Amici File Brief With D.C. Circuit in Favor of Regulation of Return Preparers

B. Rulings under review. References to the rulings at issue appear in the Brief for the Defendants-Appellants.

C. Related Cases. To the best of their knowledge, counsel for the amici curiae are not aware of any previous or pending related cases in this Court.

DATED: April 5, 2013

Pursuant to D.C. Circuit Rule 29(d), the undersigned counsel certify that they are submitting a separate brief from other amici curiae in this case in support of Defendants-Appellants due to the uniquely specialized nature of each amici's distinct interests and expertise. This brief is submitted by advocates for low-income consumers and taxpayers, arguing for their interests and explaining how they have been victimized by the incompetence and abuse of paid tax preparers. Our understanding is that the other amicus curiae brief is being filed by five former IRS Commissioners based on their experience heading that agency, and focuses on the issue of the needs for efficient tax administration.

Amici Curiae National Consumer Law Center (NCLC) possesses a unique expertise and interest because of its many years of work on protecting consumers from abuses by the paid tax preparation industry. NCLC coordinated several of the mystery shopper tests discussed in this brief that revealed rampant and widespread incompetence and fraud amongst paid tax preparers.

Amicus Curiae National Community Tax Coalition (NCTC) advocates for the interests of low-income working families to secure greater financial stability and economic opportunity. Many members of NCTC are nonprofits that provide free tax preparation to low-income taxpayers, and as a result have extensive experience with the abuses perpetrated by paid preparers on these taxpayers.

Given the different purposes and expertise of the amici curiae, NCLC and NCTC certify that filing a joint brief would not be practicable.

DATED: April 5, 2013

The Illinois-based National Community Tax Coalition (NCTC) was founded in 2002 as a project of the nonprofit Center for Economic Progress (CEP) to focus on strengthening the financial security of low- to moderate-income working families, particularly through tax-time activities such as community-based, volunteer-assisted help with preparation and filing of tax returns. NCTC assumed limited liability corporation status in 2012 and is in the process of obtaining its own, nonprofit status as a tax-exempt organization under the provisions of § 501(c)(3) of the Internal Revenue Code. It has no parent corporation and no publicly held company owns 10% or more of its stock.

DATED: April 5, 2013

Amicus curiae NCTC is the nation's largest, most comprehensive membership organization for community-based organizations offering free tax preparation and financial services to low-income working families. For its 2,400-plus members, NCTC is a critical source for information, training and resources; networking opportunities; and advocacy tools. NCTC and its members are voices united in the fight for increased access to community Volunteer Income Tax Assistance (VITA) programs; fair state and federal tax policies; and honest financial services. Everything NCTC does is focused on the goal of helping hardworking, low-income families to secure greater financial stability and economic opportunity. To further this goal, NCTC strongly supports preparer regulation. Volunteers for NCTC member organizations and other VITA programs have long faced fundamental training and certification requirements. IRS, Pub. 1084 -- IRS Volunteer Site Coordinator's Handbook 29 (Oct. 2012) (requiring that all "[v]olunteer preparers must pass at least the basic certification test. A minimum score of 80% is required for each certification test"). NCTC and its member organizations have gladly implemented these requirements for many years.

Unfortunately, fraud and incompetence are rampant in the paid preparation industry, especially by fringe preparers. "Mystery shopper" testing by consumer and advocacy groups, as well as government agencies, demonstrates high levels of errors and outright fraud. In some cases, the majority of returns in the testing were incorrect or fraudulently prepared, often leading to inflated refund claims.

On their own, enforcement actions by the IRS and other government agencies are simply inadequate to address this massive, rampant level of fraud. There are simply not enough resources to go after all of the bad actors. Preparer licensing is the only way to ensure that both consumers and the U.S. Treasury are adequately protected.

A tax return is probably the most critical financial interaction that a consumer has with the federal government during the year. A wrongly prepared return can lead to dire economic consequences, or even criminal sanctions. And for many consumers, especially recipients of the Earned Income Tax Credit (EITC), their tax refund is the single largest sum of money that they receive all year.

For consumers who rely upon paid tax preparers, their financial lives -- and their most sensitive financial information -- are literally in the hands of this industry's practitioners. Yet if the District Court's decision is upheld, there will be no regulation for these critical actors in the vast majority of states, with only a handful of exceptions.¹ There will be no minimum educational, training, competency, or other standards for the businesses that could determine the consumer's financial fate for the coming year. More regulation is required of hairdressers in many states.

