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Annette Nellen
Annette Nellen
Can the IRS regulate all return preparers?

A district court says the IRS cannot regulate all return preparers, but what might an appeals court say?

October 17, 2013
by Annette Nellen, Esq., CPA

In 2009, the IRS started devoting significant resources to creating a system to regulate all paid preparers of Form 1040, U.S. Individual Income Tax Return. This effort involves more than 700,000 preparers. A district court decision in early 2013, Loving, No. 12-385 (D.D.C. 1/18/13), dealt a significant setback by holding that the IRS lacked legal authority to regulate over 300,000 individuals for whom the IRS was imposing the most stringent eligibility requirements and by enjoining the registered tax return preparer program. This article provides background on the situation and arguments for and against whether the IRS has the requisite legal support for its comprehensive return preparer regulatory system.

Background

In 2009, then–IRS Commissioner Douglas Shulman announced the launch of a preparer regulation program (IR-2009-57). In 2010, the IRS started issuing preparer tax identification numbers (PTINs) for a fee. These were accompanied by new regulations under Sec. 6109, Identifying Numbers, and changes to Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10). A new category of preparer—the registered tax return preparer (RTRP)—was introduced for preparers who were not attorneys, CPAs, enrolled agents (EAs), or supervised/nonsigning preparers. To become an RTRP, a preparer would have to pass a test and complete at least 15 hours of continuing education annually. (For details and links to supporting documents, see Nellen, “Categories of Tax Return Preparers.”)

Numbers

The IRS maintains a website summarizing the number of PTIN-holders within various categories. The data as of Oct. 2 (taken directly from the IRS website) indicates the following:

Before the court suspended the RTRP program in January 2013, the data included the number of RTRPs. On Nov. 5, 2012, the IRS PTIN data (taken directly from the IRS website) was as follows:

As evident from the 2012 data, the majority of PTIN holders have been affected by the 2013 decision (32,902 RTRPs plus 314,860 with provisional PTINs totals 347,762, which exceeds 50% of the total number of PTIN holders in 2013). The total number of PTIN holders dropped from 733,887 to 690,059 between November 2012 and October 2013, with the data indicating that this is mostly attributable to what would be the RTRP group.

Although these numbers are high, they are below original IRS estimates. As noted by the Loving decision, the IRS estimated that there were between 600,000 and 700,000 preparers who were not CPAs, attorneys, or EAs who would pursue the RTRP designation. (See T.D. 9527, amending Circular 230, 76 Fed. Reg. at 32299 (6/3/11).)

District court litigation

Three individuals who were required to become RTRPs to continue to prepare Forms 1040 filed suit against the IRS. The D.C. District Court issued an opinion in January 2013 enjoining the IRS from enforcing its testing and continuing education requirements (Loving, No. 12-385 (D.D.C. 1/18/13)).

The decision turned on the meaning of 31 U.S.C. Section 330, originally enacted in 1884. Specifically, the court examined the meaning of the term “representatives” and the linkage between paragraphs (1) and (2) . Here are the relevant parts of Section 330(a) of the statute (emphasis added):

(a) ... the Secretary of the Treasury may—
(1) regulate the practice of representatives of persons before the Department of the Treasury; and
(2) before admitting a representative to practice, require that the representative demonstrate—
(A) good character;
(B) good reputation;
(C) necessary qualifications to enable the representative to provide to persons valuable service; and
(D) competency to advise and assist persons in presenting their cases.

The court did not agree with the IRS’s argument that the Supreme Court’s Chevron U.S.A. Inc. v. Natural Res. Def. Council Inc., 467 U.S. 837 (1984), decision (which provides a two-step analysis to determine whether regulations are beyond an agency’s authority) did not apply to the case because each agency has inherent authority to regulate those who practice before it. The court found that because the statute “specifically defines the Treasury Department’s authority to regulate the people before it, that statute controls the inquiry here” and that a Chevron analysis was appropriate. In addition, the court noted that merely filing a return did not constitute presenting a case before the IRS, which was the language in the statute. Also, according to the court, subsections (a)(1) and (a)(2) both contain the term “representative,” which should have the same meaning throughout (a).

Section 330(b), which provides the authority to disbar, suspend, or censure a representative did not, according to the court, provide “open-ended discretion” that would “eclipse” numerous provisions of the Internal Revenue Code, under which the IRS has the ability to regulate all return preparers, including:

  • Sec. 6694, Understatement of Taxpayer’s Liability by Tax Return Preparer;
  • Sec. 6695, Other Assessable Penalties With Respect to the Preparation of Tax Returns for Other Persons; and
  • Sec. 7407, Action to Enjoin Tax Return Preparers.

As a result, the IRS may only continue with its PTIN system. In response, the IRS stopped testing individuals to become RTRPs and preparing continuing education information.

The appeal

The IRS appealed the lower court ruling. The Court of Appeals heard oral argument on Sept. 24. During oral argument (mp3 file from the court), the judges questioned the IRS’s interpretation of Section 330. For example, the judges queried why the IRS might view “and” between Sections 330(a)(2)(C) and (D) as meaning “or.”

Pro and con: Is congressional action needed?

Yes: Prior proposals made.There have been other proposals for Congress to take action to regulate all return preparers. The National Taxpayer Advocate’s 2002 annual report (page 217) called on Congress to “enact a registration, examination, certification, and enforcement program for Federal Tax Return Preparers.” An FTRP was defined as someone other than an attorney, CPA, or EA, who prepares more than five tax returns annually and meets “registration, examination, and certification requirements” to be developed by the IRS.

The 2002 report provides numerous reasons for regulating all return preparers. It also notes that in 1997 the National Commission on Restructuring the IRS made a similar suggestion (page 227).

