IRS’s Authority to Regulate Paid Preparers Is Limited, Although Use of Preparers is High

A paid preparer is simply anyone who is paid to prepare, assist in  preparing, or review a taxpayer’s tax return. In this statement, we refer to  two categories of paid preparers—tax practitioners and unenrolled  preparers. CPAs, attorneys, and enrolled agents are tax practitioners.  Tax practitioners differ from unenrolled preparers in that they can practice  before IRS, which includes the right to represent a taxpayer before IRS,  prepare and file documents with IRS for the taxpayer, and correspond  and communicate with IRS. We use the term unenrolled preparer to  describe the remainder of the paid preparer population. In most states,  anyone can be an unenrolled preparer regardless of education,  experience, or other standards.
Tax practitioners are subject to standards of practice under the  Department of Treasury Circular No. 230. Enrolled agents are generally  required to pass a three-part examination and complete annual continuing  education, while attorneys and CPAs are licensed by states but are still  subject to Circular 230 standards of practice if they practice before IRS.  Generally, unenrolled preparers are not subject to these requirements.
In April 2006, we made a recommendation to IRS to conduct research on  the extent to which paid preparers meet their responsibility to file accurate  and complete tax returns. conducted a study of the quality of paid preparers and issued a report  recommending increased oversight of paid preparers.  Recommendations included (1) mandatory registration, (2) competency  testing and continuing education, and (3) holding all paid preparers— including unenrolled preparers—to Circular 230 standards of practice.  IRS implemented each recommendation through regulations issued in  September 2010 and June 2011. The June 2011 regulations amended  Circular 230 and established a new class of practitioners called  “registered tax return preparers.” IRS intended for these new  requirements to support tax professionals, increase confidence in the tax  system, and increase taxpayer compliance.
GAO-06-563T.
According to IRS officials, approximately 84,148 competency exams were taken prior to  the District Court’s decision. new testing and continuing professional education requirements. IRS  appealed the order, but it was affirmed in February 2014 by the U.S.  Court of Appeals for the District of Columbia Circuit. Figure 1 provides a  summary timeline of IRS’s implementation of paid preparer requirements  and legal proceedings. The President’s Fiscal Year 2015 budget,  released in March 2014, included a proposal to explicitly provide the  Secretary of the Treasury and IRS with the authority to regulate all paid  preparers.
Although the District Court determined that IRS does not have the  authority to regulate unenrolled preparers, the decision did not affect the  requirement that all paid preparers obtain a Preparer Tax Identification  Number (PTIN) and renew their PTIN annually. As of March 16, 2014,  approximately 676,000 paid preparers have registered or renewed their  PTINs. As shown in figure 2, the two largest categories of PTIN  registrations and renewals are unenrolled preparers—55 percent—and  CPAs—31 percent.

		Four States Regulate Paid Preparers, but Requirements Vary

Currently, Oregon, Maryland, California, and New York regulate paid  preparers. Both Oregon and California began to regulate paid preparers  in the 1970s, while Maryland and New York’s programs were  implemented more recently. Further, the programs themselves involve  different types of requirements for paid preparers as illustrated in table 1.
In August 2008—prior to Maryland and New York implementing paid  preparer requirements—we reported on state-level paid preparer  requirements in California and Oregon. Specifically, we reported that  both California and Oregon have requirements that paid preparers must  meet before preparing returns; of the two states, Oregon has more  stringent requirements.
According to our analysis of IRS tax year 2001 NRP data, Oregon returns  were more likely to be accurate while California returns were less likely to  be accurate compared to the rest of the country after controlling for other  factors likely to affect accuracy. Specifically, in August 2008, we found  that the odds that a return filed by an Oregon paid preparer was accurate  were 72 percent higher than the odds for a comparable return filed by a  paid preparer in the rest of the country.