Informed by years of experience with the abuses committed by certain paid preparers, advocates for consumers and taxpayers have long supported IRS regulation of tax preparers. Amici believe that ensuring tax preparers are competent, licensed, and bound by a code of ethics represents the minimum that should be done to protect consumers, who rely on this industry for advice and direction.

Amici disagree with the argument that IRS regulation of paid preparers harms consumers by encumbering the small businesses that engage in tax preparation. Opponents claim that regulation of paid preparers creates burdens for small businesses, which give rise to costs that are, in turn, passed along to consumers. However, the interests of consumers in obtaining competent, accurate and ethical tax preparation assistance far outweigh any increased marginal cost that is alleged.

Furthermore, IRS preparer regulation will not create greater costs to consumers. Preparers' compliance costs are minimal -- for example, less than $65 for a Preparer Tax Identification Number and less than $120 for a competency exam. IRS, Registered Tax Return Preparer Test -- Candidate Information Bulletin, Apr. 16, 2012, at 2-3. These costs are dwarfed by the hundreds of dollars in fees that some paid preparers charge. Also, it is worth noting that, tax preparation fees are entirely non-transparent. This is one of the few services for which consumers typically cannot obtain a price before they incur the service. Tax preparers assert that they charge by the tax forms required in preparing a particular return, and cannot predict which forms will be generated until they actually finish the preparation process. Thus, consumers cannot obtain quotes to comparison shop. See Chi Chi Wu and Jean Ann Fox, NCLC and Consumer Federation of America, The Party's Over for Quickie Tax Loans: But Traps Remain for Unwary Taxpayers 14-16 (Feb. 2012), available at http://www.nclc.org/images/pdf/pr-reports/report-ral-2012.pdf.

As a result of this lack of transparency, low-income consumers face tax preparation fees that are already very high, and inflated, in many instances. Mystery shopper testing, discussed below, has documented preparation fees of $400 or $500 in some cases. Government enforcement actions also have revealed fees of up to $1,000 for as little as 15 minutes worth of work. See Complaint, United States v. Fesum Ogbazion, Civil No. 3:12-cv-95 (S.D. Ohio. Mar. 28, 2012), ¶¶ 33-34. Thus, preparer regulation has more potential to lower costs than to increase them, by improving transparency and reducing abuses.

Finally, competent and ethical small-business tax preparers actually benefit from IRS regulation. Basic standards are important to protecting the integrity of an industry. Commercial preparers who are honest and ethnical, investing in training and education, are hurt when their competitors cut corners, commit outright fraud, and give tax preparation a bad name.

B. Fringe Preparers Present Major Risks to Consumers

The tax preparation industry consists of three larger commercial chains (H&R Block, Jackson Hewitt, and Liberty Tax Service), a number of smaller chains, and many thousands of small or solo independent preparers. See Chi Chi Wu and Jean Ann Fox, NCLC and Consumer Federation of America, RALs, Tax Fraud, And Fringe Preparers 11 (Feb. 2009), available at http://www.nclc.org/images/pdf/high_cost_small_loans/ral/2009-ral-appendix.pdf.

There is a wide range of independent preparers, from licensed professionals -- such as attorneys, enrolled agents, and certified public accountants -- to businesses that primarily deal in another line of goods and services. Among the latter, there is a segment that is highly problematic -- the fringe preparer.

Fringe preparers include businesses that are historically associated with the exploitation of consumers, such as payday loan stores, check cashers, and used car dealers. Some retailers, such as jewelry and furniture stores, also act as fringe tax preparers.

In June 2008, the Government Accountability Office (GAO) conducted mystery shopper testing that focused on identifying types of businesses where refund anticipation loans (RALs) were marketed. Government Accountability Office, Refund Anticipation Loans, GAO-08-800R, June 5, 2008, available at http://www.gao.gov/new.items/d08800r.pdf. Of the 27 paid preparers subject to testing, 13 were located in businesses that target low-income consumers, such as check cashers, payday loan vendors, rent-to-own stores, and pawn shops. Nine of the preparers in the GAO study offered incentives to encourage tax customers to spend their refunds on the businesses' primary goods and services. For example, an auto dealer told GAO investigators that if they didn't have enough money for the down payment on a car, they could get their taxes done by its tax preparer and use the refund as a down payment. Another preparer operated out of a shoe store, and offered a free pair of shoes with tax preparation.

A fundamental problem with fringe preparers is the questionable quality of tax preparation by a business that specializes in goods and services other than tax preparation. The mystery shopper tests discussed in the next section found several instances of incompetent tax preparation by fringe preparers. One particular example was an Alabama small loan company that prepared a tester's return to show a $6,247 refund when the tester actually owed $112 to the IRS. Impact Alabama, Impact Alabama Undercover Investigation of Commercial Tax Preparers in Alabama Results and Analysis, Jan. 2009.

