 48 hours but did not give us the amount we would receive if we
were willing to wait for a check from IRS, did not identify the faster
refund as a loan, and did not explain that the amount we would receive
was reduced by the amount of the fee associated with the option. In
this case, the fee for the RAL was between about $470 and about $570,
after subtracting the amount charged to prepare the return. With a
refund amount of about $5,000 and assuming a 10-day wait for the
refund, this means that the annual percentage rate for the loan was
between about 380 percent and about 470 percent.
The fees charged in our 19 visits varied widely, sometimes between
offices affiliated with the same chain, and were sometimes
significantly larger or smaller than the original estimate we were
given. In both the plumber and the sales worker scenarios, we received
1 set of returns at no cost, and another paid preparer reduced the fee
for the sales worker without explaining why. Figure 4 shows the fees
charged by each of the 19 paid preparers we visited. The pairs of bars
in figure 4 represent the fees charged by offices of the same chain for
the same scenario. In only 1 of the 9 cases where the same firm
prepared the same tax return were we charged the same amount. In some
cases, the preparer stressed that one advantage of purchasing a RAL or
paying the fees to arrange for direct deposit of the refund would mean
that the cost of the visit would come out of the refund and that we
would not have to pay any money on the day of the visit.
Figure 4: Fees Charged for Tax Preparation Services:
[See PDF for image]
[End of figure]
One of the common sense steps we mentioned earlier when choosing or
working with a paid preparer is to make sure you understand how much
the services you are getting cost. For this reason, we asked for an
estimate of fees at the start of every paid preparer transaction. Eight
preparers either did not provide an estimate or gave an estimate with
the qualifier that the fee would depend on the forms required. In the
other 11 cases, we were quoted a fee or a range that did not depend on
a variety of forms, and in 9 of those the fee we were ultimately
charged was within the quoted range, within $30 of the fee quoted, or
less than the estimate. Some preparers provided a detailed receipt
showing the forms that were prepared, but some receipts only showed the
final fee. None of the more detailed receipts, however, included
specific costs for individual forms.
Many Problems on Our Tax Returns Could Risk IRS Enforcement Actions
against the Paid Preparer, the Taxpayer, or Both:
According to IRS officials, paid preparers and taxpayers risk
enforcement action by filing a tax return that includes the types of
misstatements or omissions that we have described. According to the
officials, although IRS seldom has clear evidence about what transpires
between a preparer and a taxpayer, if IRS were to uncover problems with
the preparation of real tax returns similar to several that we found,
the preparers would be subject to civil sanctions.
Several penalties would be applicable depending on the facts and
circumstances of each situation. IRS officials said that if the
preparers had been preparing tax returns to be actually filed, many of
them would have been subject to civil penalties for such things as
negligence and willful or reckless conduct. For example, as stated
earlier in our testimony, if a paid preparer encourages a taxpayer not
to report or to erroneously report transactions on his or her tax
return, resulting in a tax-due understatement or refund overstatement,
the preparer could be assessed penalties of up to $1,000 for willful or
reckless disregard of tax rules and regulations.[Footnote 18] In both
of our scenarios, information provided to preparers included self-
employment income that the preparer did not encourage reporting.
According to IRS officials, the preparer is clearly responsible for
properly reporting all income, including the self-employment income in
these scenarios, on a taxpayer's return. They added that although
preparers are not required to audit taxpayers to uncover unreported
income, they must make reasonable inquiries to correctly report income.
IRS officials also said that civil penalties would be applicable to
other issues we encountered, depending on the facts and circumstances.
Preparers who did not ask all the EIC due diligence questions would be
subject to the penalty for the failure to be diligent in determining
EIC eligibility. Similarly, preparers who improperly included hundreds
of dollars of books in the education credit taken would be subject to a
penalty for negligence.
IRS officials we spoke with, who included representatives of Criminal
Investigation, said that although the dollar amounts of errors made by
the practitioners might not result in prosecutions, criminal sanctions
such as willful preparation of a false or fraudulent return might
apply.
