Paid Tax Return Preparers: In a Limited Study, Chain Preparers	 
Made Serious Errors (04-APR-06, GAO-06-563T).			 
                                                                 
Despite the importance of paid tax return preparers in helping	 
taxpayers fulfill their obligations, little data exist on the	 
quality of services they provide. Paid preparers include, for	 
example, enrolled agents, who are approved by the Internal	 
Revenue Service (IRS) once they pass an examination on tax	 
matters or demonstrate past IRS employment experience, and	 
unenrolled preparers, who include self-employed individuals and  
people employed by commercial tax preparation chains. GAO was	 
asked to determine (1) what the characteristics were of tax	 
returns done by paid preparers, (2) what government regulation	 
exists for paid preparers, and (3) what specific issues taxpayers
might encounter in using paid preparers. To do its work, GAO	 
analyzed IRS data, reviewed paid preparer regulatory		 
requirements, and had tax returns prepared at 19 outlets of	 
several tax preparation chains. 				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-563T					        
    ACCNO:   A50720						        
  TITLE:     Paid Tax Return Preparers: In a Limited Study, Chain     
Preparers Made Serious Errors					 
     DATE:   04/04/2006 
  SUBJECT:   Income taxes					 
	     Quality control					 
	     Regulation 					 
	     Tax administration 				 
	     Tax consultants					 
	     Tax credit 					 
	     Tax returns					 
	     Taxpayers						 
	     Errors						 
	     Fines (penalties)					 
	     Earned Income Credit				 

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GAO-06-563T

     

     * Appendix I: Paid Preparer Visit Examples

Testimony

Before the Committee on Finance, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 10:00 a.m. EDT

Tuesday, April 4, 2006

PAID TAX RETURN PREPARERS

In a Limited Study, Chain Preparers Made Serious Errors

Statement of Michael Brostek, Director Strategic Issues

GAO-06-563T

Mr. Chairman and Members of the Committee:

I appreciate the opportunity to testify on the services offered by paid
tax return preparers. Every year tens of millions of taxpayers pay someone
to prepare their tax returns. According to Internal Revenue Service (IRS)
officials, several hundred thousand certified public accountants (CPA) and
attorneys were authorized to practice before it as of March 2006, and
there were about 41,000 active enrolled agents. Enrolled agents are
approved by IRS once the agents pass an examination on tax matters or
demonstrate past IRS employment experience. In 2003, the National Taxpayer
Advocate said the number of unenrolled preparers-those not enrolled with
IRS-ranged from 300,000 to 600,000. On the basis of scanning major
preparation company Web sites, we know the major preparation companies
have thousands of offices nationwide. Despite the importance of paid tax
return preparers in helping taxpayers fulfill their obligations, little
data exist on the quality of services they provide.

In most states, anyone can be a paid preparer regardless of education,
training, or licensure. However, there are different types of preparers.
Paid preparers who hold professional certification include CPAs and
attorneys. CPAs and attorneys are licensed through state agencies,
although licensure is not focused on their role as tax preparers. CPAs,
attorneys, and enrolled agents are referred to collectively as
practitioners. Other preparers are called unenrolled preparers. This
population of preparers is very diverse, ranging from many of the
individuals employed by commercial tax preparation companies to those who
are self-employed. Some have extensive training and experience and others
do not.

In 2003, we reported to this Committee that while many taxpayers who used
paid preparers believed they benefited from doing so, some were poorly
served. We said that the available evidence did not allow a precise
estimate of the percentage of taxpayers affected, but none of it suggested
that the percentage was large. We reported that preparer mistakes can
cause taxpayers to over- or underpay their taxes, and that taxpayers may
pay for certain services, such as short-term loans called Refund
Anticipation Loans (RAL), without understanding their costs and benefits.1
In an April 2003 hearing of this Committee, we testified that taxpayers
can take common sense steps when choosing or working with a paid preparer,
such as:

1GAO, Tax Administration: Most Taxpayers Believe They Benefit from Paid
Tax Preparers, but Oversight for IRS Is a Challenge, GAO-04-70
(Washington, D.C.: Oct. 31, 2003).

           o  when searching for a preparer, obtain recommendations from
           people you trust;
           o  check out your preparer's qualifications;
           o  make sure you understand the services you will be getting, how
           much they cost, and how they will benefit you;
           o  make sure your preparer understands your personal circumstances
           and reviews your official tax documents; and
           o  review your completed return before you sign it.2

           Although taxpayers should take these common sense steps, IRS also
           notes on its Web site under "Tips for Choosing a Tax Preparer"
           that no matter who prepares a tax return, the taxpayer is legally
           responsible for all of the information on that tax return.

           My statement today is based on recent work we have done at the
           request of the Committee. Our objectives were to determine (1)
           what the characteristics were of tax returns done by paid
           preparers, (2) what government regulation exists for paid tax
           return preparers, and (3) what specific issues taxpayers might
           encounter in using paid preparers.

           In preparing this statement, we did the following work:

           o  We analyzed IRS's Statistics of Income (SOI) individual
           taxpayer database for tax year 2002, the most recent reliable data
           available, to determine the income levels of users of paid
           preparers and characteristics of the tax returns that these users
           filed.3

           o  We reviewed laws, regulations, and other guidance and
           interviewed IRS officials to determine regulatory requirements
           that apply to different types of paid preparers.

           o  We had tax returns prepared for us at 19 outlets of several
           commercial chain preparers scattered throughout a major
           metropolitan area. We chose a large metropolitan area in which
           several chain preparers were represented so that we could do our
           investigation in different sections of the area. Our staff posed
           as taxpayers and asked the paid preparers to prepare, but allow us
           to file, our federal tax returns under two scenarios. In one
           scenario, a plumber and his wife, with one of their children in
           college, derived almost all of their income from his job, some
           work on the side, and a mutual fund. They had enough deductions of
           various kinds to make it advantageous for them to itemize tax
           deductions using Schedule A. We had 9 returns prepared for this
           scenario. In the second scenario, a low-income single mother was a
           retail sales worker who had side income from babysitting. She had
           one child who lived with her and one who did not. We had 10
           returns prepared for this scenario. In general, we used each
           scenario twice when visiting individual chain preparers but at
           different outlets. Our 19 site visits cannot be used to generalize
           our findings to the retail tax preparation community. We did not
           visit any law firms, CPA firms, or single-office tax return
           preparation businesses.

           To arrive at correct returns for the two scenarios, our staff and
           staff from the Senate Committee on Finance and the Joint Committee
           on Taxation (JCT) completed the tax returns and agreed on (1) what
           should and should not be reported on the returns and (2) the
           correct refund amount for each scenario. For each of the 19
           visits, we then compared the tax returns produced with the
           consensus mock returns. In doing its mock returns, JCT noted that
           it relied on the facts we provided and discussions in which we
           participated. JCT cautioned that a paid preparer might reach a
           reasonable conclusion different from JCT's on certain issues or on
           the basis of actual questions asked or answers given during a site
           visit. To minimize any potential for preparers to have
           legitimately different results from our returns, we trained our
           staff to answer preparers' questions consistently with the facts
           we used in preparing our mock returns. Although we are defining
           the mock returns as correct, we recognize that the final
           determination of the accuracy of a return is subject to IRS and
           court interpretation.

           o  We analyzed IRS's National Research Program (NRP) database to
           compare the compliance found on returns that used paid preparers
           and returns that did not.4

           We did our work in February and March 2006 in accordance with
           generally accepted government auditing standards and the quality
           standards for investigations as set forth by the President's
           Council on Integrity and Efficiency.

