Earlier this month, a federal judge effectively halted the IRS’s proposed multi-million dollar initiative to regulate tax preparers. The magnitude of the blow became clear on Friday when the IRS asked the court to reconsider its permanent injunction on the initiative, citing the $50 million already spent on launching the program, $100 million already collected in fees, and over 100,000 tax preparers currently registered to take a competency test. If the decision stands, the IRS not only faces these tremendous losses, but also potential class-action lawsuits from tax preparers and breach-of-contract costs.
U.S. District Court Judge James Boasberg for the District of Columbia previously issued a permanent injunction prohibiting enforcement of the agency’s rules requiring licenses for all previously unregulated tax preparers. Judge Boasberg found that the IRS over-stepped its statutory authority by including tax preparers in the category of persons who “practice before the IRS” and are thereby subject to its regulations. This was a victory not only for the three tax preparers who filed the suit last year with the help of the libertarian law firm Institute for Justice, but also for the estimated 600,000 tax preparers who would have been subject to the licensing rules starting this year. The IRS’s proposed rules are available for viewing here, and the U.S. District Court’s opinion is here.
Introduced in early 2010, the IRS Return Preparer Initiative was a response to the agency’s 2009 “Return Preparer Review” and the GAO’s 2006 “Paid Tax Return Preparers” reports, both of which found that taxpayers are increasingly relying on paid tax preparers to file individual income tax returns and that these paid preparers often generate incorrect returns, some with significant tax consequences. The GAO report surveyed 19 commercial chain preparers in a large metropolitan area by posing as individual taxpayers. The results showed that only 2 of the 19 preparers calculated the correct refund amount, with over-claims as high as $2,000 and under-claims up to $1,700. Combining that scenario with the fact that over 55 percent of all federal individual income tax returns in recent years have been prepared by paid preparers, the IRS decided to address this alarming situation by extending regulations to all commercial tax preparers.
Prior to the Return Preparer Initiative, the IRS only regulated individuals recognized as “practicing” before the IRS, which included attorneys, Certified Public Accountants, and other agents federally authorized to represent claimants. The IRS’s initiative would have imposed similar professional standards on the currently unregulated commercial tax preparers, by requiring them to register with the IRS for a fee, pass an initial competency test, pay an ongoing annual fee, and participate in a minimum of 15 hours of continuing education each year. The initiative also would have extended ethical standards already in place for certified preparers to the uncertified preparers in order to prohibit certain conduct and impose penalties for noncompliance.
In the judicial opinion, however, Judge Boasberg explained that the IRS does not have congressional approval to enforce these regulations based on an 1884 statute. The statute grants authority to the Treasury Department, and thereby the IRS, to regulate “representatives” who “practice” before it, such as attorneys and certified accountants who present cases on behalf of their clients. The IRS argued that tax-return preparers are included in this definition, claiming that they “practice” before the agency by simply preparing returns. However, the court found the IRS’s interpretation to go beyond the plain meaning of the statute and also conflict with existing interpretations from related statutes. Furthermore, in response to the IRS’s policy arguments, Judge Boasberg wrote, “With an invalid regulatory regime on the IRS’s side… and a threat to Plaintiffs’ livelihoods on the other, the balance of hardships tips strongly in favor of Plaintiffs.”
This recent decision presents an interesting conflict between libertarian and consumer advocacy camps. Libertarians like the Institute for Justice maintain that paid tax preparers are already sufficiently regulated by the IRS, since the agency still has the authority to investigate and prosecute preparers for violating existing laws. Enforcing licensing regulations, they argue, would impose serious costs on many small-scale preparers, thereby causing them to raise their prices and potentially go out of business. On the other hand, consumer advocates and IRS regulators point to the potentially large losses in federal revenue, the wasted time and money expended in correcting unnecessary errors, and the transparency issues that consumers face in trusting their tax returns to incompetent, sometimes unethical, preparers.
Now, the looming question is whether Judge Boasberg will reconsider his ruling, and if not, whether the Department of Justice will back an IRS appeal. With millions already invested in the program and hundreds of thousands of tax preparers already enrolled, the IRS has a lot to lose if the current outcome stands.