IRS and Congress Clash Over How to Regulate Tax Prep Industry

Much of the tax return preparer industry wants to be regulated, but Congress and the IRS are conflicted over whether and how to get involved.

Dodgy and unethical tax preparers who falsify or inflate client tax breaks are an ongoing threat for taxpayers, the IRS has warned. But despite a bipartisan effort in the Senate to increase tax preparer oversight, an early House version of what became the GOP tax law enacted July 4 would have prohibited the IRS from regulating preparers that use a payment arrangement prone to abuse.

Who attempts to regulate the billion dollar industry, and how it is regulated, is a point of contention between the IRS, preparers, and lawmakers.

Here’s where the issue stands.

The State of Regulations

The IRS during the Biden administration proposed rules in December 2024 to modernize Circular 230, guidance governing those practicing before the IRS, including attorneys, certified public accountants, and enrolled agents. It hasn’t been updated for over a decade.

The proposed rules would classify the charging of contingency fees for preparing returns or refund claims as disreputable conduct. Those who continue contingency fee arrangements—where fees are charged based on the size of the refund—could be subject to sanctions ranging from monetary penalties and disbarment.

The IRS has said contingency fee arrangements are a source of fraud and inflated tax credit claims. The proposed rule would prohibit the fee structures for tax advisers who prepare tax returns or refund claims. The ban is meant to protect taxpayers duped by preparers financially motivated for fat IRS payoffs.

But backers of preparers who charge contingency fees say these loosely regulated operators are the only affordable avenue for many small businesses. Without them, some may miss out on tax incentives.

The proposed rules are an attempt at a workaround to court rulings limiting how much the IRS can regulate tax preparers.

The agency tried to regulate all tax preparers in 2009, but in 2014 a federal appeals court said in Loving v. IRS that generating a tax return wasn’t considered practicing before the agency. These professionals would only be bound to Circular 230 if their client gets an audit letter and they choose to execute power of attorney.

A federal district court also in Ridgley v. Lew in 2014 ruled that preparing tax returns did not involve representing cases before the IRS and wouldn’t be bound by the contingency fee rules.

Earlier this year the Trump administration paused all rulemaking and asked for agencies to eliminate 10 regulations for every one regulation they issue. It’s unclear if the proposed rules for tax professionals will be a priority or will be cut.

The administration has been slashing the IRS workforce—with about a quarter of its 100,000 employee base taking resignation offers or simply fired.

More to the point, the office that handles Circular 230 and related matters, like the rest of the IRS, has been in turmoil. The acting director of the officer of professional responsibility was put on leave after being accused of partisanship in late July. Her predecessor left the agency in January.

Where Congress Stands

Industry professionals, tax officials, and software company groups have lobbied Congress for years to give IRS the power to set minimum standards for preparers to help protect taxpayers.

Many Republicans, however, don’t want to give the IRS more authority. The House version of the tax law enacted July 4 included a provision that barred the Treasury Department from regulating contingency fees charged for tax returns, refunds, or documentation, though that provision wasn’t in the final version of the package.

The American Institute of CPAs said that such a provision would encourage more bad actors.

In January, Senate Finance Committee Chair Mike Crapo (R-Idaho) and ranking member Ron Wyden (D-Ore.) jointly released a discussion draft that would authorize Treasury to establish minimum standards for tax return preparers.

But a bipartisan tax bill anytime soon seems unlikely after Republicans excluded Democrats when crafting the new tax law.