           My statement today will make the following points:

           o  Many taxpayers choose to pay others to prepare their tax
           returns rather than prepare their own returns. About 56 percent of
           about 130 million individual tax returns filed for tax year 2002
           used a paid preparer, with higher paid preparer usage among
           taxpayers with more complicated returns, that is, those using the
           Form 1040 as opposed to the Form 1040EZ, those claiming itemized
           deductions and not the standard deduction, and those claiming the
           earned income credit (EIC).

           o  All paid preparers are subject to some IRS regulations and may
           be penalized if they fail to follow them. For example, all paid
           preparers must identify themselves on the returns they prepare and
           must not deliberately understate a taxpayer's tax liability. When
           the EIC is involved, paid preparers must also ask specific
           questions to determine a taxpayer's eligibility for the credit.
           Lawyers, certified public accountants, and certain tax
           professionals are also subject to additional requirements.

           o  In our site visits, paid preparers often prepared returns that
           were incorrect, with tax consequences that were sometimes
           significant. Their work resulted in unwarranted extra refunds of
           up to almost $2,000 in 5 instances, while in 2 cases they cost the
           taxpayer over $1,500. Some of the most serious problems involved
           preparers

                        o  not reporting side income in 10 of 19 cases;
                        o  not asking about where a child lived or ignoring
                        our answer to the question and claiming an ineligible
                        child for the EIC in 5 out of the 10 applicable
                        cases;
                        o  failing to take the most advantageous
                        postsecondary education tax benefit in 3 out of the 9
                        applicable cases; and
                        o  failing to itemize deductions at all or failing to
                        claim all available deductions in 7 out of the 9
                        applicable cases.

           We discussed these issues with IRS. Had these problems been
           discovered by IRS on real returns, IRS officials said that many of
           the preparers would have been subject to penalties for such things
           as negligence and willful or reckless disregard of tax rules. We
           have referred matters we encountered to IRS so that any
           appropriate follow-up actions can be taken.

           As shown in table 1, according to SOI data, somewhat over half of
           the approximately 130 million individual tax returns filed for tax
           year 2002 were done by a paid preparer. This filing breakdown was
           true for all income levels we analyzed, although the income level
           exceeding $100,000 had the highest percentage-64 percent.5 As not
           all paid preparers provide preparer information on returns they
           prepare, the percentages of returns that actually were prepared by
           another person for pay is probably somewhat higher.

           Table 1: Estimated Percentage of Individual Taxpayers' Returns
           Prepared by a Paid Preparer for Tax Year 2002, by Adjusted Gross
           Income Level

           Source: GAO analysis of IRS SOI data.

           As table 2 shows, this consistency of use did not hold for other
           groupings of individual tax returns prepared by paid preparers.
           Use of paid preparers differed among different types of returns,
           taxpayers of different filing statuses, filers taking different
           types of deductions, and claimants and nonclaimants of the earned
           income tax credit. According to the breakdown in table 2,
           one-third of taxpayers filing the simplest individual tax form-the
           Form 1040EZ-used a paid preparer for tax year 2002, and two-thirds
           of a low-income working group-those claiming the EIC-paid someone
           to prepare their tax returns.

           Table 2: Estimated Percentage of Individual Taxpayers Using a Paid
           Preparer for Tax Year 2002, by Various Groupings

           Source: GAO analysis of IRS SOI data.

           Table 3 shows that whether taxpayers prepared their own returns or
           paid a preparer, their tax returns showed a median of hundreds of
           dollars in tax refunds for tax year 2002.6 However, overall and at
           the four lowest income categories, those using paid preparers had
           a higher median at statistically significant levels.

           Table 3: Estimated Median Tax Year 2002 Refunds on Returns Filed
           by Individual Taxpayers Using Paid Preparers and Those Preparing
           Their Own Returns

           Source: GAO analysis of IRS SOI data.

           At the $0-20,000 income level, a major part of the reason why
           refunds are so different for those who used paid preparers versus
           those who prepared their own returns appears to be the EIC. As
           table 4 shows, those who claimed the EIC and used a paid preparer
           had tax returns showing a median more than $900 higher in refunds
           than those who claimed the EIC and prepared their own returns.

           Table 4: Estimated Median Tax Year 2002 Refunds on Returns Filed
           by Low-income Individual Taxpayers Using Paid Preparers and Those
           Preparing Their Own Returns, by Whether They Claimed the EIC

           Source: GAO analysis of IRS SOI data.

           aThe 95 percent confidence interval surrounding this estimate
           ranges from $1,596 to $1,944.

           Different types of paid preparers are governed by different
           regulations. All are subject to Internal Revenue Code (IRC)
           penalties, and all paid preparers who choose to file
           electronically are subject to IRS Electronic Return Originator
           (ERO) rules. However, only paid preparers who choose to represent
           taxpayers before IRS are governed by IRS Circular No. 230
           regulations.7 In addition, California and Oregon have their own
           regulations that apply to all paid preparers. Table 5 summarizes
           how different types of paid preparers are covered by different
           regulations.

           Table 5: Summary of Paid Preparer Regulation

           Source: GAO.

           All paid preparers are subject to IRC penalties and the
           regulations that implement them. According to the Internal Revenue
           Manual, penalties are IRS's key tools against noncompliant
           preparers. Table 6 lists civil penalties that apply specifically
           to preparers and some of the criminal penalties (sections 7206,
           7207, and 7216) that apply to paid preparers.

           Table 6: Internal Revenue Code Penalties

           Source: Internal Revenue Code.

           Some civil penalties for preparers who engage in improper conduct
           are found in IRC sections 6694 and 6701. These include a $1,000
           per return penalty if the understatement of the taxpayer's
           liability was due to the preparer's willful attempt to understate
           liability or reckless or intentional disregard for the rules. They
           also include a $1,000 penalty on preparers who help taxpayers
           understate their liability. In addition, they include a $250 per
           return penalty if the preparer knew or reasonably should have
           known that the understatement of a taxpayer's liability was due to
           a position that had no realistic possibility of being sustained.

           IRC section 6695 contains many identification penalties that apply
           to preparers. For instance, a preparer must sign the return after
           it is completed but before the taxpayer signs it and provide the
           taxpayer a copy of the return. The preparer must also put his or
           her social security number or other number issued by IRS on the
           return. The penalty for failing to meet these requirements is $50
           per failure but cannot annually exceed $25,000 per person for each
           type of failure. Most penalties in this section are not to be
           assessed if the preparer shows that the violation was due to
           reasonable cause or not due to willful neglect. All penalties in
           this section can be assessed in conjunction with other penalties.

           IRC section 6695 includes requirements specific to the EIC. It
           requires paid preparers to take certain actions in determining the
           taxpayer's eligibility for the EIC and the amount of EIC claimed.
           For instance, preparers are required to complete an eligibility
           checklist to determine if a child is a "qualifying child" by
           meeting residency, age, and relationship requirements. Of
           particular importance in our investigation, a qualifying child
           must have lived with the taxpayer for over half of the year.