In addition to paying the tax due after correcting the return and any
related late payment interest, the taxpayer may also be assessed a
penalty, depending on the facts and circumstances of each situation,
according to IRS officials. For example, if taxpayers substantially
understate income, overstate deductions, or provide other incorrect
information resulting in decreased tax or improperly high refunds, they
may be assessed an accuracy-related penalty. The penalty could be
assessed for any failure to comply with the tax laws, including the
failure to report self-employment income.[Footnote 19]
Because the returns we had prepared were not real returns and were not
filed, penalties would not apply. However, we have referred matters we
encountered to IRS so that any appropriate follow-up actions can be
taken.
The National Research Program Found Errors on Returns Prepared by Paid
Preparers:
IRS's tax year 2001 NRP data also indicate that tax returns prepared by
paid preparers contained a significant level of errors. As shown in
table 7, IRS audits of returns prepared by a paid preparer showed a
higher error rate--56 percent--than audits of returns prepared by the
taxpayer--47 percent.[Footnote 20] Errors in this context changed
either the tax due or the amount to be refunded. A similar
statistically significant relationship existed for all income groups of
$80,000 and below that we studied. Of course, as noted before, it is
important to remember that tax preparers are used more often on some
more complicated returns than on some simpler ones, although we were
unable to gauge the full extent to which this might be true. Also, the
fact that errors were made on a return done by a paid preparer does not
necessarily mean the errors were the preparer's fault; the taxpayer may
be to blame. The preparer must depend on the information provided by
the taxpayer.
Table 7: Estimated Percentage of NRP-audited Tax Year 2001 Individual
Returns with Errors:
Type of return: Prepared by a paid preparer;
Estimate (percent): 56.
Type of return: Prepared by the taxpayer;
Estimate (percent): 47.
Type of return: All returns;
Estimate (percent): 52.
Source: GAO analysis of IRS NRP data.
[End of table]
The different error rates for paid preparer and self-prepared returns
translated into different amounts that taxpayers owed IRS after audit.
For instance, as shown in table 8, taxpayers using a paid preparer owed
a median of $363 to IRS after audit, compared with a median of $185 for
taxpayers preparing their own returns. This type of disparity in taxes
owed existed for every income level we studied except for the $40,001-
60,000 and $60,001-80,000 ranges in which the differences were not
statistically significant.
Table 8: Estimated Median Additional Taxes Owed on NRP-audited Tax Year
2001 Individual Returns[A]:
Type of return: Prepared by a paid preparer;
Estimate: $363;
Lower bound: $338;
Upper bound: $397.
Type of return: Prepared by the taxpayer;
Estimate: $185;
Lower bound: $164;
Upper bound: $210.
Type of return: All returns;
Estimate: $279;
Lower bound: $262;
Upper bound: $300.
Source: GAO analysis of IRS NRP data.
[A] The 95 percent confidence intervals surrounding the estimates range
from the lower bounds to the upper bounds.
[End of table]
Table 9 shows some specific Form 1040 line items for which the NRP paid
preparer and self-prepared error rates differed from each other in a
statistically significant way. We also found problems with these line
items in our visits to paid preparers. For example, NRP audits revealed
that, for the Form 1040 line showing the amount of standard deduction
or itemized deductions taken, about 23 percent of self-prepared
individual returns had errors, compared with about 31 percent of
returns done by paid preparers. Paid preparer and self-prepared error
rates did not differ from each other in a statistically significant way
for business income and education credits line items, other line items
for which we had found problems.
Table 9: Estimated Percentages of NRP-audited Tax Year 2001 Individual
Returns Containing Specific Line Items with Errors on Those Line Items:
Form 1040 line item: Deductions;
Self-prepared returns (percent): 23;
Returns done by a paid preparer (percent): 31.
Form 1040 line item: Foreign tax credit;
Self-prepared returns (percent): 16;
Returns done by a paid preparer (percent): 6.
Form 1040 line item: Earned income credit;
Self-prepared returns (percent): 45;
Returns done by a paid preparer (percent): 53.
Form 1040 line item: Refund;
Self-prepared returns (percent): 48;
Returns done by a paid preparer (percent): 57.
