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. 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. 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. 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.