           Preparers are also subject to criminal sanctions arising from
           improper conduct. Civil and criminal penalties can be imposed for
           the same violation. Preparers who help taxpayers prepare false or
           fraudulent returns may be liable and could receive a prison term
           and a fine of up to $100,000.

           Other penalties, both civil and criminal, protect taxpayers from
           paid preparers improperly disclosing the information they provide
           for their tax return. Section 6713 imposes a civil penalty on
           preparers who improperly use or disclose taxpayer information.
           Section 7216 imposes a criminal penalty on preparers who knowingly
           or recklessly disclose or use return information.

           IRS's Small Business/Self Employed Division has responsibility for
           assessing and collecting monetary penalties against any paid
           preparers who do not comply with civil tax laws when filing
           returns. Under section 7407, IRS may also bring a civil action in
           District Court to seek an injunction prohibiting preparers from
           preparing taxes. IRS's Criminal Investigation Division
           investigates paid preparers suspected of violating criminal tax
           laws. In fiscal year 2005, Criminal Investigation conducted 248
           investigations under its Return Preparer Program, with 140 of
           these resulting in recommended prosecutions.

           Some IRS rules and regulations apply only to paid preparers in
           certain circumstances. For example, ERO rules apply to preparers
           who are EROs-entities that IRS has approved to file electronic
           returns. EROs may or may not be preparers. ERO rules also apply to
           ERO principals and responsible officials. Circular 230 regulations
           apply to enrolled agents, attorneys, and CPAs.

           IRS has broad authority to monitor and sanction any paid preparer
           who is authorized to file tax returns electronically. To
           participate in the IRS e-file program, applicants must pass an IRS
           suitability check that may include a background check, a credit
           history check, a tax compliance check, and a check for prior
           e-file noncompliance. An IRS official told us that although some
           EROs do not provide preparation services, most do.

           IRS monitors EROs to ensure compliance with revenue procedures and
           publications that govern IRS's e-file program. For instance,
           according to an IRS official, IRS continues to see if program
           participants are suitable to participate. It also suggests that
           EROs verify the identity and taxpayer identification number of
           taxpayers to protect the e-file program from fraud and abuse.
           Violation of provisions in either a revenue procedure or an IRS
           publication could lead to sanctions. IRS sanctions range from a
           letter of reprimand for a relatively minor infraction to expulsion
           from the e-file program for more severe infractions. According to
           IRS, in 2005 it conducted 1,104 monitoring visits for the e-file
           program resulting in 322 sanctions or proposed sanctions.

           Circular 230 imposes standards on enrolled agents, attorneys, and
           CPAs. According to the Circular, in general, only practitioners
           may represent taxpayers before IRS; however, unenrolled preparers
           may represent taxpayers in certain situations.8 An attorney or CPA
           may represent taxpayers before IRS by filing a written declaration
           with IRS that he or she is licensed as either an attorney or a
           CPA. Under Circular 230, tax preparers who are not attorneys or
           CPAs but who wish to have the unrestricted privilege of
           representing taxpayers must be approved as enrolled agents with
           IRS. Enrolled agent applicants must either pass an examination on
           tax matters or have past IRS employment experience. They are also
           required to meet continuing education requirements.

           Circular 230 describes the standards of conduct that practitioners
           must follow to maintain the right to represent taxpayers before
           IRS. There are generally three categories of misconduct covered
           under Circular 230: (1) misconduct while representing a taxpayer,
           (2) misconduct while preparing a taxpayer's return, and (3)
           misconduct not directly involving IRS representation. In terms of
           the second category-tax preparation-one standard is the realistic
           possibility standard. This standard restricts practitioners from
           signing tax returns if the position does not have a realistic
           possibility of being sustained by IRS. In addition, practitioners
           are required to advise taxpayers of any noncompliance issue or
           omission from tax returns submitted to IRS, advise taxpayers of
           the consequences of this noncompliance or omission, and exercise
           due diligence to ensure accuracy in preparing tax returns.
           Practitioners are also prohibited from charging contingent fees,
           that is, fees based on whether the return will avoid challenge
           from IRS, for some services including preparation of an original
           tax return. Finally, practitioners are prohibited from making
           fraudulent, coercive, or deceptive advertising statements.

           IRS's Office of Professional Responsibility (OPR) administers the
           rules set forth in Circular 230. OPR may censure, suspend, or
           disbar any practitioner from practice before IRS if the
           practitioner violates any Circular 230 regulation, is shown to be
           incompetent or disreputable, or misleads or threatens a client
           with intent to defraud. OPR receives complaints from taxpayers and
           IRS employees regarding tax preparers. The American Jobs Creation
           Act of 20049 added the authority to impose a monetary penalty on a
           practitioner who violates Circular 230, and an employer or firm if
           it knew, or should have known, of the misconduct. The act also
           added violations of Circular 230 to the list of misconduct that
           can lead to an injunction. In fiscal year 2005, OPR investigated
           719 practitioners, resulting in 320 sanctions.

           In the section on diligence as to accuracy in Circular 230, a
           practitioner will have been "presumed to have exercised due
           diligence for purposes of this section if the practitioner relies
           on the work product of another person and the practitioner used
           reasonable care in engaging, supervising, training, and evaluating
           the person, taking proper account of the nature of the
           relationship between the practitioner and the person."10 According
           to an IRS official, "another person" includes an unenrolled
           preparer, and enrolled agents are responsible for ensuring that
           unenrolled preparers working for them do high quality work.
           According to the official, if there were a problem with an
           unenrolled preparer's work, IRS could take action against the
           employing enrolled agent.11

           Although all states have licensing requirements for CPAs and
           attorneys, only two states have licensing requirements for
           unenrolled preparers. California and Oregon both require
           unenrolled paid preparers to register with state agencies and meet
           continuing education requirements. California requires that paid
           preparers pass a 60-hour approved course and obtain a tax preparer
           bond to become registered. California also requires 20 hours of
           continuing education annually. In Oregon, tax preparers must be at
           least 18 years old, have a high school degree or equivalent,
           complete 80 hours of income tax law education, and pass a tax
           preparer examination. Oregon also requires 30 hours of continuing
           education annually. While Oregon requires enrolled agents to
           register, enrolled agents must meet far fewer registration
           requirements than unenrolled preparers must.

           In addition to state licensing requirements, tax practitioners
           often belong to professional organizations such as the American
           Institute of Certified Public Accountants, the American Bar
           Association, or the National Association of Enrolled Agents. These
           organizations impose general standards of conduct on the actions
           of their members, including those who prepare tax returns.

           Taxpayers relying on paid preparers to provide them with accurate,
           complete, and fully compliant tax returns may not get what they
           pay for. Tax returns prepared for us in the course of our
           investigation often varied widely from what we determined the
           returns should and should not include, sometimes with significant
           consequences. Many of the problems we identified put preparers,
           taxpayers, or both at risk of IRS enforcement actions. The
           National Research Program's review of 2001 tax returns also found
           many errors on returns prepared by paid preparers, and some of
           those errors were more frequent on paid prepared returns than on
           self-prepared returns.

           All 19 of our visits to tax return preparers affiliated with
           chains showed problems. Nearly all of the returns prepared for us
           were incorrect to some degree, and several of the preparers gave
           us very bad tax advice, particularly when it came to reporting
           non-W-2 business income. Only 2 of 19 tax returns showed the
           correct refund amount, and in both of those visits the paid
           preparer made mistakes that did not affect the final refund
           amount. While some errors had fairly small tax consequences,
           others had very large consequences. Incorrectly reported refunds
           ranged from refunds overclaimed by nearly $2,000 to underclaims of
           over $1,700.

