IRS’s Heavy Oversight of Tax Preparers Creates Chilling Effect (1)

IRS intrusiveness into the professional practices of tax preparers has grown steadily in the past decade. This has created a chilling effect on the tax industry. Instead of threatening preparers with onerous penalties, it would be better for the agency to work on lessening oversight and allow tax preparers to operate without as much fear of being penalized.

Tax attorneys and professional tax preparers have an ethical duty to advocate for clients; they aren’t agents of the IRS. Yet the IRS’s ever-increasing burdens and liabilities will discourage tax professionals from practicing and threaten the autonomy of their relationships with their clients. Tax professionals must remain aware of new penalties and preparer rules to avoid being surprised by unexpected noncompliance penalties.

For example, due diligence regulations relate to paid preparers of returns with an earned income tax credit. They must take additional steps to ensure the return information impacting earned income tax credit eligibility is correct, including additional documentation and inquiries.

This is just one of the penalties used to discipline tax preparers. Here are a few other notable examples that punish tax preparers for failing to comply in a willful, negligent, or at times only in a manner without “reasonable cause”:

• Penalty of the greater of $1,000 or 50% of the income earned by the tax preparer for tax liability understatement due to the tax preparer’s unreasonable position
• Penalty of the greater of $5,000 or 75% of the income earned by the tax preparer for tax liability understatement due to the tax preparer’s willful or reckless conduct
• Maximum annual penalty of $25,000 for failing to sign a return ($50 each) without reasonable cause
• Maximum annual penalty of $25,000 for failing to list an identifying number ($50 each) without reasonable cause
• Maximum annual penalty of $25,000 for failing to keep a copy or a list of returns ($50 each) without reasonable cause
• One year in prison or $1,000 fine for knowingly or recklessly disclosing or otherwise using information the taxpayer shares for use in preparing tax return

If the IRS finds preparers are engaging in business in a way it deems improper, under Section 7407 of the tax code, the Department of Justice may allege that enjoining a preparer from preparing tax returns is necessary to prevent repeated violation. It may seek an injunction prohibiting a tax return preparer from acting as a tax return preparer entirely.

Navigating the criteria that must be met is nuanced, ambiguous, and far-reaching. For example, the IRS may seek injunctive relief when it believes an income tax preparer has:

• Engaged in conduct subject to penalty under the preparer rules or subject to any tax code penalty
• Misrepresented their eligibility to practice before the IRS or misrepresented their experience or education
• Guaranteed a tax refund payment
• Engaged in other fraudulent or deceptive conduct that substantially interferes with the proper administration of the tax laws

Injunctive relief may also be sought for tax preparers of estate and gift tax, employment tax, excise tax, and exempt organization returns.

In one case, after a court broadened the exceptions to free speech and issued an injunction against tax advisers providing guidance that was deemed to be directing taxpayers toward “imminent lawless action,” the IRS broadened its role further.

It provided guidance to IRS agents issuing a summons in anticipation of a taxpayer’s free speech defense under the First Amendment of the Constitution when providing guidance to its clients. In this case, the chief counsel carefully instructed the government to narrowly tailor any summons to exclude information regarding protected speech under the First Amendment and develop evidence that the information sought relates to unprotected speech.

Numerous injunctions illustrate the threat to tax preparers’ roles as advocates representing their clients—not the IRS. Taxpayers should be mindful of the IRS’s scrutiny and their successfully obtaining court orders that prohibit tax preparers from various activities, including:

• Taking “unreasonable tax positions” to minimize clients’ tax liability
• Opposing the current tax structure
• Regularly and negligently misconstruing the IRC due to a lack of understanding, though not willfully

It is important to protect tax preparers’ roles as advocates for their clients. Clients have often contacted their tax preparer, panicking when an IRS notice is received by mail. The complex tax code coupled with high taxpayer interest and penalty charges has created taxpayer fear.

IRS imposter scammers prey on this fear. The agency recognizes this and provides warnings on its website, noting that scams are aggressive and sophisticated.

But rather than use penalties and injunctions to monitor taxpayers and tax preparers, the IRS and Congress can better spend their time and taxpayers’ money by simplifying the tax code and flattening the tax.

This would allow a greater understanding of the tax code, decreasing taxpayers’ need to rely on paid preparers so heavily, and lessen IRS oversight of tax preparers’ actions.

Otherwise, the government’s intrusion into tax preparation will continue to create a chilling effect on the industry, especially impacting small businesses that provide affordable tax preparation services.

Stricter compliance rules make it harder for businesses to remain profitable because of the increased time it takes to comply. Smaller tax preparers must consider whether the increased liability threat of harsh penalties and possible injunctive relief can be withstood. The IRS’s growing oversight is curtailing natural competition.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Amanda Afton Martin is shareholder at Kemp Klein, concentrating on estate and tax planning, probate and trust administration, and business planning.

Neal Nusholtz is shareholder and tax attorney at Kemp Klein, specializing in tax controversies.

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