The federal government’s attempt to rein in the virtually unregulated tax-preparation industry was dealt a serious blow this morning after a federal appeals court upheld a lower court ruling that the IRS overstepped its authority by trying to require registration and testing for all tax preparers.

In 2011, the IRS created a system that would require all non-CPA tax-preparers to register and demonstrate their mastery of the topic through testing and continuing education courses. This change would apply to some 700,000 preparers in the U.S.

Before the program could launch, those opposed to the regulations sued the IRS in a U.S. District Court in Washington, D.C., contending that the agency had not been given authority by Congress to institute such far-reaching rules, as its argument for claiming it had such authority was based on an 1884 statute that allows the IRS to “regulate the practice of representatives of persons before the Department of the Treasury.”

In early 2013, the court sided with the plaintiffs and stopped the IRS from rolling out these requirements, saying that whatever good was intended by the regulation effort is negated by the fact that the IRS didn’t have the authority to enforce these rules.

The IRS appealed that ruling, but today the Circuit Court of Appeals in D.C. upheld the previous ruling [PDF].

In its case, the IRS argued that paid tax-preparers are representatives of persons in their dealings with the Treasury. However, the court saw things differently, saying that preparers assist taxpayers but don’t necessarily represent them:

“The term ‘representative’ is traditionally and commonly defined as an agent with authority to bind others, a description that does not fit tax-return preparers… Put simply, tax-return preparers are not agents. They do not possess legal authority to act on the taxpayer’s behalf. They cannot legally bind the taxpayer by acting on the taxpayer’s behalf. The IRS cites no law suggesting that tax- return preparers have legal authority to act on behalf of taxpayers.”

The court cites existing IRS regulations stating that in order for someone to legally represent a taxpayer to the agency, that rep must formally obtain the taxpayer’s power of attorney, “something tax-return preparers do not typically obtain when preparing returns.”

It also points out that the IRS requires that taxpayers must still sign and submit their tax returns even when using a paid tax-preparer.

“The IRS is surely free to change (or refine) its interpretation of a statute it administers,” writes the court. “But the interpretation, whether old or new, must be consistent with the statute.”

The appeals court admitted that it may not be a bad idea to regulate taxpayers:

“It might be that allowing the IRS to regulate tax-return preparers more stringently would be wise as a policy matter. But that is a decision for Congress and the President to make if they wish by enacting new legislation.”

A 2013 report from the National Consumer Law Center found that tax preparers are effectively unregulated in 47 states, with only California, Maryland, and Oregon having any sort of requirements for being a paid preparer.

In those 47 other states, there are more regulations on being a barber than there are for being a tax-preparer.

The report also found numerous accounts of incompetence and fraud among ill-prepared tax-preparers, especially those marketing their services to lower-income Americans. Given that 70 million Americans use paid preparers every year, this is of some concern.

NCLC attorney Chi Chi Wu tells Consumerist that this morning’s appeals court ruling is “disappointing, but not unexpected. Today’s decision makes it even more important for state governments take action and pass laws regulating tax preparers, since now only the states or Congress have the power to do so.”

Depending on your age and income, there are ways to get free tax-preparation help from people who know what they’re talking about. The IRS’s VITA program provides free tax-prep assistance for people earning $52,000 or less, and its Tax Counseling for the Elderly (TCE) program assists those 60 years of age or older. Click here for information on how to find a VITA or TCE site near you.

The AARP also offers its free Tax Aide program to low/moderate-income individuals, with a focus on those 60 years of age and older. Click here for more info on that program.

Want more consumer news? Visit our parent organization, Consumer Reports, for the latest on scams, recalls, and other consumer issues.