		Use of Paid Preparers Varied by Complexity of Tax Return, but Often Resulted in Larger Refunds

According to IRS’s SOI data, an estimated 81.2 million or 56 percent of  approximately 145 million individual tax returns filed for tax year 2011  were completed by a paid preparer. Estimated use of paid preparers was  fairly evenly distributed across income levels, and as table 2 shows,  taxpayers with more complex returns used preparers the most. For  example, preparers were more commonly used by taxpayers who filed  the Form 1040 as opposed to the 1040EZ or 1040A and those claiming  itemized deductions or the Earned Income Tax Credit (EITC).
Across all income levels taxpayers who used paid preparers had a higher  median refund than those who prepared their own returns at statistically  significant levels, as shown in table 3. Specifically, individual taxpayers  who used a paid preparer had an estimated median tax refund across all  adjusted gross income levels that was 36 percent greater than taxpayers  who prepared their own return.

	Limited Investigation and IRS Data Reveal Significant Errors in Returns Prepared by Paid Preparers

Taxpayers rely on paid preparers to provide them with accurate,  complete, and fully compliant tax returns; however, 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 would put  preparers, taxpayers, or both at risk of IRS enforcement actions. The  NRP’s review of tax returns from 2006 through 2009 also found many  errors on returns prepared by paid preparers, and some of those errors  were more common on paid prepared returns than on self-prepared  returns.

		Nineteen Site Visits Revealed Significant Paid Preparer Errors

Nearly all of the returns prepared for our undercover investigators were  incorrect to some degree, and several of the preparers gave us incorrect  tax advice, particularly when it came to reporting non-Form W-2 income  and the EITC. Only 2 of 19 tax returns showed the correct refund amount.  While some errors had fairly small tax consequences, others had very  large consequences resulting in the overstatement of refunds from $654  to $3,718.
Our undercover investigators visited 19 randomly selected tax preparer  offices—a non-generalizeable sample—to have taxes prepared. We  developed two taxpayer scenarios based on common tax issues that we  refer to as our “Waitress Scenario” and our “Mechanic Scenario.” Key  characteristics of each scenario are summarized in table 4.

		Errors in Tax Preparation Resulted in Inaccurate Refund Amounts

Refund amounts derived by the 19 preparers who prepared tax returns  based on our two scenarios varied greatly. For our waitress scenario, the  correct refund amount was $3,804, however, refund amounts on returns  prepared for our undercover investigators ranged from $3,752 to $7,522.  Similarly, the correct refund amount for the mechanic scenario was  $2,351; however, refunds ranged from $2,351 to $5,632. Paid preparer  errors generated during our 19 non-generalizeable visits resulted in  refund amounts that varied from giving the taxpayer $52 less to $3,718  more than the correct amount. Of the 19 paid preparers we visited, 2  determined the correct refund amount: one correct tax return was  prepared for the waitress scenario and one for the mechanic scenario. An  additional 4 paid preparers calculated tax returns within $52 of the correct  refund amount. On the remaining 13 tax returns—7 for the waitress  scenario and 6 for the mechanic scenario—preparers overestimated the  total refund by $100 or more. Figure 3 shows the amount of the refund  over and under the correct refund amount.
In some instances, paid preparers made similar errors across multiple site  visits. For example, on the waitress return paid preparers made two of the  same errors: (1) not claiming the unreported cash tips and (2) claiming  both children as eligible to receive the EITC. These errors resulted in  clusters of overstated refunds. In four site visits, paid preparers not  claiming unreported cash tips resulted in a refund amount overstated by  $654. In three site visits, paid preparers made both errors, which resulted  in a refund amount overstated by $3,718. In the mechanic scenario, paid  preparers that did not include side income resulted in tax refunds that  ranged from $2,677 to $3,281 above the correct refund amount.

		Quality and Accuracy of Tax Preparation Varied Based on the Scenario and Specific Form or Line Number