Source: GAO analysis of IRS NRP data.
[End of table]
Concluding Observations:
Our limited review and the problems we found do not permit observations
about the quality of the work of paid tax preparers in general.
Undoubtedly, many paid preparers do their best to provide their clients
with tax returns that are both fully compliant with the tax law and
cause them to neither overpay nor underpay their federal income taxes.
Furthermore, as we observed in 2003, it is easy to understand how the
complexity of the tax code brings many taxpayers to conclude that they
should turn to a paid preparer.
As we also observed in 2003, however, our tax system depends on
taxpayers accurately completing and filing their returns. With their
important role in helping taxpayers meet their obligations, paid
preparers become a critical quality-control checkpoint for the tax
system. Where we saw serious problems in our few visits, these same
preparers may make similar mistakes on the genuine tax returns they
complete this year. Their mistakes and misstatements may also ripple
even further through the system as the taxpayers they serve may come to
believe that, for example, non-W-2 business income does not have to be
reported, and they may even spread that misinformation among their
friends and neighbors. In light of the importance of paid preparers in
our tax system today, knowing if what we found is the exception or the
rule in the paid tax preparation services industry is critical. With
better information about the extent of problems, IRS can better target
its limited enforcement and education resources.
Finally, our observation in 2003 that taxpayers who choose to use paid
preparers need to be wise consumers is even more important today in
light of our most recent findings. As IRS notes on its Web site under
"Tips for Choosing a Tax Preparer," no matter who prepares a tax
return, the taxpayer is legally responsible for all of the information
on that tax return.
We discussed our findings and observations with senior IRS officials,
and they generally agreed with our message.
Recommendation for Executive Action:
We recommend that the Commissioner of Internal Revenue conduct
necessary research to determine the extent to which paid preparers live
up to their responsibility to file accurate and complete tax returns
based on information they obtain from their customers. In conducting
this research, the Commissioner should consider whether the methodology
we used would provide IRS with a more complete understanding of paid
preparers' performance.
Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions you or other Members of the Committee may have
at this time.
Contacts and Acknowledgments:
For further information on this testimony, please contact Michael
Brostek at (202) 512-9110 or brostekm@gao.gov. David Lewis, Assistant
Director; Mario Artesiano; Paul Desaulniers; Danielle Free; Leon Green;
George Guttman; Christine Hodakievic; Lindsey Houston; Shirley Jones;
Jason Kelly; Lawrence Korb; Barbara Lewis; John Mingus; Karen O'Conor;
and Cheryl Peterson made key contributions to this testimony.
[End of section]
Appendix I: Paid Preparer Visit Examples:
None of our 19 visits to paid preparers were problem-free, but some had
relatively minor issues while others had more serious problems. The
following are descriptions of selected visits we made to paid
preparers. For each scenario, we provide one example of a visit that
had fewer compliance issues than most of our visits under the same
scenario, and one example that had more serious problems than most.
Example of a Plumber Visit with Minor Issues:
During this site visit, the paid preparer asked various questions and
prepared a return with few problems. For example, presumably to
determine the taxability of a state income tax refund, the preparer
asked about the previous year's itemized deductions and their amount.
The preparer also asked about which year the college-age child was in
schooling and whether the tuition in question had been paid in 2005,
questions needed to determine the applicability of the Hope education
credit. While the preparer did not ask about side income, when the
taxpayer volunteered that he had non-W-2 income, the preparer included
it on the return without discussing whether to either change it or not
report it. The preparer also probed for expenses to offset it.
The refund on the completed tax return was only $4 below the correct
amount. The difference was due to the preparer (1) overclaiming the
amount of personal property tax paid by including nondeductible fees
and (2) not taking the credit for foreign taxes paid. The preparer also
listed noncash charitable donations as cash donations, though this did
not affect the amount of the refund.
