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POLICY INSIGHT
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IRS Needs Authority to Regulate Tax Return Preparers

President Biden’s new American Families Plan includes several proposals to rebuild the IRS to improve tax compliance, including authorizing the IRS to regulate paid tax return preparers. That long-overdue reform is even more necessary now. Extensive changes to tax law this year — involving unemployment benefits, advance payments for the 2021 Child Tax Credit, and the Earned Income Tax Credit (EITC), to name just a few — highlight the important role of tax preparation professionals in helping people file their returns.

Millions of low-income families raising children will become eligible for the major expansion of the Child Tax Credit enacted in March, and millions of young low-income workers will newly qualify for the larger EITC for workers not raising children in the home when they file their return in early 2022. Many have never filed a tax return and will likely turn to paid return preparers in their neighborhoods for help.

We don’t know what, if anything, hundreds of thousands of preparers are doing to ensure they understand the many new tax changes this year. Some surely kept up with the changes. But individual filers generally don’t know which preparers did and which didn’t. And when preparers make mistakes, the filer bears the burden by owing more tax and penalties or losing out on a tax benefit the preparer missed. For instance, a low-income filer whose preparer submits an invalid claim for the EITC will need to repay the refund, which could be thousands of dollars, plus a 20 percent “erroneous refund” penalty, and could be banned for at least two years from again claiming the EITC — even if otherwise eligible. This can be a devastating hit on low- and moderate-income households.

Some tax preparers, known as “enrolled preparers,” have a professional credential that they must submit to the IRS to show that they've passed tests to certify their competency. For example, a certified public accountant (CPA) would be an enrolled preparer and would submit verification of their CPA license to the IRS. But most preparers are “unenrolled preparers” and don’t have any credential to indicate to the IRS that they have demonstrated competency in tax preparation. The IRS currently has limited tools to ensure they’re competent.

Unenrolled preparers submit more EITC returns than all credentialed paid preparers combined. In fact, about 400,000 preparers who prepare more than 13 million EITC claims each year never have to pass any test to certify that they know the tax rules or to take any training on changes in tax rules, according to the IRS. IRS studies have found that the rate of error on claims by such preparers is quite high. Considering the concerns raised about EITC overpayments, the IRS, Treasury, and the Government Accountability Office have repeatedly identified regulation of such preparers as a priority.

The IRS launched an initiative in 2010 to regulate paid preparers, requiring them to pass a competency test and take annual classes to stay abreast of tax changes. The large tax preparation chains (whose preparers are not professionally credentialed), such as H&R Block and Jackson-Hewitt, supported it even though it would add a step for their employees, as did trade groups such as the American Institute of Certified Professional Accountants and the National Association of Enrolled Agents. But when the IRS began administering the test, a few small-scale preparers filed suit claiming the IRS lacked the legal authority to regulate paid preparers. The IRS lost the case, halting the program.

The IRS’ brief experience in administering the test showed why regulating paid preparers is so important. Roughly 1 in 4 of the 84,000 unenrolled preparers who took the test failed it. Yet those who failed — and the over 320,000 unenrolled preparers who never took it — continue to submit returns and charge taxpayers for their services.

There’s bipartisan support for regulating paid preparers. Both the Obama and Trump administrations asked Congress to give the IRS this authority, and a 2018 bipartisan Senate bill from Republican Robert Portman and Democrat Ben Cardin would have made this important change.

Former IRS National Taxpayer Advocate Nina Olson, who has called the taxpayer preparation industry “the wild, wild West,” has stressed the need for IRS authority and a comprehensive approach to reducing error and fraud by paid preparers. As her 2018 report to Congress explained:

The case for IRS oversight of the return preparation industry is clear. When an attorney is hired, there is some level of confidence that the attorney is competent. One could verify that the attorney has passed a bar exam and meets the continuing legal education and professional responsibility requirements of his or her state’s bar association. When one visits a hair salon, the hair stylist will have a certificate displayed, which attests to the fact that the stylist has undergone the training necessary to obtain the license. In contrast, there is no such guarantee that an unenrolled tax return preparer has passed any exam, continues to engage in ongoing education, or meets any other minimum standard of competency to prepare federal tax returns.

If anyone can hang out a shingle as a “tax return preparer” with no minimum competency requirements or oversight, problems with return accuracy will abound.