2014 Office of Professional Responsibility Report

Notice: Historical Content

This is an archival or historical document and may not reflect current law, policies or procedures.

INTRODUCTION/EXECUTIVE SUMMARY

            The IRSAC OPR Subgroup (hereafter "Subgroup") is comprised of a diverse group of tax professionals, including lawyers, enrolled agents and a certified public accountant.  This year the OPR Subgroup addressed the regulation of tax professionals, the application of return preparer standards and ethics obligations to marijuana businesses, and continued participating in the promulgation of new and expanded guidance for practitioners.

            The Subgroup has always enjoyed a very good working relationship with the Director of the Office of Professional Responsibility and this year was no exception as all the personnel from the Office of Professional Responsibility were extremely cooperative and forthcoming, even in a difficult budget environment and as they addressed various court challenges. 

            IRSAC was asked to provide feedback and recommendations on the following three topics included in this report.

1.  Statutory authority of the IRS to regulate tax return preparers

            In 2010, the IRS instituted a program requiring all individuals who prepare tax returns for compensation to meet certain minimum standards including testing and annual continuing education.  Earlier this year, the U.S. Court of Appeals for the D.C. Circuit invalidated this program because the IRS does not have the statutory authority to make this program mandatory.  The Court’s decision also raised questions about the extent to which the IRS can regulate any tax return preparer who is not acting as a taxpayer’s representative. We believe all tax return preparers should be required to demonstrate competency by successfully passing an appropriate test, taking annual continuing education, and being subject to the competency and ethical standards in Treasury Circular 230.  We therefore recommend the IRS be granted the explicit statutory authority to regulate tax return preparers.

2.  Tax assistance to marijuana businesses

Marijuana businesses that are now legal in some states but still illegal under

federal law need ethical and competent professional tax advice.  Tax professionals who give that advice need assurance that they will not be adversely affected by the fact that the business is illegal under federal law.

3.  Guidance to practitioners regarding professional obligations

            Following up on the recommendations in the 2012 and 2013 OPR Subgroup reports concerning guidance regarding the obligations of practitioners under Treasury Circular 230, we recommend that the IRS address additional guidance as part of a multi-phase project.  We also offer suggested “Frequently Asked Questions” for this guidance at Appendix A.


 

 

ISSUE ONE:  STATUTORY AUTHORITY OF THE IRS TO REGULATE TAX RETURN PREPARERS

Executive Summary

In 2010 the IRS instituted a program requiring all individuals who prepare tax returns for compensation to meet certain minimum standards including testing and annual continuing education.  Earlier this year the U.S. Court of Appeals for the D.C. Circuit invalidated this program because the IRS does not have the statutory authority to make this program mandatory.  The Court’s decision also raised questions about the extent to which the IRS can regulate any tax return preparer who is not acting as a taxpayer’s representative. We believe all tax return preparers should be required to demonstrate competency by successfully passing an appropriate test, taking annual continuing education, and being subject to the competency and ethical standards in Treasury Circular 230.  We therefore recommend the IRS be granted the explicit statutory authority to regulate tax return preparers.

Background

In order to help them deal with the complexities of federal income tax rules, regulations and filing requirements, approximately 80 million taxpayers pay someone else to prepare their federal returns for them. Whether the taxpayer has received his or her money’s worth is open to question.

The Government Accountability Office (GAO) addressed tax preparer competency in a recent report, GAO-14-467T, to the Senate Finance Committee.  In its report, the GAO noted that 45 percent of preparers were subject to regulation by the IRS because they were attorneys, certified public accountants or enrolled agents, while 55 percent were subject to no regulation.  It conducted site visits to 19 preparers and found that only two calculated the correct tax refund for its sample return. Although this is a small sample, GAO also found that some preparers did not even prepare the correct type of return.

The GAO concluded that its findings in this study are consistent with the results of GAO’s analysis of IRS’ National Research Program (NRP) database from tax years 2006 through 2009, which showed that both individuals and preparers make errors on tax returns.  Most surprising, even startling, is that tax returns prepared by preparers had a higher estimated percent of errors—60 percent—than self-prepared returns—50 percent.

