Targeting the tax gap: the case of the RAL and the advanced notice of proposed rulemaking.

• Author: Cords, Danshera
• Position: Refund anticipation loan - Symposium: Closing the Tax Gap

1. INTRODUCTION

   Refund Anticipation Loan (RAL) supporters and critics are both very committed to their positions and fervent in their beliefs, (1) as demonstrated by the more than 8,600 comments generated by an Advanced Notice of Proposed Rulemaking (ANPR) issued by the Treasury January 7, 2008. (2) The ANPR would amend the current Treasury Regulations to subject tax return preparers (preparers) to criminal penalties for knowingly disclosing tax return information to lenders to help taxpayers obtain RALs, even when the taxpayer consents to the disclosure. (3) In the ANPR, Treasury stated that the proposed rulemaking was prompted by comments made in response to a prior rulemaking, where commentators expressed concern that the potential financial benefit to preparers from RALs, Refund Anticipation Checks (RACs), audit insurance, or certain other financial products would or could cause preparers to inflate taxpayers' refunds by taking overly aggressive or erroneous return positions. (4) Critics these products expressed additional concerns because they are marketed more heavily to and purchased more frequently by low income taxpayers who receive the Earned Income Tax Credit (EITC). (5)

   This proposed rule would drastically change the RAL industry and it would change the amount of freedom that taxpayers have to consent to the disclosure of their return information. Recognizing the second point, Treasury stated in the proposed rulemaking that

   [a]s a general rule, the Treasury Department and the IRS believe that taxpayers should have the ability to control the use or disclosure of their tax return information. Taxpayer control, however, must be balanced against the ability of the government to effectively administer the internal revenue laws, which includes guarding against (1) the potential lessening of tax compliance, (2) the potential exploitation of taxpayers described by certain commentators, and (3) the potential existence of inappropriate financial incentives for tax preparers to inflate tax refunds. (6) This Article will respond to Professor Leslie Book's conclusions regarding the ANPR and discuss the problems with assumptions underlying the ANPR. Although RALs may have adverse consequences for low-income taxpayers that would justify their regulation or elimination, the rationale found in the ANPR is not supported by the available data. Based on current information and data there is insufficient justification to require a major reorganization of an industry and substantially reduce taxpayers' freedom to choose how their tax return information can or cannot be used. These rules or rules like these should not be adopted without more information and a demonstrated causal connection between preparer marketed RALs and taxpayer noncompliance. After discussing the background of this problem in Part II, in Part III this Article will look at the costs to preparers and taxpayers of inaccurate refunds and erroneous refund positions along with the costs of RALs to demonstrate why more data should be obtained before a conclusion is reached regarding RALs. Part V concludes that unless and until a causal relationship between RALs and similar financial products offered by preparers and inflated returns caused by preparers incentive to inflate refunds either independently or in collusion with taxpayers, concerns regarding preparers' errors should be addressed effectively using the full range of civil and criminal preparer penalties currently available, even where the monetary amounts of the penalties are small. In addition to more effective use of available penalties, increased preparer regulation, in the form of certification, licensing, or education requirements to ensure quality preparation, are needed and may help address the concerns identified in the ANPR.

2. BACKGROUND

   The ANPR involves several issues about which the public, commentators, and politicians tend to have strong opinions, including EITC noncompliance, RALs, and reducing the tax gap, which may make it easier to justify the proposal. The EITC is a politically charged credit that is often viewed as part of the welfare system and is considered by many to be rife with fraud and error. (7) High error and fraud rates have led to high audit rates of EITC claimants, (8) severe penalties for over claims and fraud, (9) and due diligence requirements for preparers. (10) Similarly, the possibility that RALs and other financial products might increase noncompliance increases the concerns regarding EITC error and fraud rates. However, as Professor Book states, a causal link among the availability of RALs, preparer behavior, and taxpayer noncompliance has not been established. (11)

   RALs are...