Bad Tax Prep Is A Symptom, Not the Disease
Nice to hear the IRS is finally going to regulate tax preparers. For years, fly-by-night tax prep outfits have been doing, how shall we say, a less-than-stellar job filling out returns for the confused and vulnerable. But cracking down on those seasonal shysters who abuse the system is only attacking a symptom of the real disease, which is our insanely complex tax code.
Making preparers register with the IRS and take a test is a good idea. But it isn’t going to do very much to close the tax gap, as Senate Finance Committee chair Max Baucus (D-Mont) and ranking Republican Chuck Grassley (R-Iowa) seem to believe. And, surprisingly enough, it may not even result in more accurate returns.
Last October, TPC visting fellow Larry Lokken noted in TaxVox that unregulated preparers hardly have a monopoly on errors. In fact, one study showed that highly-trained and registered enrolled agents often make more mistakes than other preparers. The truth is, no one can agree on the “right” answers for an even moderately-complicated return. Give 10 honest and highly-trained accountants or lawyers the same information, and you are likely to get back 10 different returns.
The real solution, as Baucus and Grassley well know, is a tax return that people can understand and does not scare the hell out of them. And they don’t need to create the proverbial return-on-a- postcard to fix the problem. A few simple changes could make filing vastly easier for many low-income people who are frequent victims of ill-prepared (and worse) preparers.
For instance, my TPC colleague Elaine Maag suggests Congress could drop the asset test for the Earned Income Credit. The child credit and the dependent exemption are based on income. There is no reason why the EITC should not be as well. Similarly, a few years ago Congress simplified the definition of a child. That was a big step, but it did not go far enough. A child qualifies for the EITC and the dependent exemption if she is under 19 or under age 24 and a student. But she qualifies for the child credit if she is younger than 17. Want to protect low-income filers from being abused by bad preparers? Make it easier for them to do their own returns.
Congress could also stop adding above-the-line deductions for those who don't itemize. This has become a troubling fad lately, and it only does more to complexify life for those taking the standard deduction which, after all, was supposed to make their lives easier.
We are all appalled at the way taxpayers are abused by tax prep. But even outfits such as Mo Money Taxes, started by a jewelry wholesaler and a FedEx worker, are not the real problem. The tax code is the problem. And Congress should fix it.
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My last comment on the topic: I disagree with Howard. Bad tax prep is a disease.
One of the IRS' proposals on return preparers should get more attention: a proposal to commit more IRS resources to policing preparers and the preparer industry. Although the proposed licensing regime will help, the best and most complete long-run solution to the preparer problem is the slogging process of rooting out bad preparers, one at a time, and sending clear signals through actions, as well as words, that incompetence and willful misconduct by preparers will not be tolerated. It's not pretty, but it's probably the only way.
Another issue that the IRS should consider in developing its proposals is the definition of “tax return preparer.” Under current regulations, this term refers to the individual with primary responsibility for the accuracy and completeness of a return. This makes sens under the current rules because the function of this term is to identify the individual to whom the IRS should look if a return evidences preparer incompetence or misconduct.
This definition is less clearly appropriate for the system that the IRS is proposing, which would only apply to “tax return preparers.” Suppose a return preparation firm has 50 employees and prepares 10,000 returns annually. Should it be sufficient if just one of these employees satisfies the registration, testing, and education requirements and signs all 10,000 returns as preparer? If it is possible for one person to assume primary responsibility for 10,000 returns, it may be appropriate to extend licensing requirements beyond those having primary responsibility.
I think the IRS proposals — to require every paid preparer to register with the IRS, pass a competency exam, and complete 15 hours of continuing education annually — are good. The hard part is going to be in the implementation of the proposals. Poor implementation could make the problem worse, rather than better.
In its report, the IRS estimates that there may now be more than a million people preparing tax returns. More than 80 million returns annually are signed by paid preparers. Bringing a million preparers into this system is going to be a real challenge.
The IRS proposals will inevitably drive many preparers out of business. Most of those leaving will not be a loss to the tax system. However, if too many of them leave, many of the 80 million taxpayers using paid preparers will be unable to get this service at a reasonable cost.
Another risk is that the new system will drive much of the preparer world underground. Anyone who prepares a tax return for pay must sign it as preparer. My guess is that compliance with this requirement is very high. If a preparer is not qualified under the proposed system, he or she may continue preparing returns for pay, but just not sign them. Illegal, but how is the IRS to know? A large underground preparer system would, in my opinion, be worse than what we have now.
