When 47 States Have Stricter Regulations On Barbers Than On Tax Preparers, Mistakes Are Going To Be Made

If you visit a legitimate barber, hairdresser, or cosmetologist in any state in the U.S., that person will have gone through some sort of state-mandated education, testing, and licensing procedure. Yet only three states have any substantive requirements for someone employed as a tax preparer. Not surprisingly, a new report finds that this lack of quality control results in a large amount of errors, fraud, and abuse.

This is a big problem, as around 70 million Americans used a paid tax preparer in 2012, and while your hair will grow back (and you can always wear a hat while you’re waiting), errors and fraud on your tax return can haunt you for a very long time. Making the matter worse for lower-income taxpayers, an estimated 60% of families claiming the Earned Income Tax Credit in 2012 paid someone who may have zero qualifications to do their taxes for them.

California, Maryland, and Oregon each have regulations regarding who can work as a tax preparer (New York, where 5.56 million people paid to have their taxes done in 2012, has a requirement that preparers register with the state, but no testing or licensing).

The only place in all states that you’re certain to find a (non-CPA or enrolled agent) tax preparer that has been tested on the subject are the unpaid volunteers at Volunteer Income Tax Assistance (VITA) sites.

The IRS attempted to create a system that would regulate all paid tax preparers by requiring registration, testing and mandatory continuing education, but it failed a legal challenge earlier this year when a U.S. District Court in Washington, D.C., ruled [PDF] that the IRS overstepped its authority under existing law.

A new report [PDF] from the National Consumer Law Center looks at various undercover “mystery shopper” tests that private and governmental organizations have used over the years to test the quality of being done in the tax preparation market.

While there are only a few national tax-prep chains — H&R Block, Jackson Hewitt, Liberty Tax Service being the largest — there are countless smaller operations or pop-up prep services being offered, especially in businesses that normally cater to financial needs of lower-income Americans. These are deemed “fringe preparers” and are of great concern for both the lack of accountability and some rather obvious conflicts of interest.

There is a company that claims to have partnership with thousands of used car dealerships that lets the business prepare customers’ taxes and apply the refunds to the down-payments for the vehicles they’re buying. According to the company’s website, “There is no experience required, and our web-based program was designed for use by someone who knows nothing about taxes. Also, our customer packets have a checklist inside to walk you through the whole process.”

Tax preparers who have a vested interest in the outcome of your tax return may be tempted to falsely inflate the value of your refund, and leave you to deal with the fallout if the IRS realizes things are not okay.

A 2008 study of RALs in Durham, NC, and Philadelphia found instances of tax error or fraud in nearly 1-in-4 tests.

One preparer told a customer to “ignore” $5,000 on his return in order to get a $3,000 refund instead of owing $100 to the IRS. Another tax preparer, who admitted to never having seen a Form 1098 (mortgage interest statement), and did not include $3,500 in unemployment benefits for the undercover couple. As a result, he calculated a refund that was $600 higher than it should have been.

A 2009 study in multiple cities found errors or fraud in 6 out 19 tests. A preparer in New York City tried to convince a tester to commit tax fraud by including a $2,000 figure for church donations she didn’t make (to a church she didn’t belong to). Oh yeah, he also tried to get her to lie and say she had a dependent to increase the value of her refund. Fudging on expenses is one thing (not that it’s right), but creating entire human beings out of thin air is probably going a little too far.

A tax preparer in Arkansas was both incompetent and unethical. First, he didn’t know the difference between a 1099 (miscellaneous income) and a church tithing statement. The preparer thought the 1099 was the tithing statement and deducted the money instead of counting it as taxable income. Then, when the mistake was pointed out to the preparer, he tried to convince the customer to keep it like that because it resulted in a higher refund… not realizing that the IRS had a copy of the 1099 info and would be expecting to see it when the return was filed.

“He said he had to ask because some people don’t want them to report additional income because it lowers their refund amount,” wrote the mystery shopper. “So he has to do what the customers tell him to do.”

It’s not just the fringe preparers who are preparing error-riddled returns. A 2011 undercover study found a pretty bad example of fraud at a Liberty branch in NYC.

The tester asked the preparer if the income reported on her 1099 form would alter her refund (correct answer: yes), but according to the study, “the preparer answered that they would ‘fix it.'”

The preparer and his boss then asked her questions about her bank account, her material assets, retirement accounts, and any debts she might have.

When the tester asked how any of this would “fix” the issue, the preparer responded that they needed to make it look like she was in debt and had no assets to sell. They then filled out a worksheet — which they didn’t show to the tester. They also improperly claimed Earned Income Tax Credit for one of her daughters and falsely stated that she did not know the location of her children’s father.

While the IRS attempt to rein in unregulated tax preparers failed because the agency might have overstepped its authority, the long-term solution is for lawmakers in D.C. to craft legislation that would make these requirements a law.

In its report, the NCLC uses the existing laws in California, Maryland, and Oregon (along with the aborted IRS regulation) to suggest three requirements for any legislation aimed at curbing tax-preparer problems.

1. Tax prepares must register with their designated state agency (with a few exceptions, like Certified Public Accountants).
2. Preparers must pass a basic competency exam to demonstrate their knowledge of tax law and practice.
3. They must also have 60 hours of initial education and 15 hours per year of continuing education courses on tax law, theory, and practice.

Obviously, the preparers who can’t currently be bothered to learn the basics are unlikely to do any of the above, but they would then be in violation of federal law. One may claim that these regulations will reduce consumer access to tax preparation, but we’d argue that this is like complaining that quack doctors can no longer operate out of the back rooms of your local saloon.

And the regulations in California have not put a crimp in the tax-prep business, with 9.3 million people paying to have their returns prepared in 2012. That’s nearly 4 million more than the state with the next highest number of people paying preparers for returns (New York, 5.5 million).

If you’re going to pay for tax preparation, your best bet is to find a CPA. The American Institute of CPAs has this tool for finding a CPA near you along with information on how you can verify they are indeed certified.

For people making $51,000 or less, the IRS makes tax-prep help available for free at its VITA locations.

Starting in January, the IRS will use this search tool to make public the locations around the country where people can go for free tax-prep help from VITA-certified preparers and the AARP will also begin updating this page in January with information on tax-prep for the elderly.

This Consumerist post from 2011 has some more information on other free tax-prep programs and how to prepare properly for when you get ready to have your return prepared.

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