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What is the Right Penalty to Combat Preparer Fraud?

Tax penaltyThe day after she gets her W-2s, my aunt arrives at my doorstep with her tax documents and an apology (I’ll explain that part later). It all started years ago when she got a notice saying she owed the Internal Revenue Service money. When my aunt signed her return, she was due a refund, so she couldn’t understand how the IRS was now saying that she could possibly owe anything at all.

Her situation was not as uncommon as I originally thought, a discovery I made while reviewing a draft bill that would allow the IRS to implement a new preparer fraud penalty with expanded collections authority. The bill was prompted by a finding from the National Taxpayer Advocate (2011 Annual Report to Congress, pages 558-561) that a small number of tax return preparers annually defraud taxpayers and the IRS by altering the taxpayers’ returns without their knowledge.  In many cases, preparers claim increased refunds – that the taxpayers were not entitled to receive – in order to pocket the extra money themselves.  We believe this is what happened to my aunt.  The bill would assess a penalty of 100% of the erroneous refund directly on the preparer and redirect IRS attention from the unsuspecting taxpayer to the fraudulent preparer.

My first thought was that these unscrupulous tax preparers need to be taught a bigger lesson – let’s triple the penalty, add criminal charges and prohibit the preparer from ever preparing returns again.   I know firsthand that the emotional toll on the victim is terrible (just ask my aunt who lost three nights of sleep before she asked me for help!).  Under current law, the IRS must go through the Department of Justice (DOJ) to get authorization to file a suit to pursue the fraudulent preparer.  This becomes a lengthy and costly procedure, especially for what may often be relatively small amounts.  This draft bill would allow the IRS to strike quickly and directly with a penalty to recoup their losses.  If the crime is egregious enough, the IRS can still go through the DOJ to pursue criminal charges under the PTIN regulations, which subject registered preparers to Circular 230. And if the IRS quickly recoups their loss, they can leave the taxpayer alone. 

I know penalties are meant to enhance compliance and deter inappropriate behavior.   Would a 100% penalty of the erroneous refund have been sufficient to really deter inappropriate behavior in this case? I don’t know. What I do know is that even now, my aunt won’t let anyone touch her tax information but me.  Every year she apologizes to me as she hands me her tax data.  She doesn’t want to be a burden.  I just chuckle and tell her (again) that I am happy to help, knowing it is just a little something I can do to give her peace of mind.  I also know that taxpayers who get these notices can contact the IRS to get resolution, but some, like my aunt, would prefer simply being asked for a copy of the signed return and be done with the whole thing.

(Note:  The AICPA’s Tax Practice Responsibilities Committee is reviewing the draft legislation but the AICPA does not have a position on the legislative proposal discussed in this blog.

Melanie Lauridsen, Technical Manager - Taxation, American Institute of CPAs. Melanie is the staff liaison for the AICPA’s Tax Practice Responsibilities Committee, Exempt Organizations Tax Technical Panel and the Tax Checklist Task Force. Her public accounting experience includes working for PriceWaterhouseCoopers, where she provided tax expertise to high net worth individuals (clients with an average net worth of 125 Million) and privately held companies, as well as public accounting at a regional firm.  Melanie has her Master’s degree in Accountancy from the George Washington University and her Bachelors in Economics from Brigham Young University.

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