A majority of the 19 paid preparers we visited made errors on common  tax return issues; on some lines of the tax return most paid preparers  were correct. Some of the most significant errors involved paid preparers  (1) not reporting non-Form W-2 income, such as unreported cash tips, in  12 of 19 site visits; (2) claiming an ineligible child for the EITC in 3 of 10  site visits; and (3) not asking the required eligibility questions for the  American Opportunity Tax Credit. Such errors could lead taxpayers to  underpay their taxes and may expose them to IRS enforcement actions.  By contrast, in some instances the majority of preparers took the right  course of action. For example, 17 of 19 paid preparers completed the  correct type of tax return and 18 of 19 preparers correctly determined  whether to itemize or claim the standard deduction. Our results are  summarized in figure 4.
Type of tax return. Paid preparers completed the correct type of tax  return—the Form 1040—for 17 of 19 site visits. Two paid preparers  incorrectly completed the Form 1040A for the waitress scenario. The  Form 1040A should not have been used because the waitress  received tip income that was not reported to her employer.
Dividend and capital gains income. Preparers recorded the income  correctly on 8 of 9 returns. The mechanic received qualified and  ordinary dividends, and capital gains from a mutual fund that were  reinvested into the fund. This income was documented on a third  party reporting form; the Form 1099-DIV. According to IRS guidance,  a Form 1099-DIV must be filed for any person who receives dividends  of $10 or more, including for funds that are reinvested.
Mechanic Scenario, Site Visit #1  One paid preparer who did not accurately record the investment income  said that it was not necessary to include income that was reinvested in a  mutual fund.
Total income. Of the 10 waitress returns prepared for us, 3 included  the unreported cash tip income. However, only one of the three  returns included the correct amount of tip income. Total income for the  waitress scenario should include income documented on the Form W- 2, as well as the amount of unreported cash tip income offered by our  investigator to the paid preparer during the site visit. The two returns  that did not include the correct amount of tip income included lesser  amounts.
Waitress Scenario, Site Visit #5  In response to the investigator mentioning her unreported cash tip  income, one paid preparer told her that tips not included on the Form   W-2 do not need to be reported.
Total income for the mechanic return should include non-Form W-2  business income—resulting from mechanic work and babysitting  conducted outside of a formal employment arrangement—and income  from ordinary dividends and capital gains. Of the 9 mechanic returns  prepared for us, 4 returns included both the business income and the  investment income. However, only 3 returns included the correct  amounts of business and investment income.
Incorrectly reporting income often resulted in cascading errors on  other lines of the tax return. Tax returns that did not include side  income had errors in credits that are calculated based on income. For  example, if a paid preparer did not report side income in the mechanic  scenario, the resulting total income would make the mechanic eligible  for the EITC when he otherwise would not be eligible. Similarly,  because two paid preparers incorrectly chose not to include  unreported tip income for the waitress, they selected the wrong type  of tax return, the Form 1040A.
Mechanic Scenario, Site Visits #3 and #9  Two paid preparers demonstrated what the refund amount would be if the  side income were reported compared to if it were not reported. Both  preparers did not record the side income.
Itemized or standard deduction. All but one of the 19 returns  correctly recorded the most advantageous deduction for the two  scenarios. According to IRS guidance, taxpayers should itemize  deductions when the amount of their deductible expenses is greater  than the standard deduction amount. For the waitress scenario, the  most advantageous deduction would be the standard deduction for  head of household, and for the mechanic scenario, the itemized  deductions were more advantageous. One paid preparer chose to use  the standard deduction for the mechanic, even though it was  approximately $3,000 less than the total amount of the itemized  deductions we included in the scenario.
Child-care expenses. All 19 paid preparers did not record child-care  expenses because neither the waitress nor mechanic was eligible to  receive the credit. While none of the paid preparers recorded the  credit, the reasons the preparers cited were often incorrect. According  to IRS guidance, a taxpayer must attempt to collect the Social  Security number of his or her child-care provider, but if unsuccessful,  can report that fact to IRS and still claim the credit. For the waitress  scenario, the reason that she was ineligible to claim the child-care  expenses was that she did not attempt to get her child-care provider’s  Social Security number. Upon learning that she did not have the  Social Security number of the provider, several of the paid preparers  did not enter her child care expenses on her return.
IRS guidance states that qualified child-care expenses only include  amounts paid while the taxpayer worked or looked for work. The  mechanic and his wife were not eligible for the credit because the  child-care expenses were incurred for running errands, and not so  that either parent could work. Again, many tax preparers said that the  reason the credit could not be claimed was because the mechanic did  not have the child-care provider’s Social Security number, not  because he was otherwise ineligible.
Student loan interest. Eight of 10 paid preparers correctly included  the deduction for student loan interest. The waitress’s Form 1098-E  shows the interest the lender received from the taxpayer on qualified  student loans. A taxpayer receives a Form 1098-E if student loan  interest of $600 or more is paid during the year.
Sales tax deduction. Seven of 9 preparers recorded sales tax as a  deduction on the mechanic’s tax return, however not all chose the  most advantageous amount. According to IRS guidance, taxpayers  who itemize deductions can choose whether to deduct local income  taxes or sales taxes. Because the mechanic lived in a state that did  not have income tax, sales tax should have been deducted. Of the 7  paid preparers that deducted sales taxes, only 2 recorded the amount  that was most advantageous to the taxpayer. IRS provides an online  calculator to help taxpayers estimate the amount of sales taxes they  likely paid in a year. To determine this estimate, taxpayers input basic  information such as ZIP code and annual income in the calculator.  Five preparers chose amounts that were lower than the amount the  calculator estimated.
Social Security and Medicare tax on unreported tips. Two of 10  paid preparers completed the Form 4137 and reported the amount of  taxes owed on the tip income. Because the waitress received  unreported cash tips, the amount of taxes owed on the unreported  cash tip income should be calculated using the Form 4137.  However, one of the preparers included a lesser amount of tip income  when performing the calculation, resulting in a smaller amount of  taxes owed. Another preparer reported the tip income by incorrectly  completing a Schedule C, Profit or Loss from Business, and a  Schedule SE for self-employment taxes.
Earned Income Tax Credit. The EITC on line 64a was another area  where paid preparers made mistakes that resulted in a significant  overstatement of the refund. Of the 10 returns prepared for the  waitress, 3 reported two children on the Schedule EIC, instead of the  one child who lived with the taxpayer in 2013 and was eligible for the  EITC.
Waitress Scenario, Site Visit #4  One paid preparer questioned the investigator on the amount of time her  older child lived with her. The investigator responded that the older child  stayed with her on weekends. The paid preparer discussed the  investigator’s response with the office manager and then stated that she  can claim the child for the EITC if no one else does, which was not  correct.
American Opportunity Tax Credit. All 9 paid preparers correctly  chose the American Opportunity Tax Credit for the mechanic  scenario. The mechanic had a 20-year-old son attending a community  college and paid for both his tuition and books. According to IRS  guidance, to be eligible for this credit, a student must meet certain  requirements including full-time enrollment at least half the year and  no felony drug offense convictions. Although we instructed the  investigator to respond to paid preparer inquiries such that his son  met these requirements, some paid preparers did not ask the required  questions to determine eligibility.