           Figures 1 and 2 below show how the tax return preparers we visited
           completed key lines on the 1040 form, and explanations of some of
           these lines follow the figures. Also, appendix I has descriptions
           of selected visits we made to paid preparers, describing two
           example visits with fewer issues and two with serious compliance
           problems.

2GAO, Paid Tax Preparers: Most Taxpayers Believe They Benefit, but Some
Are Poorly Served, GAO-03-610T (Washington, D.C.: Apr. 1, 2003).

3As part of this and other work we have done, we tested this SOI database
by comparing record counts and selected totals in the files provided to us
by IRS to published amounts, finding that the required data elements were
sufficiently reliable for the purposes of our work. We used the 2002
database rather than the 2003 database that was the most recent available
because IRS officials told us that some 2003 preparer information had been
miscoded and would not be fixed until after we needed the information.
Because the SOI individual file and the National Research Program files to
be discussed later are created following a probability procedure based on
random selections, each sample is only one of a large number of samples
that might have been drawn. Since each sample could have provided
different estimates, we express our confidence in the precision of our
particular sample's results as a 95 percent confidence interval (e.g.,
plus or minus 5 percentage points). This is the interval that would
contain the actual population value for 95 percent of the samples that
could have been drawn. As a result, we are 95 percent confident that each
of the confidence intervals in this statement will include the true values
in the study population.

4NRP is a detailed IRS study of taxpayer compliance for tax year 2001. As
part of other work we have done or are doing, we tested the NRP database
by interviewing knowledgeable agency officials, finding that the required
data elements were sufficiently reliable for the purposes of our work. See
the earlier footnote on the SOI file for a discussion of NRP confidence
intervals.

 More than Half of Taxpayers Used a Paid Preparer, but Use Varied by Tax Return
                  Complexity and Often Involved Larger Refunds

5All percentage estimates from the SOI files have margins of error of plus
or minus 5 percentage points or less, unless otherwise noted. All
numerical estimates other than percentages have margins of error of plus
or minus 5 percent or less of the value of those numerical estimates,
unless otherwise noted.

Adjusted gross income level      Estimate (percent) 
$0-20,000                                        53 
20,001-40,000                                    56 
40,001-60,000                                    57 
60,001-80,000                                    58 
80,001-100,000                                   55 
Over 100,000                                     64 
All adjusted gross income levels                 56 

Grouping and subgrouping Estimate (percent) 
Type of return           
Form 1040EZ                              33 
Form 1040A                               50 
Form 1040                                64 
Filing status            
Single                                   48 
Married filing jointly                   61 
Head of household                        65 
Type of deductions       
Itemized                                 62 
Standard                                 52 
Earned income credit     
Claimed                                  67 
Not claimed                              54 

Income level                    Using a paid preparer Preparing own return 
$0-20,000                                        $751                 $365 
20,001-40,000                                   1,324                  846 
40,001-60,000                                   1,436                1,224 
60,001-80,000                                   1,611                1,359 
All adjusted gross income                       1,118                  674 
groups                                                

6The median is the middle value in a distribution, with an equal number of
values above it and below it.

Taxpayer category              Using a paid preparer Preparing own return 
All taxpayers                                   $751                 $365 
Taxpayers claiming the EIC                     2,675               1,754a 
Taxpayers not claiming the EIC                   367                  273 

             Regulation of Tax Preparers Varies by Type of Preparer

7Department of the Treasury, Circular No. 230, Regulations Governing the
Practice of Attorneys, Certified Public Accountants, Enrolled Agents,
Enrolled Actuaries, and Appraisers before the Internal Revenue Service
(Washington, D.C.: June 20, 2005).

                    Preparers covered     
                               Unenrolled                                     
Regulation    Practitioners preparers  Description of regulation
IRC penalties X             X          Address such areas as fraud,        
                                          negligence, due diligence, and      
                                          unauthorized disclosure             
ERO rules     X             X          Apply to all entities in IRS's      
                                          e-file program and their principals 
                                          and responsible officials and       
                                          include application requirements    
                                          and rules for participating in      
                                          electronic filing                   
Circular 230  X                        Applies to CPAs, attorneys, and     
                                          enrolled agents and governs duties  
                                          and restrictions, sanctions, and    
                                          disciplinary proceedings            
State         X                        Contain licensing and usually       
regulations                            continuing education requirements   
                                          for CPAs and attorneys with only    
                                          California and Oregon having these  
                                          requirements for unenrolled tax     
                                          preparers                           

Some Regulations Apply to All Paid Preparers

Code section Description                        Penalty                    
6694(a)      Understatement of taxpayer's       $250 per return            
                liability due to an unrealistic    
                position                           
6694(b)      Understatement of taxpayer's       $1,000 per return          
                liability due to willful or        
                reckless conduct                   
6695(a)      Failure to provide copy of return  $50 per failure            
                to taxpayer                        
6695(b)      Failure to sign return             $50 per failure            
6695(c)      Failure to furnish identifying     $50 per failure            
                number                             
6695(d)      Failure to retain a copy or list   $50 per failure            
                of returns filed                   
6695(e)      Failure of employers to file       $50 per failure            
                correct information on each tax    
                preparer employed                  
6695(f)      Negotiation of taxpayer's refund   $500 per check             
                check                              
6695(g)      Failure to be diligent in          $100 per failure           
                determining earned income tax      
                credit eligibility                 
6701         Aiding and abetting understatement $1,000                     
                of tax liability                   
6713         Improper disclosure or use of      $250 per disclosure, up to 
                return information                 a maximum of $10,000       
7206         Willful preparation of a false or  Up to $100,000, 3 years    
                fraudulent return or other         imprisonment, or both      
                document                           
7207         Knowingly providing fraudulent     Up to $10,000, 1 year      
                returns or other documents to IRS  imprisonment, or both      
7216         Knowingly or recklessly disclosing Up to $1,000, 1 year       
                or using return information        imprisonment, or both      
7407         Authority to enjoin income tax     
                preparers                          

Additional Regulations Apply Only to Some Paid Preparers

8Unenrolled preparers may only represent those taxpayers before IRS whose
returns they prepared and only during examination of the return. When
unenrolled preparers represent taxpayers before IRS, they are governed by
IRS Revenue Procedure 81-38, which contains standards of conduct similar
to those in Circular 230, including the need for due diligence in
preparing tax returns.

State Regulation of Paid Preparers Focuses on Licensed Practitioners

9Pub. Law No. 108-357, Oct. 22, 2004.

10Circular No. 230.

11In our 19 site visits that will be described later, we do not know if
any of the paid preparers we saw were enrolled agents or working for
enrolled agents.

  Taxpayers Using Paid Preparers May Receive Incorrectly Completed Tax Returns

All of the Tax Return Preparer Visits We Conducted Produced Errors, Some with
Substantial Consequences

Figure 1: Summary of How Paid Preparers Completed Selected Lines on the
IRS Form 1040 (page 1)

Figure 2: Summary of How Paid Preparers Completed Selected Lines on the
IRS Form 1040 (page 2)

Identifying information. Taxpayer names and social security numbers were
correctly entered on all but one of our returns, with one preparer
entering a wrong middle initial. Some preparers asked for this information
orally, and some asked us to complete information worksheets.

