Civil War Horses, Con Men and Lois Lerner

I think I have been insulted.

I am reading this morning that the Court of Appeals for the D.C. Circuit is hearing the IRS appeal of the Loving decision.  That decision concerned the recent effort by the IRS to regulate tax preparers, and the IRS lost the case. There were three parts to the IRS effort:

• a unique preparer identification number, called a PTIN (“pea tin”). The PTIN would allow – in theory - the IRS to track which individuals prepared which returns. I say “in theory” because it is not uncommon for larger returns to have two or more preparers and one or more reviewers. Traditionally the highest-ranking last person in the chain is considered the official preparer, but the IRS did not write its regulations that way.

• a competency test. CPAs, enrolled actuaries, attorneys and enrolled agents were exempt, as their credentialing already includes a competency test.

• a continuing education requirement. Tax laws change frequently, so the IRS thought that continuing education would be a good idea. It is.

Here is the rub: where does the IRS get the authority to make these proclamations? I know it sounds a bit quaint to talk about “government of laws rather than of men” in the current political environment, but there are a few sticklers out there who still believe in the concept. One of them was Judge Boasberg in the Loving decision.

Yesterday the IRS trotted out its attorneys, arguing that they have the right to regulate whatever they want under the “Horse Act of 1884.” Folks, that is “18” 84. 

Do you remember the following words?

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

This is the 16^th amendment, creating the income tax and ratified in February 1913. That is “19”13. Which comes after “18”84, for most people. Let’s be blunt here: how can a law from the 1800’s give the IRS any authority over income tax preparers when the income tax was not even created until 1913?

I have to admit, I had to look up the Horse Act of 1884. We must have missed that bright shiny in high school American History. After the Civil War, people brought claims against the U.S. for dead or missing horses. Makes sense, as horses were required to work the farm or for transportation, and their loss would have been keenly felt. Always seeking a vacuum, fraudsters soon appeared to help people press horse claims against the government. Soon all horses were thoroughbreds, and the government was facing more actions than there were horses lost in the Civil War. The government realized they were being scammed by con men and, in defense, starting regulating those people. The government even used the term “enrolled agent,” a term still used today for a class of preparer who has passed a competency examination given by the IRS itself.

So the IRS attorneys are arguing that tax CPAs like me are akin to fraudsters who inflated the value of dead or missing horses in action against the government following the Civil War?

As I said, I think I have been insulted.

I am also reading that Lois Lerner, the former head of the IRS Exempt Organizations Division, is retiring. You may remember that she invoked the Fifth Amendment when appearing before Congress on May 22, 2013. She was the political hack from the Federal Elections Commission who somehow wound up at the IRS reviewing and delaying applications from conservative groups, especially Tea Party organizations, seeking 504(c)(4) status in time for the 2012 presidential election. Good thing she was there too or the election may have gone a different way. She was quite happy to initially throw a few Cincinnati IRS employees under the bus, saying they had gone “rogue.” Later investigation, including e-mails, put a rest to that lie. Congress could have instead spoken with a few practicing tax CPAs, and we could have told them the same thing.  

She has been on “administrative” leave since then, drawing an approximate $170,000 salary. Now she gets to retire. It’s a nice retirement too, as she able to look for another government position and still collect her retirement pay, estimated over $50,000 annually. 

I would love a deal like that. Unfortunately, the IRS thinks of me as a con man.

Smackdown On IRS Regulation of Tax Preparers

In 2009 the IRS commissioned a study of the tax preparation industry. Some of the findings were obvious: as the tax law becomes more complex, taxpayers are increasingly relying upon tax preparers or tax software (think TurboTax) in preparing accurate returns. The study then went on to look at the preparers themselves, from attorneys and CPAs to big-block preparers (such as H&R Block) to someone who prepares a few returns for compensation from their kitchen table.

It was on that last point that the IRS had an issue. It noted that anyone could enter the tax preparation business and that that ill-equipped preparers were making numerous errors that were costly to the Treasury. The IRS was unsure even of the number of tax preparers out there, guessing there were between 900,000 and 1.2 million preparers.

The IRS observed that:

...the American public overwhelmingly supports efforts to increase the oversight of paid tax return preparers.”

Sorry, that one sounds like self-serving flourish. I doubt the American public is barely aware of this issue.

The IRS, then under Commissioner Shulman, instituted a three-part program to oversee individual income tax preparers:

(1) A specific identification number for each preparer

           

This is called the “preparer tax identification number” (PTIN), and every preparer is required to obtain one and use it on every return he/she signs. Before January 1, 2011, use of a PTIN was optional.

(2) The competency test

The IRS mandated that preparers had to take an exam and then went on to exempt categories of preparers, such as attorneys, CPAs and EAs. There were reasonable grounds for these exceptions, as each of these groups has its own licensing system. 

After much wrangling, the IRS also exempted preparers supervised by an  attorney, CPA or EA. If you worked for me, for example, you could be exempt by working under my supervision.

(3) Continuing education

           

Preparers had to complete 15 hours of continuing education each year. Again, attorneys, CPAs and EAs were exempt because of their own education requirements.