Since at least 2005, bills have been introduced to modify Section 330(a)(1) to add parenthetical language to encompass return preparers. These proposals include the following bills to add the specified language after “representatives” in Section 330(a)(1):

  • 2005: S. 832 (109th Congress): “including compensated preparers of tax returns, documents, and other submissions”;
  • 2007: S. 1219 (110th Congress): “including compensated preparers of federal tax returns, documents, and other submissions”;
  • 2008: H.R. 5716 (110th Congress): “including tax return preparers of federal tax returns, documents, and other submissions.”

No: Current statute sufficient. In the 2013 litigation, the government argues that Congress has indicated no intent to limit “practice of representatives” to include only people who present cases. In addition, the preparer sanctions in the Code are not identical to those of Section 330(b).

The IRS might argue that the earlier legislative proposals only clarify (rather than change) the statute, which is why the proposed addition to Section 330(a)(1) is in parentheses.

Yes: Why did the IRS wait? If the statute has always allowed for regulation of all preparers, why did the IRS wait so long to do it? Might the IRS have been “testing the waters” rather than waiting for legislative clarification or authority?

No: The existing statute is broad. An amicus brief filed for the government by five former IRS commissioners posits that all preparers do present cases. They observe that various “financial claims against the Treasury” are included on tax returns. “Congress has decided to administer an increasingly wide variety of government assistance programs through the federal income tax system, including assistance for low income families, health care, education, and homebuyers. In each instance, preparing and filing a tax return is the sole means by which taxpayers are able to present to Treasury their qualification for these programs and to obtain the financial assistance intended by Congress.” Today, preparers present these cases before the government when they prepare returns with the claims covering “hundreds of billions of dollars.”

Yes: “Represent” means an official encounter. The plaintiffs in Loving note that return preparation is not representation because no Form 2848, Power of Attorney and Declaration of Representative, is required to prepare a return (plaintiff brief, page 38 (5/17/13)).

No: “Representative” is broad. Although no power of attorney form is required to prepare a return, the preparer’s signature is required on the return (Sec. 6695(b)). While the taxpayer is responsible for the contents of a tax return, the preparer’s signature can be viewed as representing the return information as well, and misrepresentation of the information subjects the preparer to various penalties.

Also, Circular 230, Section 10.7(c)(1)(viii), before it was amended in 2011, provided that a preparer “may represent the taxpayer before revenue agents” for an examination of that return (Circular 230, 2005 version). The preamble to the 2002 Circular 230 regulations (T.D. 9011, 67 Fed. Reg. at 48762 (7/26/02)) refers to this as “unenrolled practice.”

Yes: Look at history of the Sec. 7525 privilege. Sec. 7525, Confidentiality Privileges Relating to Taxpayer Communications, which was enacted as part of the IRS Restructuring and Reform Act of 1998, P.L. 105-206, extends the attorney-client privilege to any “federally authorized tax practitioner” providing tax advice. The legislative history states that the privilege applies to tax advice from “any individual who is authorized under Federal law to practice before the IRS if such practice is subject to regulation under section 330 of Title 31.” It further states that those individuals include attorneys, CPAs, EAs, and enrolled actuaries (S. Rep’t No. 105-174, 105th Cong., 2d Sess., at 70 (April 22, 1998)).

No: Sec. 7525 is not relevant. It might be argued that Congress referred to Section 330 and “federally authorized tax practitioner” rather than the term “tax return preparer” of Sec. 7701(a)(36), because it wanted to limit the reach of the privilege. Such an interpretation would indicate Congress did not view Section 330 as covering all preparers.

Use of the term “federal authorized tax practitioner” at Sec. 7525 may be due to Congress’s not viewing all preparers as providing tax advice. The IRS took this interpretation in its recent effort to regulate preparers. Under Circular 230, Section 10.3(f)(3), RTRPs only have “authority to provide tax advice to a client or another person except as necessary to prepare a tax return, claim for refund, or other document intended to be submitted to” the IRS.

In addition, the preamble to T.D. 9527 (the latest version of Circular 230), provides that the privilege “generally does not apply to communications between a taxpayer and a registered tax return preparer because the advice a registered tax return preparer provides ordinarily is intended to be reflected on a tax return and is not intended to be confidential or privileged."

Looking forward

As noted above and in the briefs parties submitted to the appeals court, the question is not crystal clear whether Treasury and IRS had authority to broaden the reach of Circular 230. Meanwhile, the IRS RTRP system remains on hold pending the appellate court’s decision. Yet, at least one related modification to Circular 230 appears to be in force. Changes included in Section 10.8, Return preparation and application of rules to other individuals, make compensated preparers subject to “the duties and restrictions related to practice in subpart B, as well as subject to the sanctions for violation of the regulations in subpart C.” (§10.8(c)). As reported in the Internal Revenue Bulletin (see, e.g., 2013-16 I.R.B. 945 and 2013-33 I.R.B. 143), unenrolled preparers have had sanctions imposed on them for violation of Circular 230.

Legislation has been proposed to address the current confusion. H.R. 1570 (113th Congress), the Taxpayer Protection and Preparer Fraud Prevention Act, would modify Section 330 to clearly allow the IRS to regulate all return preparers. U.S. Rep. Cedric Richmond, D-La., sponsor of the bill, describes this modification as also protecting taxpayers. The congressman said that the proposal “implements and enforces policy that would allow the Internal Revenue Service (IRS) to certify paid tax preparers and ensure they are competent, of good character and able to render services” (press release (4/15/13)).

It will be interesting to see what happens.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. Nellen is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is the immediate past chair of the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax policy and reform and a blog.