Perhaps as a result of the GAO report and others like it, including the 2008 report of IRSAC, the IRS launched a Tax Return Preparer Review in June 2009.  As part of this effort, the IRS received input from a large and diverse community, including tax return preparers, tax professional organizations, members of associated industries, federal and state government officials, consumer groups and the public. The review focused on individuals meeting the definition of “tax return preparer” contained in 26 USC 7701(a)(36), which includes individuals who prepare for compensation, or who employ one or more persons who prepare for compensation, any tax return or claim for refund of tax imposed by Title 26 of the US Code. The definition of tax return preparer includes individuals who prepare a substantial portion of a return or claim for refund.

The report issued following the review, IRS Publication 4832, noted that, “although some tax return preparers (e.g., attorneys and certified public accountants) are licensed by their states and others are enrolled to practice by the IRS, many tax return preparers do not pass any competency requirements before they prepare a federal tax return.  This last category of tax return preparer is not required to have any minimum education, knowledge, training or skill before they prepare a tax return for a fee.”  The report concluded that, due to the concerns outlined in the preceding paragraphs, the IRS should increase its oversight of unenrolled preparers by, among other things, requiring such preparers to take and pass an IRS-administered test and to take at least 15 hours of annual continuing education.  Accordingly, the IRS incorporated such requirements in the Registered Tax Return Preparer Program it began to implement in the fall of 2010.  The regulations requiring unenrolled preparers to take the test and annual continuing education were issued in June 2011.

In Loving v. Commissioner, 920 F. Supp. 2d 108 (D.D.C. 2013), three individual paid tax return preparers (Plaintiffs) filed suit against the IRS, arguing that tax return preparers cannot be regulated by the IRS because the preparers are not acting as “representatives of persons before the Department of the Treasury” under 31 USC §330, the statute underlying Treasury Circular 230.  The District Court agreed with the Plaintiffs, as did the U.S. Court of Appeals for the D.C. Circuit, which decided that the term “representative” generally is understood to refer to an agent with authority to bind others.  “Put simply, tax-return preparers are not agents.  They do not possess legal authority to act on the taxpayer’s behalf.”  Furthermore, the preparation of a tax return does not constitute “practice . . . before the Department of the Treasury.” 

The rationale in the Loving case was followed by the District Court in Ridgely v. Lew, Civ. No. 1:12-cv-00565 (CRC), which involved a CPA who entered into a contingent fee arrangement with a client to prepare ordinary refund claims. Such contingent fees are prohibited by §10.27 of Treasury Circular 230.  The plaintiff argued that, even though he is a CPA, while preparing the claims he was not acting as a “representative” and was therefore not subject to IRS regulation. The Court agreed that §10.27 does not apply in this situation and enjoined the IRS from enforcing this section of Treasury Circular 230.

In the absence of statutory authority to regulate all tax return preparers, IRSAC is concerned that:

  • We will return to a tax preparation environment where, as GAO discovered, tax returns prepared by preparers have a higher estimated percent of errors than self-prepared returns;
  • The IRS will be severely limited in its ability to prevent unethical and incompetent tax preparers from taking advantage of taxpayers;
  • The outcomes of Loving and Ridgely will spawn additional cases challenging other sections of Treasury Circular 230 and possibly, or perhaps probably, limiting some of the ethical rules of practice applicable even to attorneys, CPAs and enrolled agents; and
  • The IRS will be restricted or prevented altogether from offering even a voluntary program of testing and education for preparers. 

Recommendation

We believe it imperative that appropriate tax return preparer testing and education be required before an individual can prepare an income tax return or claim for refund and that all such preparers, whether or not they are considered “representatives,” should be subject to Treasury Circular 230.

Accordingly, we strongly believe the IRS should be granted the explicit statutory authority to regulate tax return preparers.

 
 

ISSUE TWO: TAX ASSISTANCE TO MARIJUANA BUSINESSES

Executive Summary

Marijuana businesses that are now legal in some states but still illegal under federal law need ethical and competent professional tax advice.  Tax professionals who give that advice need assurance that they will not be adversely affected by the fact that the business is illegal under federal law.