Filing status. All of our prepared tax returns showed the correct filing
status for the two different scenarios we used. The plumber's return
always correctly indicated married filing jointly, and the sales worker's
return always indicated her filing status as head of household.

Exemptions. Exemption information entered on the returns prepared for us
included some mistakes. All 9 of the plumber's returns listed the correct
number of exemptions. However, the plumber's daughter was listed with a
different last name on 1 return. Also, both of the plumber's children were
listed with first and middle names on another return, despite the 1040
form clearly calling for dependents' first and last names.

Of the 10 sales worker returns prepared for us, 7 incorrectly indicated
both children lived with the taxpayer in 2005. When asked where her
children lived, our staff always said that one lived with her and the
other with the child's grandmother throughout 2005. However, this question
was not always asked. In general, incorrectly reporting the number of
dependent children may have implications for other lines on a tax return,
specifically the dollar amount of personal exemptions on line 42, the
child tax credit reported on line 52, and the additional child tax credit
on Form 8812 and line 68.

Wages and investment income. Most income documented by third-party
reporting forms (Forms W-2 or 1099) was included on our returns correctly,
but not in every case. Wages shown on forms W-2 were correctly listed on
line 7 (see fig. 1) of all 19 of the tax returns prepared for us in our
investigation. Similarly, tax-exempt interest (line 8a) and qualified
dividends (line 9b) were listed on a Form 1099 from a mutual fund and were
entered correctly on all 9 of the plumber's returns. However, the same
Form 1099 included ordinary dividends, but 1 preparer entered the wrong
amount on line 9a. Also, the mutual fund Form 1099 listed capital gains,
but 2 returns did not include capital gains income on line 13.

State tax refunds. State tax refunds were also shown on Forms 1099 given
to the paid preparers we visited, but 8 out of 19 preparers handled them
incorrectly.12 In the plumber scenario, the state tax refund should have
been reported as income (line 10) on this year's return, but this was not
done on 5 of the 9 returns prepared for him. The sales worker did not
itemize deductions for 2004, so her state tax refund was not supposed to
be reported as income this time. However, 2 of 10 preparers included her
state tax refund on line 10, and a third preparer listed the state tax
refund amount from the state Form 1099 as unemployment compensation on
line 19.

Business income. Reporting "side income"-income from casual
self-employment arrangements-was very problematic in many of our visits to
paid preparers. Both of our taxpayer scenarios included self-employment
income, and we told the preparer that we had such income whenever we were
asked. Also, if the preparer did not ask about non-W-2 business income, we
still told the preparer that we had such income before the end of the
visit. Despite being told of the side income in every case, 2 out of 9
plumber return preparers and 8 out of 10 sales worker return preparers did
not report the income as required.13

Even in cases where the side income was reported, several paid preparers
gave us incorrect information. Several advised us that reporting such
income was our decision because IRS would not know of it unless we
reported it. One preparer told our investigator posing as a sales worker
that she did not have to report the income unless it was over $3,200.
Another said that her income could not be reported because she did not
have the names and the social security numbers of the children she
watched. On the other hand, the discussion of side income with the paid
preparers (when a discussion took place) often, to the sales worker's
potential benefit, included detailed probing by the preparer to identify
expenses to offset the income we described.

12According to IRS publication 525, a state tax refund generally must be
reported as income if the taxpayer deducted the tax in an earlier year.
The plumber scenario included that he itemized deductions, including state
income taxes paid, in the prior year and the sales worker scenario
included that she did not itemize deductions the prior year. There are
some qualifications to the reporting requirement in the IRS publication,
but questions asked by paid preparers (if any) either did not address them
or led to answers that would cause the refund to be included as income.

13Our taxpayers' returns should have included either a Schedule C-EZ, Net
Profit from Business, or a Schedule C, Profit or Loss from Business. In
both scenarios, the income also required a Schedule SE for self-employment
taxes.

The amount of business income we built into our scenarios, and that
preparers often did not include on the tax returns that they prepared, was
not unusual for wage-earning taxpayers who underreported business income
for tax year 2001. According to data taken from IRS's recent NRP efforts,
for tax year 2001, about 37 percent of taxpayers with wages and business
income who underreported their business income did so by amounts of up to
$1,500, and about 65 percent underreported their business income by up to
$5,000.14

Deductions. Only 2 of 9 of the plumber's returns reported the correct
amount of itemized deductions (line 40). Returns done by 2 preparers
claimed the standard deduction, even though it was about $4,000 less than
the total amount of itemized deductions we included in the scenario. Five
other preparers itemized deductions for the plumber, but made other
mistakes. These errors changed the amount of the plumber's refund,
although sometimes by fairly small amounts. One preparer, however, missed
deductions for property taxes worth about $4,000, meaning that the claimed
refund was hundreds of dollars lower than it should have been. On the
other hand, all 10 of the sales worker returns claimed the standard
deduction, which was to the taxpayer's advantage in these cases because
she had very few deductions to itemize. In 2002, we reported that as many
as 2 million taxpayers failed to minimize their taxes by failing to
itemize their deductions and that about half of these taxpayers had
returns prepared by another person.15

Foreign tax credit. The plumber's Form 1099 from his mutual fund showed a
small amount of foreign taxes paid, but only 1 of the 9 preparers we
visited claimed the foreign tax credit (line 47) for which the taxpayer
was eligible.

Child-care expenses. The sales worker had child-care expenses, but none of
the 10 preparers we visited included the credit for child- and
dependent-care expenses (line 48) for which she was eligible. Some
preparers told her that she could not claim the credit because she did not
have the social security number of her child-care provider. This
information was incorrect. The instructions for Form 2441 state that a
taxpayer who attempts to collect the social security number of his or her
child-care provider but is unsuccessful can report that fact on Form 2441
and still claim the credit.16

14Taxpayers with wage income who underreported their business income by
amounts ranging from $1,500 to $5,000 accounted for only a relatively
small amount-about $5.8 billion-of the approximately $53.6 billion
underreported as business income by all wage earners with business income.

15GAO, Tax Deductions: Further Estimates of Taxpayers Who May Have
Overpaid Federal Taxes by Not Itemizing, GAO-02-509 (Washington, D.C.:
Mar. 29, 2002).