		Improper Conduct May Subject Preparers to Internal Revenue Code Penalties

All paid preparers are subject to certain requirements in the Internal  Revenue Code (IRC) and may be subject to penalties for non- compliance. For example, the IRC imposes monetary penalties on paid  preparers who understate a taxpayer’s tax liability due to willful or  reckless conduct. As shown in figure 5, in 12 of 19 cases, paid preparers  did not record additional side income not reported on Form W-2’s and  may be subject to this penalty. The IRC also requires that paid preparers  sign the tax return and furnish an identifying number. In 3 of 19 cases,  preparers did not meet the signature requirement. In addition, 3 preparers  used a PTIN that did not belong to them and one used a fake PTIN.
Additionally, 3 of 10 preparers in our study may be subject to a penalty for  not meeting due diligence requirements when determining if both of the  waitress’s children qualified for the EITC. When considering the EITC,  paid preparers must meet four due diligence requirements. Generally, if  paid preparers file EITC claims, they must (1) ask all the questions to get  the information required on Form 8867, Paid Preparers’ Earned Income  Credit Checklist; (2) compute the amount of the credit using the EITC  worksheet from the Form 1040 instructions or a similar document; (3) ask  additional questions when the information the client gives the preparer  seems incorrect, inconsistent, or incomplete; and (4) keep a copy of Form  8867, the EITC worksheets, and other records used to compute the  credit.
Because the returns we had prepared were not real returns and were not  filed, penalties would not apply. However, we plan to refer the matters we  encountered to IRS so that any appropriate follow-up actions can be  taken.

