Crackdown on Fraudulent Tax Return Preparers

Total investigations initiated by the IRS’s Criminal Investigations division rose in fiscal year 2006 from the previous year, as did the division’s time spent on tax-related investigations, the Treasury Inspector General for Tax Administration reported in June. TIGTA noted that the present enforcement climate represents a reaction to an erosion of the Service’s enforcement activities in the late 1990s and a recognition that enforcement had drifted away from tax compliance to investigating related violations of money laundering and organized crime.

A similar recommitment within the Department of Justice’s Tax Division has garnered more than 240 injunctions in the past six years against preparers of false or fraudulent tax returns and promoters of tax fraud schemes. This spring, the DOJ sought an injunction against more than 125 Jackson Hewitt franchises in four states for allegedly engaging in tax return preparation scams.

CONGRESS GETS INTO THE ACT
For the vast majority of tax practitioners who strive to represent clients with tax positions that reflect a good-faith effort to comply with tax law, the stricter climate also has had repercussions. Congress has strengthened penalties against tax preparers who file a return containing a position for which there is not a reasonable basis. In May, the Small Business and Work Opportunity Tax Act of 2007 amended IRC section 6694(a) to provide higher penalties for tax practitioners who prepare a return or refund claim reflecting an undisclosed unreasonable position . A reasonable position is defined as one that the practitioner reasonably believes is more likely than not to be sustained on its merits.

The new standard is considered higher than the old law’s realistic possibility that a position would be sustained. Moreover, monetary penalties increased from $250 to the greater of $1,000 or half of the income derived from preparing the return, and the new law extends the penalty beyond income tax returns to those for gift, estate, excise and employment taxes. For a willful or reckless understatement of tax liability, the new law increases the penalty from $1,000 to $5,000 or half the preparer’s income derived from preparing the return, whichever is greater. The new rules were supposed to go into effect immediately, but the IRS recently announced in Notice 2007-54 that it would delay the effective date of the penalties until 2008 (see “Tax Matters”).

The changes had been proposed earlier in the Bush administration’s 2008 budget. The Treasury Department explained the reasons for broadening the penalties to include other returns besides income taxes: “Unscrupulous preparers facilitate the reporting of unreasonable and unrealistic positions on various types of returns in addition to income tax returns. Expanding the penalty to other types of returns and increasing the amount of applicable penalties will help to ensure the accountability of preparers.” A more-likely-than-not standard was previously adopted by state taxing authorities in California and New York.

AICPA STANDARDS
An AICPA task force is working to propose language that would align the Institute’s Statements on Standards for Tax Services with the new more-likely-than-not standard. SSTS no. 1 currently invokes the realistic-possibility standard. A new provision will be part of an ongoing project to update and revise all eight standards.

PREPARER REGULATION EYED
Since the Jackson Hewitt report surfaced, members of Congress have also said greater regulation of tax return preparers is needed. For example, at a recent Senate Finance Committee hearing, Sen. Chuck Grassley, R-Iowa, the committee’s ranking minority member, called for increased regulation. “While I believe most tax return preparers are honest, knowledgeable individuals who serve the community well in providing sound financial advice, there are clearly some sharks lurking in the water,” he said. “And these sharks are preying on innocent taxpayers—either through bad advice, incompetence, or downright fraud.” Sen. Max Baucus, D-Mont., the committee’s chairman, also commented on these issues shortly after the Jackson Hewitt news broke. “The Finance Committee was already going to return to the issue of regulating paid preparers this year, and this news from the IRS underscores the need for closer oversight,” he said. Taxpayer Advocate Nina Olson also called for a comprehensive oversight program in her annual report to Congress earlier this year.

While CPAs already must comply with professional requirements far beyond those of what the IRS calls “unenrolled” preparers, they nonetheless are affected by the current mood in Congress and the executive branch. Thus, they must make sure they are aware of their legal and ethical obligations when preparing tax returns and giving tax advice.

By Ryan H. Pace , M.Tax, J.D., LL.M., assistant professor of accounting, Goddard School of Business and Economics, Weber State University, Ogden, Utah.