Education credits. In the plumber scenario, one of the taxpayer's children
was a college student in the second year of postsecondary education, but 6
of 9 paid preparers made some sort of error in determining the line 50
education credit-either improperly including items in expenses, not
claiming the credit most advantageous to the taxpayer, or both. The
expenses and the year in school made the Hope education credit far more
advantageous to the taxpayer than either the tuition and fees deduction
(line 23) or the Lifetime Learning credit. Of the 9 plumber's returns, 6
included the Hope credit, but 3 of the 6 preparers involved improperly
included books among the expenses, increasing the credit by about $100
above what it should have been. One preparer included the tuition and fees
deduction instead of the Hope credit and 2 others claimed the Lifetime
Learning credit, reducing the taxpayer's refund by hundreds of dollars. In
2005, we reported that many tax returns, including many prepared by paid
preparers, made such suboptimal choices among the three postsecondary
education tax preferences.17

Earned income credit. The EIC on line 66a was another area where paid
preparers made very significant mistakes. Of the 10 returns prepared for
the sales worker, 5 reported two children on Schedule EIC, Earned Income
Credit, instead of the one child who lived with the taxpayer in 2005 and
was eligible for the EIC. IRS has estimated that incorrectly claimed
children are the largest category of errors for the EIC, accounting for
about $3 billion of the estimated $8.5 billion to $9.9 billion in EIC
overclaims in tax year 1999. IRS regulations require that paid preparers
ask a series of questions to determine eligibility for the EIC, including
whether children lived with the taxpayer in the United States for more
than half of the year. We were posing as a fairly unsophisticated taxpayer
who was unaware of EIC eligibility rules, so we did not volunteer that one
of our children did not live with us in 2005. Whenever we were asked if
our children lived with us, however, we said that one did and one did not.
Only 1 preparer asked all of the required questions. Three preparers asked
about the names, dates of birth, and social security numbers of the two
children but never asked where the children lived in 2005. Three preparers
gave us a worksheet to complete that asked most but not all of the
required questions, but 2 of these preparers still entered two children
when we wrote down that one child did not live with the sales worker at
all during the year. In 1 of these cases, another employee reviewed the
return.

16It is possible that some preparers understood the rules for reporting
the credit. Other preparer mistakes, such as not reporting side income or
claiming the wrong number of exemptions, had the effect of eliminating the
sales worker's tax liability. Because the credit for child- and
dependent-care expenses is not refundable, not claiming it in cases where
the taxpayer's tax liability was reduced to 0 may not have been a mistake
in its own right.

17GAO, Student Aid and Postsecondary Tax Preferences: Limited Research
Exists on Effectiveness of Tools to Assist Students and Families through
Title IV Student Aid and Tax Preferences, GAO-05-684 (Washington, D.C.:
July 29, 2005).

Refunds. As a result of the errors described above, some claimed refunds
on line 73a on our 19 returns were either substantially higher or lower
than they should have been. Figure 3 shows the deviation from the correct
refund amount under our two scenarios. The pairs of bars shown in the
figure indicate returns prepared by employees affiliated with the same
chain. As shown in the figure, refunds reported for the plumber were
incorrect in all 9 cases-sometimes by only small amounts, but at other
times by substantial sums. Refunds reported for the sales worker were
correct in 2 cases and overstated in the other 8 cases. The paid preparers
that arrived at the refund amount that was $218 too high ignored the sales
worker's side income but reported the correct number of children living
with her when calculating the EIC. The preparers who arrived at
overclaimed refunds of $1,956 did not include the side income and reported
two children for EIC purposes.

Figure 3: Refund Amounts over or under Correct Amount

The 19 paid preparers we visited arrived at the correct refund amount only
twice. On 5 returns, all for the plumber, they understated our refund
amount by a total of $3,465. On 12 returns (4 for the plumber and 8 for
the sales worker) they overstated the refund by a total of $12,169-a total
of $1,735 in overstated refunds for the plumber and $10,434 for the sales
worker.

Preparer's identifying information. In addition to various computational
errors, some preparers also did not include identifying information
required on the 1040 forms they completed. IRS regulations require that
paid preparers include a signature or typed name, a social security number
or "PTIN" (an IRS-issued unique identifier for paid preparers), and the
name and employer identification number of their employer. Four of our 19
returns had no preparer signature and 2 had no preparer social security
number or PTIN. All but 1 return prepared for us included a company name
and employer identification number; that return was missing all
identifying information.

Preparer services and fees. Most paid preparers we visited offered
services besides the federal tax returns we requested. Some preparers
offered to prepare the state tax return for us. In a few cases the
preparer gave us completed state tax returns along with the federal return
and did not indicate that there was an additional charge. Whenever asked,
we said we only wanted a federal tax return. Electronic filing was always
an option. One preparer proceeded to electronically file our return, even
after we said we wanted to mail in a paper return. In this case, the
preparer did not ask us to provide a personal identification number or ask
us directly to sign a form authorizing the electronic filing, as required
by IRS regulations.

We were also usually offered ways to get our refunds more quickly than
waiting for a check mailed from IRS. Some of these options involved
RALs-short-term loans made to taxpayers and paid off with tax refunds-and
others involved direct deposit alternatives. In some cases, what were
clearly RALs were not described as loans but as "options" or "bank
products." One preparer gave us a RAL application to sign at the start of
the visit without explaining what it was we were being asked to sign.
Another preparer told us the size of the refund we could receive in 12 to
48 hours but did not give us the amount we would receive if we were
willing to wait for a check from IRS, did not identify the faster refund
as a loan, and did not explain that the amount we would receive was
reduced by the amount of the fee associated with the option. In this case,
the fee for the RAL was between about $470 and about $570, after
subtracting the amount charged to prepare the return. With a refund amount
of about $5,000 and assuming a 10-day wait for the refund, this means that
the annual percentage rate for the loan was between about 380 percent and
about 470 percent.

The fees charged in our 19 visits varied widely, sometimes between offices
affiliated with the same chain, and were sometimes significantly larger or
smaller than the original estimate we were given. In both the plumber and
the sales worker scenarios, we received 1 set of returns at no cost, and
another paid preparer reduced the fee for the sales worker without
explaining why. Figure 4 shows the fees charged by each of the 19 paid
preparers we visited. The pairs of bars in figure 4 represent the fees
charged by offices of the same chain for the same scenario. In only 1 of
the 9 cases where the same firm prepared the same tax return were we
charged the same amount. In some cases, the preparer stressed that one
advantage of purchasing a RAL or paying the fees to arrange for direct
deposit of the refund would mean that the cost of the visit would come out
of the refund and that we would not have to pay any money on the day of
the visit.

Figure 4: Fees Charged for Tax Preparation Services

One of the common sense steps we mentioned earlier when choosing or
working with a paid preparer is to make sure you understand how much the
services you are getting cost. For this reason, we asked for an estimate
of fees at the start of every paid preparer transaction. Eight preparers
either did not provide an estimate or gave an estimate with the qualifier
that the fee would depend on the forms required. In the other 11 cases, we
were quoted a fee or a range that did not depend on a variety of forms,
and in 9 of those the fee we were ultimately charged was within the quoted
range, within $30 of the fee quoted, or less than the estimate. Some
preparers provided a detailed receipt showing the forms that were
prepared, but some receipts only showed the final fee. None of the more
detailed receipts, however, included specific costs for individual forms.

Many Problems on Our Tax Returns Could Risk IRS Enforcement Actions against the
Paid Preparer, the Taxpayer, or Both

According to IRS officials, paid preparers and taxpayers risk enforcement
action by filing a tax return that includes the types of misstatements or
omissions that we have described. According to the officials, although IRS
seldom has clear evidence about what transpires between a preparer and a
taxpayer, if IRS were to uncover problems with the preparation of real tax
returns similar to several that we found, the preparers would be subject
to civil sanctions.

Several penalties would be applicable depending on the facts and
circumstances of each situation. IRS officials said that if the preparers
had been preparing tax returns to be actually filed, many of them would
have been subject to civil penalties for such things as negligence and
willful or reckless conduct. For example, as stated earlier in our
testimony, if a paid preparer encourages a taxpayer not to report or to
erroneously report transactions on his or her tax return, resulting in a
tax-due understatement or refund overstatement, the preparer could be
assessed penalties of up to $1,000 for willful or reckless disregard of
tax rules and regulations.18 In both of our scenarios, information
provided to preparers included self-employment income that the preparer
did not encourage reporting. According to IRS officials, the preparer is
clearly responsible for properly reporting all income, including the
self-employment income in these scenarios, on a taxpayer's return. They
added that although preparers are not required to audit taxpayers to
uncover unreported income, they must make reasonable inquiries to
correctly report income.

