Michelle Singletary: Setback on tax-preparer regulations

TO HELP COMBAT fraud by tax preparers, the IRS created the "Registered Tax Return Preparer" program. Then, just before the tax season got under way, a federal judge told the agency that it doesn't have the authority to regulate the hundreds of thousands of tax preparers covered under the program.

Although some tax-return preparers are licensed by their states or enrolled to practice before the IRS, many don't have to pass a government or professionally mandated competency test to prepare a federal return. When the IRS issued its last "dirty dozen" tax scams, return-preparer fraud was third on the list.

Crooked tax preparers can do some dastardly things.

"Tax-return preparers sometimes alter return information without their clients' knowledge or consent in an attempt to obtain improperly inflated refunds or to divert refunds for their personal benefit," wrote Nina E. Olson, a national taxpayer advocate, in her most recent report to Congress. "Often, the refunds are directed to an account in the preparer's control."

In other instances, preparers lure clients by promising large refunds even before reviewing their tax information.

The IRS program would have required any individual who is compensated for preparing or assisting in preparation of a return to obtain a preparer tax-identification number, pass a qualifying exam and complete annual continuing-education requirements.

Three independent tax preparers joined the Institute for Justice in challenging the IRS' authority to create the program. Recently, U.S. District Judge James E. Boasberg, in the District of Columbia, ruled against the agency.

Said Dan Alban, the lead attorney on the case: "The licensing requirements harmed the ability of mom-and-pop operations to compete with big tax-preparation firms. Two of the three plaintiffs would have been put out of business because of the cost of complying with the regulations."

The ruling means that tax-return preparers who would have been covered by the program don't have to complete competency testing or continue their education, the IRS said. But all paid preparers still must have a preparer tax-identification number.

There are tax professionals - lawyers, certified public accountants and enrolled agents - who were exempt from the program but are licensed by state or federal authorities and are subject to censure, suspension or disbarment from practice before the IRS in the event of wrongdoing. The ruling does not affect regulatory requirements for them.

Still hoping to continue with the regulatory program, the IRS asked the court to delay the ruling pending its appeal. The motion was denied.

"The IRS continues to have confidence in the scope of its authority to administer this program and is working with the Department of Justice to address all options, including a planned appeal," the agency said in a statement.

In response to the lawsuit, the IRS said that it has established 250 testing centers, that the program has cost more than $50 million to roll out and that nearly 100,000 preparers have registered to take the competency test.

When the IRS announced the program, I favored the licensing of preparers. Although many tax professionals do their jobs well, there are enough unscrupulous preparers to warrant some changes. Olson, the national taxpayer advocate, has recommended that Congress enact a federal registration, examination, certification and enforcement program for unenrolled tax-return preparers. "Creating a class of certified return preparers is a very positive step toward combating fraud," she said in her report.

But perhaps Judge Boasberg has it right. He said his ruling doesn't require the IRS to dismantle its registration scheme. The IRS "may choose to retain the testing centers and some staff, as it is possible that some preparers may wish to take the exam or continuing education even if not required to," the decision says. "Such voluntarily obtained credentials might distinguish them from other preparers."

And some preparers might still take the exam in case his ruling is reversed on appeal, "just as the IRS may similarly decide it is financially more prudent not to shutter the centers in hopes of an appellate victory or congressional action," Boasberg wrote.

I see great service to consumers in the IRS preparer program. So until things are settled, Boasberg offers a good compromise.