There are even third-party vendors that specialize in providing software and back office support to fringe providers. One example is Tax Max, which specifically caters to used car dealers. Tax Max advertises that it is "the leading tax consultant in the industry with a portfolio of over 3000 car dealerships nationwide." Tax Max, About Us, at https://www.taxmax.com/TRSTaxMax/AboutUs.aspx. Tax Max informs car dealers that "[t]here is no experience required, and our web-based program was designed for use by someone who knows nothing about taxes." Tax Max, FAQ, at https://www.taxmax.com/TRSTaxMax/FAQ.aspx

C. Abuses Uncovered by Mystery Shopper Testing

As a result of the lack of regulation, abuses by tax preparers have flourished over the years. Mystery shopper testing by consumer and other advocacy groups have found examples of incompetency and fraud by preparers -- a disturbingly high number, given the limited number of tests conducted. Preparer regulation is necessary to prevent this incompetence and fraud by ensuring that paid preparers meet minimum standards.

Some of the examples of this incompetence and fraud are:

The worst example involved a preparer at a small loan company in Durham, N.C., where the tester ended up having to withdraw because of the seriousness of the incompetence. According to this tester:

Essentially, this preparer had given the tester advice to commit tax fraud. Furthermore, it turns out that this tester had both dividend income plus profits from the sale of stock shares. The preparer completely missed the second source of income from the sale of stock shares. This tester concluded:

In Philadelphia, a Jackson Hewitt preparer failed to include $3,500 in unemployment income in the return of a married couple who were testers. This omission resulted in a refund that was $600 greater than the couple was entitled to, and required them to file an amended return. This preparer also had never seen a mortgage interest Form 1098 and didn't know how to handle it.

An independent preparer in Philadelphia made numerous errors in dealing with education-related tax credits. Among other mistakes, the preparer incorrectly treated a taxable education award as though it were an exempt scholarship, resulting in an additional tax liability of $66 and a loss of $134 worth of Earned Income Tax Credit. Ultimately, the tester was forced to file an amended return.

At least two of the preparers in this 2008 testing were businesses that primarily sold other goods or services. One preparer was a small loan lender/payday lender, and the other preparer was in a store that primarily operated as a gift shop.

The most disturbing example came from a tester in New York City who described how the preparer, when realizing the tester would receive only a $1,000 federal refund and would owe state taxes, began making up deductions:

Another example of attempted tax fraud by a preparer came from a tester in Arkansas who described how:

Other testers reported either fraud or incompetent preparation such as:

• A tester in New York reported that a Jackson Hewitt preparer advised her not to include $300 in income for which the tester had not received a 1099 form.

• A tester who went to a small chain in Arkansas later had her tax return reviewed by a VITA volunteer. The VITA preparer found numerous errors, resulting in the tester being required to filed an amended return and reimburse the IRS $822.

Finally, there were several violations of requirements for tax preparers to provide certain documents to the taxpayers. The IRS Code requires preparers to provide a copy of the tax return to the taxpayer no later than the time that the taxpayer signs it. I.R.C. § 6107(a). Yet three of the 19 preparers did not provide a complete copy of the tax return at the time of filing, but instead withheld the copies until the refund was received and the preparer was paid from the refund.

IRS regulations also require preparers to provide certain privacy forms if they sell a financial product to a taxpayer. 26 C.F.R. § 301.7216-3. Nine of the preparers did not provide the required privacy forms.

The most disturbing example in the 2011 testing came from a New York tester who went to a Liberty Tax office. The tester described how the preparer could not initially handle a 1099 form that she had received for a credit card debt that had been settled:

In addition, this preparer improperly claimed the EITC for one of the tester's daughters. Finally, the tester observed that the preparer reported on the tax form that the tester did not know the whereabouts of her children's father. However, the preparer never asked her that question, and the tester does know where her children's father is.

Another example involved a Jackson Hewitt preparer in New York who gave some questionable advice to a tester who owed money to the IRS. The preparer told the tester that she "needed to get a kid" in order to get a bigger tax refund.

A third tester reported that she informed the preparer that she was no longer a student, but the preparer incorrectly claimed the New York State tuition credit. The tester also reported that the preparer incorrectly inputted student loan interest, misspelled her address, and pressured her to sign the return without explaining the paperwork.

In North Carolina, a Jackson Hewitt preparer erroneously failed to claim Head of Household status for a tester. As a result, the tester's refund was smaller by $269 for her federal refund and $84 for her state refund, and she was forced to file an amended return.

