“A well-educated and competent tax-return preparer can prevent inadvertent errors, possibly saving the taxpayer from unwanted problems later and the IRS from consuming valuable compliance resources.”
This statement is from the Internal Revenue Service (IRS) report that preceded the launch of the Preparer Tax Identification Number (PTIN) registration system (Return Preparer Review, Pub. 4832 (PDF), December 2009, page five). The new PTIN system requires all paid return preparers to satisfy certain competency standards, which for some will involve passing new IRS examinations. A review of how the IRS has structured the PTIN system sheds light on what the IRS appears to believe makes someone a competent tax-return preparer. This article provides such a review and offers suggestions for what the competency examinations should include in order to help the IRS meet its goals of better serving taxpayers and helping to make the IRS more efficient.
Individuals who meet the definition of a “tax-return preparer” (Reg. §1.6109–2), must have a PTIN generally in order to prepare or assist in the preparation of all or a substantial portion of a federal tax return or claim for refund. A few types of returns that appear on a list maintained by the IRS do not require the preparer to have a PTIN (Notice 2011–6).
To obtain a PTIN, individuals must meet the following requirements:
- Fall into one of the following categories:
- Attorney, CPA or Enrolled Agent (EA).
- "Registered tax-return preparer" (RTRP). RTRPs must pass the competency exam for the types of returns they prepare and complete at least 15 hours of continuing education (CE) each year as specified by the IRS. The IRS expects to have the first examination ready in mid–2011.
- Supervised, non-signer (Notice 2011–6).
- Preparer of returns not covered by a competency examination (Notice 2011–6).
- Pay the annual registration fee.
- Satisfy a “suitability check” that considers prior felony convictions.
- Be current with their personal- and business-filing obligations and current with tax payments or have a payment-arrangement plan in place.
For more information on the IRS registration system and links to IRS information, see Yet More Paid-Return Preparer Categories!.
What IRS PTIN Guidance States or Implies About “Competency”
Various elements of the registration system and statements made by the IRS help shed light on what the IRS appears to believe makes someone a competent tax-return preparer. Several of these items are described below:
Tax forms vs. substantive law: The IRS has been inconsistent in describing the level of detail a preparer should have. The IRS describes the expected content of the competency exams by providing lists of tax forms without noting any IRC sections or specific tax rules (Pub. 4832 (PDF), pages 35 and 53). Also, the IRS “study kit materials” to prepare to become an EA is a list of IRS publications plus Circular 230.
In contrast, the IRS website — “Responsibilities of a Tax-return preparer — Filing Season 2011” states that preparers “are expected to be knowledgeable in tax law” and must review “applicable tax law to ensure all income has been reported on the return and only credits, expenses and deductions allowed under the Internal Revenue Code are taken.” As part of required due diligence, preparers must know “the underlying substantive law affecting an item of income or deduction.” This text matches that of a letter sent to 10,000 preparers in late 2010 as part of the “federal tax compliance check” program as provided for at Reg. §1.6109-2(f).
It is puzzling why the IRS would stress the need to know substantive law in reminding preparers of their responsibilities, but then not describe the EA or competency tests in terms of the IRC sections covered. While instructions to IRS forms, as well as IRS publications, are often quite detailed, they rarely mention IRC sections or other primary authority, such as court cases.
Also, forms and IRS publications are not considered “authority” for purposes of having “substantial authority” to avoid §6662 or §6694 penalties
By relying on forms and publications exclusively, preparers risk preparing incorrect returns as illustrated in the recent case Nievinski, T.C. Summary Opinion 2011–10. In this case, the taxpayer’s accountant included the $8,000 first-time homebuyer credit (FTHBC) on the return. However, the taxpayer’s home was purchased from a relative so no credit was allowed per IRC §36. The taxpayer argued that FTHBC documents from the IRS (Form 5405 (PDF), instructions and Publication 4819 (PDF)) did not mention that homes purchased from relatives do not qualify for the FTHBC. Holding for the IRS in disallowing the FTHBC, the court noted that the form and publication provide “general instructions” and “do not purport to provide all rules and limitations applicable to the FTHBC.”
Professional licensure: CPAs and attorneys are exempted from testing and mandatory CE. The rationale is that they are already subject to regulation by their state and the IRS (via Circular 230 (PDF)). In addition, these individuals have passed rigorous examinations to gain licensure. However, these exams do not include the same quantity or detail of tax questions as the EA exam (see sample EA exam questions from the IRS and exam information from Prometric). Also, while undergraduate accounting curriculum typically includes at least one tax course, law school curriculum does not. The CPA exam covers a variety of tax topics, while bar exams generally exclude tax questions (see AICPA CPA exam content information and New York State Bar Examination information (PDF)).
Despite the fact that CPA exams do include tax questions, CPAs are not always viewed as tax experts, likely because the key purpose of the designation ties to financial statements and auditing. In Friedman, TC Memo 2010–45, the judge stated that just because the preparer was a CPA did “not necessarily make him a competent tax adviser.”
The testing and CE exemptions for CPAs and attorneys likely indicates that the IRS believes the effort devoted to gaining licensure, along with the existence of state regulation and ethical obligations reduces the likelihood of filing incorrect returns. The IRS has noted though, that it will monitor CPAs, attorneys and EAs to see if future testing is warranted (Pub. 4832, pages 34 – 45).
EA designation: EAs are exempt from competency tests and mandatory CE. However, EAs are already required to take a test on the federal tax law (or have certain IRS experience) and complete 72 hours of CE every three years (IRS EA Information).
The fact that the IRS did not create a system in which everyone had to be a CPA, attorney or EA to be a preparer indicates that they do not expect an RTRP to meet the exam rigors imposed upon an EA. An RTRP will not have the same practice rights as an EA, thus making a less comprehensive test a logical approach.
Tax Prep Software
An overly complex tax law increases the likelihood of incorrect returns. Frequent changes to the law, temporary provisions and varying effective dates, increase the risk of making mistakes. To track effective dates of rules, track carryover items and assist with complicated computations (such as the earned income tax credit or alternative minimum tax (AMT)), tax preparation software is necessary for most returns. Yet, requirements to obtain a PTIN do not ask applicants how they plan to prepare returns or to rate the complexity of the returns they prepare.
Suggestions for the Competency Examinations
Based on what the IRS has stated about the new registration system and its goals, the following questions would help the IRS determine who should be an RTRP and possibly represent questions it should ask of all preparers.
- How did you prepare to become a tax-return preparer?
- How do you find answers to tax questions?
- How do you access substantive law?
- What tax-preparation software do you use? If none, explain why.
- What is the review process for the returns you prepare?
In addition, questions on Circular 230 and key penalties such as §§ 6662, 6694, 6695, 6713 and 7216 should be included.
The competency exams will provide insights on what the IRS views as a competent tax-return preparer. That view will be tested when the IRS and Treasury later check whether compliance rates improved with the new system. In creating the exams, the IRS must also consider that paid return preparers must be available for even relatively simple returns. Thus, they must also consider tying tests not just to the type of taxpayer (such as 1040), but also to the difficulty range of the returns. Time will tell whether the IRS can identify who is a competent tax-return preparer.
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