		Fees Charged for Tax Preparation Varied Widely Across Paid Preparer Site Visits

The fees charged for tax preparation services varied widely across the 19  visits, sometimes between offices affiliated with the same chain. Often,  paid preparers either did not provide an estimate of the fees upfront or the  estimate was less than the actual fees charged. In several instances,  upon completion of the tax return, the preparer initially charged one fee,  then offered a reduced amount. Figure 6 shows the fees charged by each  of the 19 paid preparers we visited for each scenario. For the waitress  scenario, the final fees charged for tax preparation ranged from $160 to  $408. For the mechanic scenario, the final fees charged for tax  preparation ranged from $300 to $587. For the two correct tax returns that  were prepared, the final fee charged was $260 for the waitress scenario  and $311 for the mechanic scenario. Some paid preparers provided  receipts that listed total charges that were higher than the “discounted”  amount ultimately charged. For example, one preparer estimated the cost  of services to be $794, but then charged the taxpayer $300.
Paid preparers provided various reasons for the amount of the tax  preparation fee, including, (1) the EITC form is the most expensive form  to file, (2) the pricing and fees are at their peak from mid-January through  February and then go down, and (3) there is a price difference depending  if the tax return is completed in the morning or the evening.

		IRS Data Suggest Errors on Paid Preparer Returns Were Similar to Those Generated During Our Site Visits

As in our limited investigation, our estimates from NRP data suggest that  tax returns prepared by paid preparers contained a significant number of  errors. As shown in table 5, returns prepared by a paid preparer showed  a higher estimated error rate—60 percent—than returns prepared by the  taxpayer—50 percent. Errors in this context changed either the tax due or  the amount to be refunded. As noted before, it is important to remember  that paid preparers are used more often on more complicated returns  than on simpler ones, although we were unable to gauge the full extent to  which this might be true. Furthermore, errors on a return prepared by a  paid preparer do not necessarily mean the errors were the preparer’s  fault; the taxpayer may be to blame. Preparers depend upon the  information provided by the taxpayer.
In addition to different rates of errors on paid preparer filed returns and  self-prepared returns, the amount taxpayers owed IRS also differed.  Specifically, the estimated median amount owed to IRS was higher for  paid preparer filed returns. For instance, as shown in table 6, it is  estimated that taxpayers using a paid preparer owed a median of $354 to  IRS, compared with $169 for taxpayers preparing their own return.
NRP estimates show that both individuals and paid preparers make errors  on specific forms and lines of Form 1040, some of which we experienced  in our undercover visits. Table 7 shows that in many instances, returns  completed by a paid preparer are estimated to have a greater percentage  of errors compared to self-prepared returns. For example, of returns  prepared by a paid preparer, 51 percent have an error on the EITC line  compared to 44 percent of self-prepared tax returns. In total, for five line  items we analyzed, the difference in the percent of errors on returns  prepared by a paid preparer was statistically greater than the percent of  errors on self-prepared returns. These line items include (1) the itemized  or standard deduction, (2) business income, (3) total income, (4) the  EITC, and (5) the refund amount. Differences between the percent of  returns with errors on the student loan interest deduction line, the  unreported Social Security and Medicare tax on tips line, and the  education credit line were not statistically significant when comparing  returns done by a paid preparer to those that were self-prepared.

	Conclusions

Over half of all taxpayers rely on the expertise of a paid preparer to  provide advice and help them meet their tax obligations. IRS regards paid  preparers as a critical link between taxpayers and the government.  Consequently, paid preparers are in a position to have a significant  impact on the federal government’s ability to collect revenue and  minimize the estimated $385 billion tax gap. As of March 2014, 55  percent of paid tax preparers are unenrolled preparers, not regulated by  IRS. 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.  However, IRS data, which more broadly track compliance, show  preparers made serious errors, similar to the findings from our site visits.  The higher level of accuracy of Oregon’s tax returns compared to the rest  of the country suggests that a robust regulatory regime involving paid  preparer registration, qualifying education, testing, and continuing  education may help facilitate improved tax compliance. The courts  determined that IRS does not have sufficient authority to regulate  unenrolled preparers. In March 2014, the administration proposed that the  Treasury and IRS be granted the explicit authority to regulate all paid  preparers. Providing IRS with the necessary authority for increased  oversight of the paid preparer community will help promote high-quality  services from paid preparers, will improve voluntary compliance, and will  foster taxpayer confidence in the fairness of the tax system.

