Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made Serious Errors
Published: 2006-04-04T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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.  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    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.
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.
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.
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.
subsections: section_title: More than Half of Taxpayers Used a Paid Preparer, but Use Varied by Tax Return Complexity and Often Involved Larger Refunds
paragraphs: 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. 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.
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 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. However, overall and at the four lowest income  categories, those using paid preparers had a higher median at statistically  significant levels.
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.
section_title: Regulation of Tax Preparers Varies by Type of Preparer
paragraphs: 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. 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.
subsections: section_title: Some Regulations Apply to All Paid Preparers
paragraphs: 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.
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.
section_title: Additional Regulations Apply Only to Some Paid Preparers
paragraphs: 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. 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 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.” 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.
section_title: State Regulation of Paid Preparers Focuses on Licensed Practitioners
paragraphs: 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.
section_title: Taxpayers Using Paid Preparers May Receive Incorrectly Completed Tax Returns
paragraphs: 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.
subsections: section_title: All of the Tax Return Preparer Visits We Conducted Produced Errors, Some with Substantial Consequences
paragraphs: 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.
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. 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.
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.
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.
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.
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.
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.
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.
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.
section_title: Many Problems on Our Tax Returns Could Risk IRS Enforcement Actions against the Paid Preparer, the Taxpayer, or Both
paragraphs: 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. 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.
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.
section_title: The National Research Program Found Errors on Returns Prepared by Paid Preparers
paragraphs: 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. 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.
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 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.
section_title: Concluding Observations
paragraphs: 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.
section_title: Recommendation for Executive Action
paragraphs: 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.
section_title: Contacts and Acknowledgments
paragraphs: 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.
section_title: Appendix I: Paid Preparer Visit Examples
paragraphs: 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.
subsections: section_title: Example of a Plumber Visit with Minor Issues
paragraphs: 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.
section_title: Example of a Plumber Visit with Serious Problems
paragraphs: 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.
section_title: Example of a Retail Sales Worker Visit with Fewer Serious Issues than Most We Encountered
paragraphs: 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.
section_title: Example of a Retail Sales Worker Visit with Several Serious Problems
paragraphs: 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.
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