The cost of the visit to the paid preparer was about $100 more than the
amount originally quoted. However, at the start of the visit, the
preparer had said that the actual amount would depend on the number of
forms used. One of the forms used was the Schedule B, Interest and
Ordinary Dividends. While this form might have been used to capture
information the taxpayer provided, it did not need to be filed with
IRS, since the income amounts were less than the minimums requiring the
form. The paid preparer did not offer other services such as a Refund
Anticipation Loan (RAL) to the taxpayer.
Example of a Plumber Visit with Serious Problems:
Costly issues for the taxpayer during this site visit were the paid
preparer's failure to itemize deductions and the preparer's decision to
claim the tuition and fees deduction instead of the Hope education
credit. The preparer did not itemize the deductions despite the fact
that the taxpayer showed the preparer the documents supporting
itemization. The preparer even asked questions about medical expenses
and charitable contributions. The preparer also asked about whether
there were any nonreimbursed employee expenses and about whether the
college-age child was a full-time student.
On another issue, when discussing the taxpayer's side income, the
preparer wondered if the taxpayer had reported it the previous year,
which he had. The preparer suggested also reporting it this time so as
not to arouse suspicion, but at a much lower amount than the taxpayer
identified. The taxpayer declined the offer, and the preparer
ultimately included the correct amount. The preparer did not provide
the taxpayer with a completed Schedule C-EZ or a Schedule SE, although
information from both was reported on the form 1040. In addition, the
preparer did not include the state tax refund as income.
When asked about the tax return's price at the beginning of the
session, the preparer could not give an exact estimate but instead
provided a range. However, the preparer ended up not charging the
taxpayer at all since the refund involved was so small. In fact, the
refund was about $1,700 smaller than the correct amount.
Example of a Retail Sales Worker Visit with Fewer Serious Issues than
Most We Encountered:
This example is 1 of the 2 retail sales worker returns in which the
refund computed by the paid preparer was the same amount we computed.
The preparer reported the correct number of children for EIC purposes
and asked most of the due diligence EIC questions. Although the
preparer claimed the wrong number of children as exemptions, that did
not affect the final refund amount. Although the preparer did not ask
directly about side income, the preparer included it when we offered
the information. The price charged was the same as the price quoted,
and the preparer pointed out that a RAL was in fact a loan. The
preparer did not, however, sign the tax return or provide any other
preparer information on it.
Example of a Retail Sales Worker Visit with Several Serious Problems:
In this example, the paid preparer's return resulted in the tax return
showing a refund of almost $2,000 more than the correct amount. The
return did not include the side income even though the preparer asked
about anything else that should be considered and the taxpayer
mentioned it. The preparer said the taxpayer would need records of
income and expense to be able to report the income. The return included
two children as qualifying for the EIC and the additional child tax
credit even though only one lived with the taxpayer. The preparer
appeared to go through an on-screen EIC checklist but did not ask the
taxpayer the questions. The papers taken away from the preparer
included an EIC worksheet with the answers completed by the preparer,
some of them incorrect.
There were also other issues with the return prepared. First, it did
not include child-care expenses as the taxpayer was told the expenses
would have to exceed $7,300 to be claimed. Second, it incorrectly
included the state tax refund as income because the preparer said the
amount was for unemployment compensation. Third, the return did not
include the preparer's social security number although it did show his
name.
The preparer offered a RAL that would have been available in an hour at
a cost of about $400.
(450471):
FOOTNOTES
[1] GAO, Tax Administration: Most Taxpayers Believe They Benefit from
Paid Tax Preparers, but Oversight for IRS Is a Challenge, GAO-04-70
(Washington, D.C.: Oct. 31, 2003).
[2] GAO, Paid Tax Preparers: Most Taxpayers Believe They Benefit, but
Some Are Poorly Served, GAO-03-610T (Washington, D.C.: Apr. 1, 2003).
[3] As part of this and other work we have done, we tested this SOI
database by comparing record counts and selected totals in the files
provided to us by IRS to published amounts, finding that the required
data elements were sufficiently reliable for the purposes of our work.