	Matter for Congressional Consideration

If Congress agrees that significant paid preparer errors exist, it should  consider legislation granting IRS the authority to regulate paid tax  preparers.
Chairman Wyden, Ranking Member Hatch, and Members of the  Committee, this concludes my statement. I would be pleased to respond  to any questions that you may have.

	Contacts and Acknowledgments

For questions about this statement, please contact James R. McTigue, Jr.  at (202) 512-9110 (mctiguej@gao.gov). Individuals making key  contributions to this testimony include: Wayne A. McElrath, Director;  Libby Mixon, Assistant Director; Gary Bianchi, Assistant Director; Amy  Bowser; Sara Daleski; Mary Diop; Rob Graves; Barbara Lewis; Steven  Putansu; Ramon Rodriguez; Erinn L. Sauer; and Julie L. Spetz.
This is a work of the U.S. government and is not subject to copyright protection in the  United States. The published product may be reproduced and distributed in its entirety  without further permission from GAO. However, because this work may contain  copyrighted images or other material, permission from the copyright holder may be  necessary if you wish to reproduce this material separately.

Summary:
Why GAO Did This Study

For tax year 2011, an estimated 56 percent of about 145 million individual tax returns were completed by a paid preparer. IRS has long recognized that preparers' actions have an enormous effect on its ability to administer tax laws effectively and collect revenue that funds the government. Likewise, many taxpayers rely on preparers to provide them with accurate, complete, and fully compliant tax returns.
GAO was asked to review the oversight and quality of paid preparers. This testimony examines (1) how preparers are regulated by IRS and (2) the characteristics of tax returns completed by preparers based on products GAO issued from April 2006 through August 2008 and work conducted from November 2013 to April 2014. GAO reviewed laws, regulations and other guidance and interviewed IRS officials. GAO analyzed IRS Statistics of Income data from tax year 2011, the most recent data available, and the NRP database, which broadly tracks compliance. To gain insight on the quality of service provided, GAO conducted 19 undercover site visits to commercial preparers in a metropolitan area. Criteria to select the metropolitan area included whether the state regulates preparers and levies an income tax.

What GAO Found

The Internal Revenue Service's (IRS) authority to regulate the practice of representatives before IRS is limited to certain preparers, such as attorneys and certified public accountants. Unenrolled preparers—those generally not subject to IRS regulation—accounted for 55 percent of all preparers as of March 2014. In 2010, IRS initiated steps to regulate unenrolled preparers through testing and education requirements; however, the courts ruled that IRS lacked the authority.
GAO found significant preparer errors during undercover site visits to 19 randomly selected preparers—a sample which cannot be generalized. Refund errors in the site visits varied from giving the taxpayer $52 less to $3,718 more than the correct refund amount. Only 2 of 19 preparers calculated the correct refund amount.
The quality and accuracy of tax preparation varied. Seventeen of 19 preparers completed the correct type of tax return. However, common errors included
not reporting non-Form W-2 income (e.g., cash tips) in 12 of 19 site visits;
claiming an ineligible child for the Earned Income Tax Credit in 3 of 10 site visits where applicable;
not asking the required eligibility questions for the American Opportunity Tax Credit; and
not providing an accurate preparer tax identification number
These findings are consistent with the results of GAO's analysis of IRS's National Research Program (NRP) database. GAO analysis of NRP data from tax years 2006 through 2009 showed that both individuals and preparers make errors on tax returns. Errors are estimated based on a sample of returns, which IRS audits to identify misreporting on tax returns. Tax returns prepared by preparers had a higher estimated percent of errors—60 percent—than self-prepared returns—50 percent. Errors refer to changes either to the tax due or refund amount.

What GAO Recommends

If Congress agrees that significant preparer errors exist, it should consider legislation granting IRS the authority to regulate paid tax preparers. Technical comments from IRS were incorporated into this report.