The government being what it is, a new unit was created within the IRS – the Return Preparer Office – to administrate all this activity. The government also created a new designation, the "registered tax return preparer," for those passing the competency exam.

So far, this sounds reasonable (or, at least, not unreasonable), right?

There was deep cynicism right away about what the IRS was actually up to. For example, the PTIN cost $63. Every year. Many practitioners, including some I have worked with, believe this to be a back-door effort by the IRS to pad its own budget. The facts seem to bear this out, as the IRS has collected more than $106 million from the preparer registration and testing system. It has spent approximately $50 million and assigned 167 employees to the program.

What about the testing? No one is truly certain how many tax preparers have to go through the testing, given that so many (like me) are exempted. The number I have seen most often is 350,000.

Let’s go with 350,000. As of December 31, 2012, only 48,000 of 350,000 had finished the certification process. Sheeeshh. No one is knocking down that door.

That leaves continuing education. The cost of those 15 hours could vary significantly. For many preparers, the number of returns prepared might not justify the cost of the education. Preparers were required to obtain their first 15 hours in 2012. After complaints, the IRS wound-up allowing preparers to make-up their 2012 hours in 2013.

Fueling the cynicism was the program’s open support by H&R Block and Jackson Hewitt. Those big guys are better positioned to comply with these new rules. The former CEO of H&R Block – Mark Ernst – was made deputy commissioner of the IRS and drafted many of the new rules for tax preparers. No conflict there, it appears. The investment firm UBS advised "the new regulations should help (H&R) Block" to put their smaller competitors out of business.

This is the United States, so you know someone sued. Three independent tax preparers did, with the assistance of the Institute for Justice.

The case is Loving v Internal Revenue Service, decided on January 23, 2013 by the District Court for the District of Columbia. Judge Boasberg wrote the opinion and he is – given that tax can be boring – quite the hoot. Let’s summarize what he said.

The Court immediately observed that the IRS was interpreting an 1884 statute as giving it authority for its actions. That statute gives the Treasury Secretary authority to regulate preparers who “practice” before it. The Court immediately noted that:

... attorneys, CPAs, enrolled agents or enrolled actuaries are otherwise regulated by the IRS and thus have no bone to pick with the new regulations.”

That leaves the other hundreds of thousands of preparers who are not attorneys, CPAs, EAs or enrolled actuaries. They comprise the 350,000 preparers we discussed previously. Sabina Loving, of the eponymous case, is a bookkeeper and tax preparer from Chicago. She is one of those 350,000.

So, is Sabina Loving “practicing” before the IRS?

Here is the Court:

Under ..., originally enacted in 1884, the Treasury Secretary has authority to regulate people who practice before the Treasury Department. This is so even though the casual student of history knows that the Sixteenth Amendment authorizing the modern federal income tax was not ratified until 1913.”

COMMENT: Heh.

           

Section 330(a) authorizes the Treasury Secretary to ‘regulate the practice of representatives.... In dispute is the IRS’s interpretation that tax-return  preparers are ‘representatives’ who ‘practice’ before the IRS.”

The IRS hurries through..., arguing that the statute is ambiguous because it defined neither ‘representative’ nor ‘practice’.... That simplistic approach will not fly, however.”

The Court goes on to observe that the statute refers to a “representative” advising and assisting persons in presenting their cases. Here is the Court again:

           

Filing a tax return would never, in normal usage, be described as ‘presenting a case.’ At the time of filing, the taxpayer has no dispute with the IRS; there is no ‘case’ to present.”

COMMENT: I like this judge. He likely has blown his chance to be on the Supreme Court, though.

With an invalid regulatory regime on the IRS’s side of the scale and a threat to the plaintiff’s livelihood on the other, the balance of hardship tips strongly in favor of plaintiffs.”

The Court permanently enjoined the IRS from enforcing its tax preparer program.

Yes, the little guy won, at least for the moment. In a motion filed January 24 with the Court, the IRS argued that it has a “reasonable likelihood” of winning its appeal and that the public will suffer “irreparable harm.” The IRS argued that it would incur “substantial costs” to restart the preparer program if the injunction is not lifted. The IRS also noted that that “thousands of return preparers who have already submitted their users fees would demand refunds, and the United States would likely face numerous lawsuits—including class action lawsuits.”

My Take: I am both happy and uncomfortable with the decision. I agree that the IRS went a bridge too far. I also understand that a rapidly-changing tax code requires ongoing education and that unscrupulous preparers fueling fraudulent deductions and tax credits have become a cottage industry.

I point out how much of this trouble has been caused by Congress introducing what most parties agree are welfare or transfer payments into the tax code. Congress could remove a lot of steam from unscrupulous preparers just by eliminating refundable tax credits, such as the earned income credit, for example. Here is a currently out-of-vogue idea:  why not have a national debate on whether the purpose of a tax system is to – you know – collect taxes?

The District Court will either lift its injunction or not. If not, expect an appeal from the IRS to the Circuit Court. It seems to me a tremendous expenditure of talent and resources by an over-tasked agency.