Regulation of tax return preparers.

• Author: Hodes, Rochelle

The role of third parties in preparing tax returns has become increasingly more important. In 2007 and 2008, over 80% of all federal individual income tax returns were prepared by paid tax preparers or by taxpayers using tax preparation software. The exact number of paid preparers is unknown, but the IRS estimates that it may be as high as 1.2 million. Several oversight groups, such as the IRS National Taxpayer Advocate, (1) the General Accounting Office (GAO), (2) and the Treasury Inspector General for Tax Administration (TIGTA), (3) have identified errors and noncompliance related to the earned income tax credit and sole proprietorship tax returns prepared by national tax preparation chains and unenrolled preparers. In addition, several bills have been introduced over the years calling for tax return preparer regulation. (4)

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One recurring criticism of the tax return preparer industry was that anyone was permitted to prepare a federal tax return for another person for a fee, regardless of competence or adherence to ethical or professional standards. Another criticism was that tax return preparers are subject to varying degrees of oversight depending on a number of factors, such as whether the preparer is enrolled to practice before the IRS, whether the preparer is a CPA or attorney, whether the preparer chooses to file electronically, and the jurisdiction in which the preparer practices. In 2009, the IRS began to address these concerns.

In April 2009, the IRS called for strengthening its partnership with tax practitioners and ensuring that tax return preparers and other third parties in the tax system strive for high standards of professional ethics and compliance, as set out in its goals in the 2009-2013 Strategic Plan. (5) IRS Commissioner Douglas Shulman next launched the IRS's Return Preparer Review in June 2009. During that process, the IRS held forums around the country and received public comments that generally supported increased oversight of tax return preparers, especially for those individuals who were not enrolled to practice before the IRS. On January 4, 2010, the IRS released Publication 4832, Return Preparer Review Report.

The report included the following recommendations:

* The IRS should implement a general requirement that tax return preparers register with the IRS;

* Tax return preparers should be subject to competency examinations;

* Tax return preparers should be required to take continuing education;

* The Circular 230 (6) ethical rules should be extended to all tax return preparers; and

* The IRS should make certain public awareness and service enhancements with respect to tax return preparers.

The IRS adopted these recommendations by establishing a tax return preparer regime that includes the following components:

* Setting a limit on who can prepare federal tax returns for compensation: Regs. Sec. 1.6109-2 provides that only an individual who obtains a preparer tax identification number (PTIN) can prepare a tax return (PTIN regulations). Regulations provide that only certified public accountants (CPAs), attorneys, enrolled agents, and a new class of tax return preparer, the "registered tax return preparer," are eligible to obtain a PTIN. Preparers are required to use their PTIN when signing all tax returns, forms, or claims for refund (except for certain specified returns and forms, as discussed in note 8 on p. 328), starting January 1, 2011.

* Ensuring that all tax return preparers meet certain competency and training requirements: CPAs, attorneys, and enrolled agents are regulated and subject to professional standards that generally include competency and training requirements. To ensure that new registered tax return preparers also meet minimum levels of competency and training, the IRS is establishing testing and continuing education requirements under Circular 230 for PTIN holders who are not CPAs, attorneys, or enrolled agents. (7)

This article focuses on the new preparer regulation requirements and proposed changes in professional responsibility. Specifically, it discusses who is required to obtain a PTIN and the changes to Circular 230.

Who Is Required to Obtain a PTIN?

Under the PTIN regulations, an individual is required to obtain a PTIN if the individual (1) is a tax return preparer under Sec. 7701(a)(36) and the regulations thereunder and (2) prepares or assists in preparing all or substantially all of a tax return or claim for refund. These rules are discussed in more detail below.

The Definition of a Tax Return Preparer

An individual is required to obtain a PTIN under the PTIN regulations if the individual is a tax return preparer under Sec. 7701(a)(36) and the regulations thereunder. Sec. 7701(a)(36)(A) provides that a tax return preparer is any person who prepares for compensation, or who employs one or more persons to prepare for compensation, all or a substantial portion of a federal tax return or claim for refund. This definition includes both signing and nonsigning tax return preparers as those terms are defined in Regs. Sec. 301.7701-15(b). Therefore, the PTIN regulations apply to both signing and non-signing tax return preparers.

The Code and regulations provide several exceptions to the Sec. 7701 definition of a tax return preparer, including an exception for individuals who furnish only typing, reproducing, or other mechanical assistance (mechanical assistance exception), certain in-house tax practitioners, certain fiduciaries, and individuals who provide services only through VITA, low-income tax clinics, and other similar organizations. For more details on these exceptions, see Regs. Sec. 301.7701-15(f). Thus, an individual who is not a Sec. 7701 tax return preparer by reason of one of these exceptions is not required to obtain a PTIN under the PTIN regulations. (8)

In the typical CPA's office, these rules mean that the CPA will be required to analyze the work performed by each member of support staff and determine, based on the facts and circumstances, who is a tax return preparer and who is not (because the individual meets the mechanical assistance exception or some other exception). For each individual who is a Sec. 7701 tax return preparer, the CPA will then have to engage in a second facts-and-circumstances analysis, described below, to determine if the individual prepares or assists in preparing "all or substantially all" of any tax return or claim for refund and is therefore required to obtain a PTIN.

Preparing "All or Substantially All" of a Tax Return or Claim for Refund

Once it is determined chat an individual is a Sec. 7701 preparer, the next step is to decide whether the individual prepares or assists in preparing all or substantially all of a tax return or claim for refund. Professional judgment will often be required to determine what constitutes "all or substantially all" of a tax return or claim for refund.

Regs. Sec. 1.6109-2(g) provides factors to determine whether an individual is a tax return preparer, including, but not limited to, the following:

* The complexity of the work the individual performs relative to the overall complexity of the tax return or claim for refund of tax;

* The amount of the items of income, deductions, or losses attributable to the work the individual performs relative to the total amount of income, deductions, or losses required to be correctly reported on the tax return or claim for refund of tax; and

* The amount of tax or credit attributable to the work the individual performs relative to the total tax liability required to be correctly reported on the tax return or claim for refund of tax.

The regulations further provide that the preparation of a form, statement, or schedule, such as Schedule EIC, Earned Income Credit, may constitute the preparation of all or substantially all of a tax return or claim for refund based on the application of the foregoing factors.

While a signing tax return preparer generally will be treated as preparing all or substantially all of a tax return, and therefore will be required to obtain a PTIN, it can be much more difficult to determine whether a nonsigning tax return preparer must obtain a PTIN. The PTIN regulations state that the factors listed above are not all-inclusive. Therefore, the determination of whether an individual's involvement with the return preparation process rises to the level of a tax return...