We used the 2002 database rather than the 2003 database that was the
most recent available because IRS officials told us that some 2003
preparer information had been miscoded and would not be fixed until
after we needed the information. Because the SOI individual file and
the National Research Program files to be discussed later are created
following a probability procedure based on random selections, each
sample is only one of a large number of samples that might have been
drawn. Since each sample could have provided different estimates, we
express our confidence in the precision of our particular sample's
results as a 95 percent confidence interval (e.g., plus or minus 5
percentage points). This is the interval that would contain the actual
population value for 95 percent of the samples that could have been
drawn. As a result, we are 95 percent confident that each of the
confidence intervals in this statement will include the true values in
the study population.
[4] NRP is a detailed IRS study of taxpayer compliance for tax year
2001. As part of other work we have done or are doing, we tested the
NRP database by interviewing knowledgeable agency officials, finding
that the required data elements were sufficiently reliable for the
purposes of our work. See the earlier footnote on the SOI file for a
discussion of NRP confidence intervals.
[5] All percentage estimates from the SOI files have margins of error
of plus or minus 5 percentage points or less, unless otherwise noted.
All numerical estimates other than percentages have margins of error of
plus or minus 5 percent or less of the value of those numerical
estimates, unless otherwise noted.
[6] The median is the middle value in a distribution, with an equal
number of values above it and below it.
[7] Department of the Treasury, Circular No. 230, Regulations Governing
the Practice of Attorneys, Certified Public Accountants, Enrolled
Agents, Enrolled Actuaries, and Appraisers before the Internal Revenue
Service (Washington, D.C.: June 20, 2005).
[8] Unenrolled preparers may only represent those taxpayers before IRS
whose returns they prepared and only during examination of the return.
When unenrolled preparers represent taxpayers before IRS, they are
governed by IRS Revenue Procedure 81-38, which contains standards of
conduct similar to those in Circular 230, including the need for due
diligence in preparing tax returns.
[9] Pub. Law No. 108-357, Oct. 22, 2004.
[10] Circular No. 230.
[11] In our 19 site visits that will be described later, we do not know
if any of the paid preparers we saw were enrolled agents or working for
enrolled agents.
[12] According to IRS publication 525, a state tax refund generally
must be reported as income if the taxpayer deducted the tax in an
earlier year. The plumber scenario included that he itemized
deductions, including state income taxes paid, in the prior year and
the sales worker scenario included that she did not itemize deductions
the prior year. There are some qualifications to the reporting
requirement in the IRS publication, but questions asked by paid
preparers (if any) either did not address them or led to answers that
would cause the refund to be included as income.
[13] Our taxpayers' returns should have included either a Schedule C-
EZ, Net Profit from Business, or a Schedule C, Profit or Loss from
Business. In both scenarios, the income also required a Schedule SE for
self-employment taxes.
[14] Taxpayers with wage income who underreported their business income
by amounts ranging from $1,500 to $5,000 accounted for only a
relatively small amount--about $5.8 billion--of the approximately $53.6
billion underreported as business income by all wage earners with
business income.
[15] GAO, Tax Deductions: Further Estimates of Taxpayers Who May Have
Overpaid Federal Taxes by Not Itemizing, GAO-02-509 (Washington, D.C.:
Mar. 29, 2002).
[16] It is possible that some preparers understood the rules for
reporting the credit. Other preparer mistakes, such as not reporting
side income or claiming the wrong number of exemptions, had the effect
of eliminating the sales worker's tax liability. Because the credit for
child-and dependent-care expenses is not refundable, not claiming it in
cases where the taxpayer's tax liability was reduced to 0 may not have
been a mistake in its own right.
[17] GAO, Student Aid and Postsecondary Tax Preferences: Limited
Research Exists on Effectiveness of Tools to Assist Students and
Families through Title IV Student Aid and Tax Preferences, GAO-05-684
(Washington, D.C.: July 29, 2005).
[18] IRC sections 6694(a) and (b).
[19] IRC section 6662(b).
[20] All percentage estimates from the NRP files have margins of error
of plus or minus 5 percentage points or less, unless otherwise noted.
All numerical estimates other than percentages have margins of error of
plus or minus 5 percent or less of the value of those numerical
estimates, unless otherwise noted.