Finally, three of the nine preparers did not provide a complete copy of the tax return or required privacy forms to the testers at the time of filing, in violation of I.R.C. § 6107(a) and 26 C.F.R. § 301.7216-3.

In this testing, 10 of the 12 taxpayers encountered problems with inaccurate, illegal, or unprofessional behavior. In seven cases, the tax preparation process was stopped or changed to avoid having the paid preparer file an inaccurate tax return.

One of the worst errors was a preparer's failure to include unemployment insurance benefits as taxable income. This omission incorrectly qualified the taxpayer for the EITC, which could have significant ramifications. If the IRS caught the omission of the unemployment income, the refund would be lowered and the EITC would be denied. Moreover, a taxpayer can be disallowed from taking the EITC for 10 years if the credit is claimed but the taxpayer is later determined ineligible. This taxpayer was required to file an amended return. This same preparer lacked the knowledge to properly handle dividend income. This preparer also told the tester: "Oh, they are just forms. If I get $4,000, I am not going to ask a lot of questions. I just want it!" Id. at 22.

Two preparers failed to report qualified student grant funds as taxable income. Both preparers became confused about Form 1098-T, which reports income from tuition. In the case of the first tester, her scholarship amount exceeded the qualified expenses and therefore the tester was required to report some income from the scholarship. The preparer for the first tester asked her supervisor what to do, and the supervisor incorrectly responded that the tester didn't have to report the income.

The second tester had a 1098-T that listed $662.65 in line 4 (adjustment from prior year). The preparer became confused and stated "Technically I think I'm supposed to subtract $662.65 from $2,235, but I'm not sure. We can probably just leave it out because it's highly unlikely that IRS can track it." Id. at 7. Before completing the return she readdressed the issue again, asking the taxpayer for permission to just ignore the $662.65.

Another tax preparer indicated she used her own bank account to receive direct deposits of taxpayers' refunds, which is prohibited under the IRS Code. I.R.C. § 6695(f). A tester asked this preparer what she did if someone could not afford to pay upfront. The preparer responded: "I just put my account number and routing number on the return and write the client a check when their refund comes in. I take my fee out before I write the check." Id. at 10.

One tax preparer encouraged tax fraud by making up frivolous expenses for the Schedule A form. This preparer included numerous expenses for which taxpayers do not usually qualify for a deduction, i.e. clothing expenses, personal cell phones (calculated for 99% business use), and numerous commuter expenses that the taxpayer was not eligible to claim. She asked questions such as, "about how much did you spend on clothing?" and then recorded answers without asking for records of expenses. This same preparer told the tester, who was a tribal member, that he did not have to pay state income tax on income earned from employment not on his reservation, which was incorrect under New Mexico law. Id.

Other problems included preparers who:

• showed a lack of knowledge regarding how to properly file a Schedule C business return.

• told a tester that federal employees do not pay Social Security taxes because they have a good retirement plan (this has not been the case since 1984).

• didn't know how to handle paperwork associated with a rollover of a Roth IRA.

Once again, this testing revealed poor quality service provided by tax preparers. All but one of the testers encountered some issue when filing their taxes. FDNI concluded "[w]hile our sample of participants was small, the frequency of these errors calls into question how many Native American taxpayers, and moreover, how many taxpayers across the country are being overcharged and underserved by paid tax preparers." Id. at 3.

In one example, an inexperienced preparer miscalculated the total refund for the tester. A FDNI staffer who accompanied the tester noted:

Since all of the testers were Native American, they potentially qualified for the New Mexico state exemption for this community. Yet several preparers skipped over this step. In one case -- in which the tester was eligible for this exemption, yet the preparer missed it -- the tester had $571 of state withholding from which she might have received some refund.

Finally, six of the 10 preparers did not provide a copy of the tax return to the testers at the time of signing, in violation of I.R.C. § 6107(a).

The testing by Impact Alabama found that 11 of the 13 preparers nonetheless incorrectly claimed the EITC. In addition, 10 preparers did not report income from other jobs such as babysitting; nine preparers did not report interest income; and 11 allowed testers to claim "head of household" status without being qualified for it.

None of the testers should have qualified for refunds, but each preparer calculated a refund ranging from $65 to $6,247. Five preparers calculated a refund of $6,247 for a taxpayer who actually owed $112 to the IRS. These five preparers included a fringe preparer (a finance company), a Mo' Money Taxes outlet, and three other independent preparers.