IRS officials also said that civil penalties would be applicable to other
issues we encountered, depending on the facts and circumstances. Preparers
who did not ask all the EIC due diligence questions would be subject to
the penalty for the failure to be diligent in determining EIC eligibility.
Similarly, preparers who improperly included hundreds of dollars of books
in the education credit taken would be subject to a penalty for
negligence.

IRS officials we spoke with, who included representatives of Criminal
Investigation, said that although the dollar amounts of errors made by the
practitioners might not result in prosecutions, criminal sanctions such as
willful preparation of a false or fraudulent return might apply.

18IRC sections 6694(a) and (b).

In addition to paying the tax due after correcting the return and any
related late payment interest, the taxpayer may also be assessed a
penalty, depending on the facts and circumstances of each situation,
according to IRS officials. For example, if taxpayers substantially
understate income, overstate deductions, or provide other incorrect
information resulting in decreased tax or improperly high refunds, they
may be assessed an accuracy-related penalty. The penalty could be assessed
for any failure to comply with the tax laws, including the failure to
report self-employment income.19

Because the returns we had prepared were not real returns and were not
filed, penalties would not apply. However, we have referred matters we
encountered to IRS so that any appropriate follow-up actions can be taken.

The National Research Program Found Errors on Returns Prepared by Paid Preparers

IRS's tax year 2001 NRP data also indicate that tax returns prepared by
paid preparers contained a significant level of errors. As shown in table
7, IRS audits of returns prepared by a paid preparer showed a higher error
rate-56 percent-than audits of returns prepared by the taxpayer-47
percent.20 Errors in this context changed either the tax due or the amount
to be refunded. A similar statistically significant relationship existed
for all income groups of $80,000 and below that we studied. Of course, as
noted before, it is important to remember that tax preparers are used more
often on some more complicated returns than on some simpler ones, although
we were unable to gauge the full extent to which this might be true. Also,
the fact that errors were made on a return done by a paid preparer does
not necessarily mean the errors were the preparer's fault; the taxpayer
may be to blame. The preparer must depend on the information provided by
the taxpayer.

19IRC section 6662(b).

20All percentage estimates from the NRP files have margins of error of
plus or minus 5 percentage points or less, unless otherwise noted. All
numerical estimates other than percentages have margins of error of plus
or minus 5 percent or less of the value of those numerical estimates,
unless otherwise noted.

Table 7: Estimated Percentage of NRP-audited Tax Year 2001 Individual
Returns with Errors

Type of return              Estimate (percent) 
Prepared by a paid preparer                 56 
Prepared by the taxpayer                    47 
All returns                                 52 

Source: GAO analysis of IRS NRP data.

The different error rates for paid preparer and self-prepared returns
translated into different amounts that taxpayers owed IRS after audit. For
instance, as shown in table 8, taxpayers using a paid preparer owed a
median of $363 to IRS after audit, compared with a median of $185 for
taxpayers preparing their own returns. This type of disparity in taxes
owed existed for every income level we studied except for the
$40,001-60,000 and $60,001-80,000 ranges in which the differences were not
statistically significant.

Table 8: Estimated Median Additional Taxes Owed on NRP-audited Tax Year
2001 Individual Returnsa

Type of return              Estimate Lower bound Upper bound 
Prepared by a paid preparer     $363        $338        $397 
Prepared by the taxpayer         185         164         210 
All returns                      279         262         300 

Source: GAO analysis of IRS NRP data.

aThe 95 percent confidence intervals surrounding the estimates range from
the lower bounds to the upper bounds.

Table 9 shows some specific Form 1040 line items for which the NRP paid
preparer and self-prepared error rates differed from each other in a
statistically significant way. We also found problems with these line
items in our visits to paid preparers. For example, NRP audits revealed
that, for the Form 1040 line showing the amount of standard deduction or
itemized deductions taken, about 23 percent of self-prepared individual
returns had errors, compared with about 31 percent of returns done by paid
preparers. Paid preparer and self-prepared error rates did not differ from
each other in a statistically significant way for business income and
education credits line items, other line items for which we had found
problems.

Table 9: Estimated Percentages of NRP-audited Tax Year 2001 Individual
Returns Containing Specific Line Items with Errors on Those Line Items

                        Self-prepared returns Returns done by a paid preparer 
Form 1040 line item              (percent)                       (percent) 
Deductions                              23                              31 
Foreign tax credit                      16                               6 
Earned income credit                    45                              53 
Refund                                  48                              57 

Source: GAO analysis of IRS NRP data.

                            Concluding Observations

Our limited review and the problems we found do not permit observations
about the quality of the work of paid tax preparers in general.
Undoubtedly, many paid preparers do their best to provide their clients
with tax returns that are both fully compliant with the tax law and cause
them to neither overpay nor underpay their federal income taxes.
Furthermore, as we observed in 2003, it is easy to understand how the
complexity of the tax code brings many taxpayers to conclude that they
should turn to a paid preparer.

As we also observed in 2003, however, our tax system depends on taxpayers
accurately completing and filing their returns. With their important role
in helping taxpayers meet their obligations, paid preparers become a
critical quality-control checkpoint for the tax system. Where we saw
serious problems in our few visits, these same preparers may make similar
mistakes on the genuine tax returns they complete this year. Their
mistakes and misstatements may also ripple even further through the system
as the taxpayers they serve may come to believe that, for example, non-W-2
business income does not have to be reported, and they may even spread
that misinformation among their friends and neighbors. In light of the
importance of paid preparers in our tax system today, knowing if what we
found is the exception or the rule in the paid tax preparation services
industry is critical. With better information about the extent of
problems, IRS can better target its limited enforcement and education
resources.

Finally, our observation in 2003 that taxpayers who choose to use paid
preparers need to be wise consumers is even more important today in light
of our most recent findings. As IRS notes on its Web site under "Tips for
Choosing a Tax Preparer," no matter who prepares a tax return, the
taxpayer is legally responsible for all of the information on that tax
return.

We discussed our findings and observations with senior IRS officials, and
they generally agreed with our message.

                      Recommendation for Executive Action

We recommend that the Commissioner of Internal Revenue conduct necessary
research to determine the extent to which paid preparers live up to their
responsibility to file accurate and complete tax returns based on
information they obtain from their customers. In conducting this research,
the Commissioner should consider whether the methodology we used would
provide IRS with a more complete understanding of paid preparers'
performance.

Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions you or other Members of the Committee may have at
this time.

                          Contacts and Acknowledgments

For further information on this testimony, please contact Michael Brostek
at (202) 512-9110 or [email protected] . David Lewis, Assistant Director;
Mario Artesiano; Paul Desaulniers; Danielle Free; Leon Green; George
Guttman; Christine Hodakievic; Lindsey Houston; Shirley Jones; Jason
Kelly; Lawrence Korb; Barbara Lewis; John Mingus; Karen O'Conor; and
Cheryl Peterson made key contributions to this testimony.

