By David S. Hilzenrath
Washington Post Staff Writer
Tuesday, January 5, 2010; A01
The Internal Revenue Service plans to test, register and screen people who get paid to prepare tax returns, stepping into a virtually unregulated business on which millions of Americans depend for crucial financial services.
The agency wants to crack down on preparers who do shoddy or fraudulent work and create a way for consumers to make more informed choices -- though the moves could increase the cost of having tax returns prepared.
"In most states you need a license to cut someone's hair," but today "most tax-return preparers don't have to meet any standards when they sit down and prepare a federal tax return for an American taxpayer," IRS Commissioner Douglas Shulman said in an interview Monday.
The agency said it will phase in the changes with the 2011 tax season.
The announcement underscores the fact that helping Americans comply with the federal tax code has become a big business. The industry is a sprawling one, taking in brand-name national players such as H&R Block and Jackson Hewitt, mom-and-pop practitioners who hang out their shingles each tax season, and fly-by-night operators who can leave taxpayers on their own when the IRS finds fault with their returns.
The IRS estimates that 900,000 to 1.2 million people prepare tax returns for a fee, and many do so without ever being officially tested.
"Right now, the IRS doesn't know who unregulated preparers are and can't track them when there's a problem. This ultimately hurts the taxpayers who end up having to pay more taxes, fines and penalties," Sen. Charles E. Grassley (R-Iowa), who presided over a hearing on the issue years ago, said in a statement.
Starting with the 2011 tax season, the IRS plans to require paid preparers to register with the agency. Subsequently -- the timeline is not yet firm -- they will be required to pass competency tests and receive continuing professional education.
The IRS said it will screen preparers to make sure they have paid their own taxes.
In a report issued Monday, the agency also raised concerns about the quality of tax-preparation software and about the marketing of loans backed by expected returns.
Last year, almost 94 million returns were completed using tax software. Both taxpayers and professional preparers relied on the programs, though "quality control over these products rests exclusively with the software publishers," the IRS said.
Meanwhile, some preparers encourage consumers to take out loans against anticipated refunds, without fully explaining the costs, the agency said.
The IRS said it plans to study the two issues further.
The new testing and education standards will exempt certified public accountants, lawyers, and tax practitioners known as "enrolled agents," who are cleared to represent taxpayers in dealing with the IRS and are already subject to professional or government requirements. The IRS said that it will take a closer look at the performance of those groups, and that it has not ruled out testing them in the future.
Tax prep giants H&R Block and Jackson Hewitt expressed support for the requirements announced Monday.
Under the new rules, H&R Block "won't be competing against people who aren't regulated and don't have the same standards as we do," said Kathryn Fulton, senior vice president for government relations.
Most of the company's preparers will be required to take the new test, but the company's continuing education requirements exceed those announced those by the IRS, she said.
Citing a gap in the agency's plan, Fulton said the IRS should impose the same rules on unpaid preparers of tax returns.
Jackson Hewitt said in a statement that all of its tax preparers must pass a company test.
In field tests, the IRS noted Monday, tax-return preparers often gave bad advice.
In a 2006 study in which employees of the Government Accountability Office posed as taxpayers and visited outlets of tax prep chains, all 19 preparers made mistakes, the IRS reported. Only two of the 19 arrived at the correct bottom line. Several did not ask about income from sources other than wages, and 10 of the 19 did not report such income even when they were told about it, the IRS said.
In a 2008 study, 17 of 28 preparers got the bottom line wrong.
It is unclear how much of the blame rests with the tax code's confusing nature, a perennial target of politicians' criticism. Do regulated professionals such as CPAs perform better than their unregulated counterparts?
The IRS commissioner said the agency does not have the data to answer that question.