The TIGTA testers found that only 11 of the 28 preparers prepared an accurate tax return. The other 17 preparers prepared the returns incorrectly. Six of these 17 preparers produced returns that contained misstatements and omissions TIGTA considered to have been willful or reckless. These six preparers engaged in conduct such as adding or increasing deductions without the testers' permission -- in some situations after the testers had questioned whether they were entitled to receive the deductions. Examples included:

• When informed by the tester that s/he paid for babysitter expenses in cash, the preparer increased the child care expenses beyond what the tester stated s/he paid. In addition, the preparer instructed the tester to tell the babysitter to file a Schedule C with the inflated amount and deduct expenses for operating a home business equal to the inflated amount. The preparer also offered to change the expenses back to the original (real) amount if the babysitter did not agree to change his or her records. The preparer's actions increased the tester's refund by more than $325.

• A tester completed an information worksheet showing children living in the home for less than one-half of the year. The preparer stated that he or she was going to show on the tax return that the children lived in the home with the tester for a full 12 months. The decision erroneously changed the tester's filing status from Single to Head of Household, increased the dependency exemptions, and qualified the tester for the Child Tax Credit and the EITC. The net effect was to increase the refund from $100 to approximately $6,000.

• Even though a tester informed the preparer s/he had no charitable contributions, the preparer included contributions on the return and did not inform the tester that they were being added. The preparer also added a deduction for property tax for a car without the tester's assertion or documentation. The effect was a refund of more than $200, when the refund should have been less than $140.

• 8. Testing by the Government Accountability Office (GAO)

These inflated refunds resulted from preparers not reporting business income in 10 of 19 cases and claiming an ineligible child for the EITC in five out of the 10 applicable cases.

D. Abuses Uncovered by Government Enforcement Actions

Enforcement actions by the USDOJ and state regulators have found numerous instances of fraud committed by preparers. Some of the most prominent actions include:

The USDOJ brought the civil enforcement action against the five Hewitt franchisees for preparing fraudulent tax returns that falsely claimed $70 million in tax refunds. The USDOJ alleged that the owners and managers of these franchisees created and fostered an environment in which fraudulent tax return preparation was encouraged and flourished. Examples of fraud alleged by the USDOJ include filing false returns claiming refunds based on phony W-2 forms; using fabricated businesses and business expenses on returns to claim bogus deductions; claiming fuel tax credits in absurd amounts for customers clearly not entitled to any such credits; and massive fraud related to EITC claims.

E. Abuses Described in News Media Articles

Over the years, Amici have collected dozens of media articles describing instances of fraud and abuse by tax preparers. The following are just a few summaries of some of the most recent examples.

F. Abuses Uncovered by Low-Income Tax Clinics

Amici provide a few recent examples of preparer fraud and abuse collected by attorneys at Low-Income Tax Clinics (LITCs). These examples typify the preparer fraud that LITC attorneys have observed in reviewing client cases.

G. Why Enforcement Actions Alone are Not Adequate to Prevent Preparer Fraud and Abuse

The massive amount of fraud, incompetence, and abuse in the tax preparation industry is astounding. Just a handful of limited mystery shopper tests have consistently uncovered numerous instances of these problems, indicating that such problems are widespread and common in the tax preparation industry. This is not an anomaly or a handful of bad apples. There is an enormous level of corruption across the entire industry. The IRS regularly ranks "preparer fraud" highly among its "Dirty Dozen Tax Scams." See, e.g., IRS, IRS Releases the Dirty Dozen Tax Scams for 2013, Mar. 26, 2013.

Bringing enforcement actions one-by-one is simply inadequate as a response to this problem. While it would get rid of a few bad actors, relying on this approach, alone, ignores tens of thousands of other violators. It is akin to only treating a skin lesion when the related disease has invaded a patient's entire body.

Protecting individual taxpayers and the U.S. Treasury from this massive amount of fraud and abuse demands some fundamental, common-sense standards. It calls for establishing baseline considerations for the practitioners who handle consumers' most sensitive information. It is not too much to ask that commercial preparers obtain basic training, pass competency exams, and seek continuing education to stay current on ever-changing tax laws.

DATED: April 5, 2013

¹ The exceptions are California, Maryland, New York, and Oregon. See Cal. Bus. & Prof. Code §§ 22250 to 22259; Md. Code §§ 21-101 to 21-502; N.Y. Tax § 32; and Or. Rev. Stat. §§ 673.605 to 673.740. In addition, some states require registration of persons that offer RALs. See National Consumer Law Center, Model Refund Anticipation Loan Act, Appendix A (Dec. 2008) (summary of state RAL laws), available at http://www.nclc.org/images/pdf/high_cost_small_loans/ral/model-refund-anticipation-loan-act.pdf.