The Government Accountability Office (GAO) has conducted a limited empirical study, here, of paid tax return preparers. Paid preparers were used by about 56% of taxpayers in 2002 and 64% of taxpayers with incomes over $100,000.
Like the pairs of testers who visit realtors to see if they are shown houses based on race, the GAO sent out testers prepared with information that showed two scenarios--a married plumber with a child in college who had some side income and a small mutual fund investment and a single mother (with one child at home, another living with a grandparent), who was employed in retail sales and had side income from babysitting. The testers made site visits to 19 commercial tax preparation outlets in a single metropolitan area. The testers acted as "fairly unsophisticated" taxpayers, testing in part whether preparers would ask the right questions when partial information was provided.
The results of the study are disheartening. The GAO report indicates that most of the prepared returns were "incorrect to some degree" with some returns representing "very bad tax advice." Id. Only 2 had the correct refund amount, and even those had errors that did not affect the bottom line. The returns would have claimed excess refunds up to almost $2000 in 5 cases and would have cost taxpayers more than $1500 in 2 cases. Seven returns reported too many exemptions. Six out of 9 returns made some error in determining the education credit. Five of 10 returns inappropriately claimed the child that did not reside with the parent for the earned income credit. Eight returns reported state tax refunds incorrectly. Ten returns omitted non-W-2 business income. Eight returns omitted a foreign tax credit that should have been claimed. 5 of the returns did not fully comply with the return preparer identification requirements.
Perhaps most disturbing was the frequent misreporting of non-W2 business income.
"Both of our taxpayer scenarios included self-employment income. ...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. ... 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."
Interestingly, most preparers offered the testers services in addition to the federal tax return preparation work requested. Some gave additional services without checking with the testers, such as preparation of state tax returns or electronic filing. Preparers generally offered various options for getting expedited refunds through short term loans or direct deposit alternatives. The study reports that "[o]ne preparer gave [the testers] a [loan] application to sign at the start of the visit without explaining what it was [they] were being asked to sign." In another case, a loan was suggested without much information about the advantage of the loan, and the fee amounted to an annual percentage rate of around 400%. This behavior is especially worrisome in light of the IRS's proposal to make it easier for return preparers to use tax return information for commercial purposes if they obtain consent of the taxpayer. See this earlier posting on this topic.
Penalties for preparer errors are too low. Unrealistic positions that understate taxpayers' liabilities only incur penalties of $250 per return. Even when the understatement is due to willful or reckless conduct, the penalty is only $1000 per return. Various failures to comply with requirements--such as failure to provide copies of returns, failure to sign returns, or failure to furnish an identifying number--are penalized at only $50 per failure. The civil penalty for aiding and abetting understatements of tax liability is only $1,000. The criminal penalties are more onerous: a tax return preparer may be fined up to $100,000 and imprisoned up to 3 years for willful preparation of a false or fraudulent return.
Clearly, measures need to be taken to ensure better quality work by return preparers, if this sample provides an accurate portrayal of their work. One possibility might be institution of a rigorous licensing requirement based on a national test. The penalty standards and confidence levels required for preparers should be raised. The level of confidence a tax return preparer is expected to have in advised positions should be increased, to ensure that tax return preparers may only advise a taxpayer to take a position on a return that the preparer reasonably believes to be more likely than not the correct position. It might also be appropriate to increase the penalty for failing to satisfy that standard to $2000 per return. A similar increase in the penalty for understatements of a taxpayer's liability due to recklessness might be appropriate.
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