Appendix I: Paid Preparer Visit Examples

None of our 19 visits to paid preparers were problem-free, but some had
relatively minor issues while others had more serious problems. The
following are descriptions of selected visits we made to paid preparers.
For each scenario, we provide one example of a visit that had fewer
compliance issues than most of our visits under the same scenario, and one
example that had more serious problems than most.

                  Example of a Plumber Visit with Minor Issues

During this site visit, the paid preparer asked various questions and
prepared a return with few problems. For example, presumably to determine
the taxability of a state income tax refund, the preparer asked about the
previous year's itemized deductions and their amount. The preparer also
asked about which year the college-age child was in schooling and whether
the tuition in question had been paid in 2005, questions needed to
determine the applicability of the Hope education credit. While the
preparer did not ask about side income, when the taxpayer volunteered that
he had non-W-2 income, the preparer included it on the return without
discussing whether to either change it or not report it. The preparer also
probed for expenses to offset it.

The refund on the completed tax return was only $4 below the correct
amount. The difference was due to the preparer (1) overclaiming the amount
of personal property tax paid by including nondeductible fees and (2) not
taking the credit for foreign taxes paid. The preparer also listed noncash
charitable donations as cash donations, though this did not affect the
amount of the refund.

The cost of the visit to the paid preparer was about $100 more than the
amount originally quoted. However, at the start of the visit, the preparer
had said that the actual amount would depend on the number of forms used.
One of the forms used was the Schedule B, Interest and Ordinary Dividends.
While this form might have been used to capture information the taxpayer
provided, it did not need to be filed with IRS, since the income amounts
were less than the minimums requiring the form. The paid preparer did not
offer other services such as a Refund Anticipation Loan (RAL) to the
taxpayer.

                Example of a Plumber Visit with Serious Problems

Costly issues for the taxpayer during this site visit were the paid
preparer's failure to itemize deductions and the preparer's decision to
claim the tuition and fees deduction instead of the Hope education credit.
The preparer did not itemize the deductions despite the fact that the
taxpayer showed the preparer the documents supporting itemization. The
preparer even asked questions about medical expenses and charitable
contributions. The preparer also asked about whether there were any
nonreimbursed employee expenses and about whether the college-age child
was a full-time student.

On another issue, when discussing the taxpayer's side income, the preparer
wondered if the taxpayer had reported it the previous year, which he had.
The preparer suggested also reporting it this time so as not to arouse
suspicion, but at a much lower amount than the taxpayer identified. The
taxpayer declined the offer, and the preparer ultimately included the
correct amount. The preparer did not provide the taxpayer with a completed
Schedule C-EZ or a Schedule SE, although information from both was
reported on the form 1040. In addition, the preparer did not include the
state tax refund as income.

When asked about the tax return's price at the beginning of the session,
the preparer could not give an exact estimate but instead provided a
range. However, the preparer ended up not charging the taxpayer at all
since the refund involved was so small. In fact, the refund was about
$1,700 smaller than the correct amount.

 Example of a Retail Sales Worker Visit with Fewer Serious Issues than Most We
                                  Encountered

This example is 1 of the 2 retail sales worker returns in which the refund
computed by the paid preparer was the same amount we computed. The
preparer reported the correct number of children for EIC purposes and
asked most of the due diligence EIC questions. Although the preparer
claimed the wrong number of children as exemptions, that did not affect
the final refund amount. Although the preparer did not ask directly about
side income, the preparer included it when we offered the information. The
price charged was the same as the price quoted, and the preparer pointed
out that a RAL was in fact a loan. The preparer did not, however, sign the
tax return or provide any other preparer information on it.

      Example of a Retail Sales Worker Visit with Several Serious Problems

In this example, the paid preparer's return resulted in the tax return
showing a refund of almost $2,000 more than the correct amount. The return
did not include the side income even though the preparer asked about
anything else that should be considered and the taxpayer mentioned it. The
preparer said the taxpayer would need records of income and expense to be
able to report the income. The return included two children as qualifying
for the EIC and the additional child tax credit even though only one lived
with the taxpayer. The preparer appeared to go through an on-screen EIC
checklist but did not ask the taxpayer the questions. The papers taken
away from the preparer included an EIC worksheet with the answers
completed by the preparer, some of them incorrect.

There were also other issues with the return prepared. First, it did not
include child-care expenses as the taxpayer was told the expenses would
have to exceed $7,300 to be claimed. Second, it incorrectly included the
state tax refund as income because the preparer said the amount was for
unemployment compensation. Third, the return did not include the
preparer's social security number although it did show his name.

The preparer offered a RAL that would have been available in an hour at a
cost of about $400.

(450471)

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Highlights of GAO-06-563T , a statement before the Committee on Finance,
U.S. Senate

April 4, 2006

PAID TAX RETURN PREPARERS

In a Limited Study, Chain Preparers Made Serious Errors

Despite the importance of paid tax return preparers in helping taxpayers
fulfill their obligations, little data exist on the quality of services
they provide. Paid preparers include, for example, enrolled agents, who
are approved by the Internal Revenue Service (IRS) once they pass an
examination on tax matters or demonstrate past IRS employment experience,
and unenrolled preparers, who include self-employed individuals and people
employed by commercial tax preparation chains.

GAO was asked to determine (1) what the characteristics were of tax
returns done by paid preparers, (2) what government regulation exists for
paid preparers, and (3) what specific issues taxpayers might encounter in
using paid preparers. To do its work, GAO analyzed IRS data, reviewed paid
preparer regulatory requirements, and had tax returns prepared at 19
outlets of several tax preparation chains.

What GAO Recommends

GAO recommends that the Commissioner of Internal Revenue conduct necessary
research to determine the extent to which paid preparers live up to their
responsibility to file accurate and complete tax returns based on
information they obtain from their customers.

Many taxpayers choose to pay others to prepare their tax returns rather
than prepare their own returns. According to the most recent reliable
data, about 56 percent of all the individual tax returns filed for tax
year 2002 used a paid preparer, with higher paid preparer usage among
taxpayers with more complicated returns such as those claiming the earned
income credit (EIC).

All paid preparers are subject to some IRS regulations and may be
penalized if they fail to follow them. For example, all paid preparers
must identify themselves on the returns they prepare and must not
deliberately understate a taxpayer's tax liability. When the EIC is
involved, paid preparers must also ask specific questions to determine a
taxpayer's eligibility for the credit.

In GAO visits to commercial preparers, paid preparers often prepared
returns that were incorrect, with tax consequences that were sometimes
significant. Their work resulted in unwarranted extra refunds of up to
almost $2,000 in 5 instances, while in 2 cases they cost the taxpayer over
$1,500. Some of the most serious problems involved preparers

           o  not reporting business income in 10 of 19 cases;
           o  not asking about where a child lived or ignoring GAO's answer
           to the question and, therefore, claiming an ineligible child for
           the EIC in 5 out of the 10 applicable cases;
           o  failing to take the most advantageous postsecondary education
           tax benefit in 3 out of the 9 applicable cases; and
           o  failing to itemize deductions at all or failing to claim all
           available deductions in 7 out of the 9 applicable cases.

GAO discussed these findings with IRS and referred to it problems that
were found. Had these problems been discovered by IRS on real returns, IRS
officials said that many of the preparers would have been subject to
penalties for such things as negligence and willful or reckless disregard
of tax rules.

Refund Amounts over or under Correct Amount in 19 Cases
*** End of document. ***