Background

In January 2014, Colorado legalized recreational marijuana businesses. Prior to this, Colorado had approved medical marijuana businesses.  Both involve the federally illegal sale of a controlled substance.  As of the end of March 2014, there were 190 recreational marijuana businesses in Colorado which are expected to gross one billion dollars in sales this year. Washington state legalized recreational marijuana businesses in July 2014.

Marijuana businesses are required to file federal income tax returns, but are not allowed to deduct all their expenses under IRC §280E, which states:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by federal law or the law of any state in which such trade or business is conducted.

The application of section 280E is not simple.  For example, section 280E is not intended to disallow the adjustment to gross receipts with respect to costs of goods sold.  S. Rep. No. 97-494 (vol. I), 97th Cong., 2d Sess. 309 (1982).  Furthermore, if a taxpayer is engaged in trades or businesses in addition to the trade or business of the sale of controlled substances, section 280E does not disallow the deduction of the expenses of those other trades or businesses.  Californians Helping to Alleviate Medical Problems v. Commissioner, 128 T.C. 173 (2007).

To complicate matters further, the new marijuana businesses, legal under state law, are cash businesses because banks will not do business with them for fear of violating federal trafficking and federal money laundering regulations.  Federal money laundering convictions can mean decades in prison.  Rep. Ed Perlmutter (D-CO-7th) was quoted on July 18, 2014, as saying “You cannot track the money.  There is skimming and tax evasion.  So the guidance by the Justice Department and the guidance by the Treasury Department is to bring this out into the open.”

With over 20 states allowing medical marijuana and now states beginning to legalize Recreational Marijuana, this industry needs qualified, ethical professionals to help them fulfill their income tax obligations.  But IRSAC members have heard concerns from tax professionals in Colorado as to whether their federal licenses are at risk or their ethics are in question if they serve the marijuana industry.

IRSAC members believe that as a matter of substantive tax law either section 280E or the controlled substance schedules incorporated by reference into section 280E (or both) need clarification in light of these state law developments. Regardless of any such substantive changes, however, tax professionals need reassurance regarding their own roles in giving tax advice to and preparing tax returns for such businesses.

Recommendation

Published guidance should promptly clarify that a tax professional will not be considered unethical, will not be targeted for audit, and will not be in violation of Treasury Circular 230 solely for representing or preparing a return for a business that is illegal under federal law but legal at the state level under state law.

 


 

 

ISSUE THREE: GUIDANCE TO PRACTITIONERS REGARDING PROFESSIONAL OBLIGATIONS

Executive Summary

Following up on the recommendations in the 2012 and 2013 OPR Subgroup reports concerning guidance regarding the obligations of practitioners under Treasury Circular 230, we recommend that the IRS address additional guidance as part of a multi-phase project.  We also offer suggested “Frequently Asked Questions” for this guidance at Appendix A.

Background

            In our 2012 and 2013 reports, the OPR Subgroup recommended that the IRS develop a publication that enumerates in reasonable detail the obligations of practitioners under Treasury Circular 230.  The purpose of this publication would be to assist the majority of practitioners who attempt to fulfill their professional obligations in good faith.  We acknowledged that the development of this proposed publication would constitute a significant undertaking for the IRS.

In light of the scope of this project and the resources that will be required to develop a publication meeting our 2012 recommendation, we believe that the IRS should not attempt to develop guidance in the form of a comprehensive publication as a single project.  Rather, we believe that approaching this guidance as a multi-phase project will permit the IRS to provide a basic framework for practitioners and to issue additional guidance on a topic-by-topic basis in the order of their importance to practitioners. Our 2014 recommendation includes “Frequently Asked Questions” at Appendix A, providing further guidance to practitioners concerning a variety of Treasury Circular 230 provisions.

Recommendation

            In furtherance of our 2012 and 2013 recommendation that the IRS develop a multi-phased project enumerating the obligations of practitioners under Treasury Circular 230, we recommend that the IRS continue with the current multi-phased plan to expand this guidance. 

In advancement of this endeavor, we offer suggested “Frequently Asked Questions” for consideration at Appendix A.