Lawrence Lokken
I agree that Congress could ease the preparer problem by simplifying the Code, but this would not eliminate the problem. Contrary to popular belief that complexity results from incompetence or willful perversity of those writing the tax laws, the most troublesome complexities in the tax law are the result of political choices and the inherent nature of income taxes and many basic policy choices. For example, the earned income credit, with its phaseins and phaseouts, is going to drive most claimants of the credit to paid preparers, regardless of how well the credit rules are drafted.
The preparer problem must be addressed directly, as the IRS proposes.
Lawrence Lokken
I am not sure if I agree about whether registration is a good idea. But you've caught the fundamental issue here the tax code is a confusing mess that even experts cannot understand. The last GAO study of the Service's own advice was that about 40% of it was wrong.
Check the IRS website–the Service will offer a free (no income restrictions) fill in the blanks 1040, 1040A and 1040EZ forms for e-filing.
But you still need to know how to fill out the forms.
Re: Simplification
Get ready for healthcare requirements in the code and health insurance requirement compliance in the forms.
The tax code is the problem but is it the real culprit?
The question that has to be asked is why the tax code is so complicated? So complicated that even a tax professional cannot get it right.
The answer to the problem is the tax itself. It is high and it is marginal.
If you have marginal taxation you need to have an extremely complicated tax code. If taxes are very high specials interests groups; homoweners, low inome earners and business owners demands special dispensations, special rules. The tax code becomes even more complicated and convoluted.
So what is the solution to making the tax code easier and abolishing the need for tax professionals to help ordinary citizens?
A flat tax that is final and the abolishment of all deductions.
Sweden, 2010 has the highest taxes in the world both so a portion of GDP as well as the highest marginal tax, in 1990 revolutionized its tax system. Marginal taxation was cut from 75 % to 50 %, nearly all deductions were disallowed and 80 % av those that had to supply a income tax declaration had the form prefilled and had only to sign.
Unfortunately the Swedish marginal taxation of 56.7% and 54 % of GDP still makes it complicated but I think that the US being, or at least used to be, a low tax country should take note from Sweden. It is dangerous to increase taxes too much it leads to aggressive tax planning among all taxpayers and a loss of revenue. Sweden learned this lesson the hard way.
In the 70's and 80's, in Sweden called the Crazy Quarter of a Century small business, SMB, were eradicated, entrepreneurs run out of the country. Sweden has as result of the aggressive tax planning one of the highest per capita wealth in offshore jurisdictions. The GDP growth was drastically cut. Sweden went from the 4th richest country to the 17th and also one of the least SMB per capita in the developed world.
Sweden has one of the lowest income GINIs in the world but higher wealth income GINI than the US.
So take it ad notam. Change the tax code and cut marginal taxation. Do not go the way we Swedes took in the 70's and 80's. Take the road we took 1993.
The reason the tax code is so bad is because individuals and constituencies seek advantages from it. We have met the enemy and it is us.
The other problem is the insistence that employees, rather than employers, be responsible for most wage taxes. Employers collect and file now. A VAT or expanded business income tax would make them responsible for the actual taxation and the distribution of credits based on family size (which would be equal regardless of base wage). If most did not have to file at all, the tax preparer problem would go away – although Joe Lieberman and Chris Dodd would filibuster the solution, since their Connecticut accounting firm constituency would lose too much business as a result.
Stuart:
I agree this might help–and that the commercial tax prep software companies will oppose it. But, as my colleague Bob Williams reminds me, a taxpayer still needs enough understanding of the law to know how to fill in the boxes. The software can help navigate the system and do the math but it is, as you say, only a partial fix. And remember there are still many low-income people who don't have computers.
Actually, there's a fairly simple partial fix. Allow the IRS to create software, both for use on the computers of taxpayers and “in the cloud” off the web. Currently, the Service is not allowed to do this because the various tax preparation companies and software providers, correctly I suspect, know that this will put a powerful hurtin' on their business.
The IRS should be in the business of efficiently and equitably collecting taxes. Allowing it to create and distribute free software is an integral part of that effort.
Congress could also stop adding above-the-line deductions for those who don't itemize. This has become a troubling fad lately
The other face of this trend is AGI-driven phase-outs of tax credits. Such phase-outs are effectively a tax on gross income, and they have become a significant part of total tax revenue.
In summary, there is a clear trend away from an income tax based on taxable net income toward an income tax based on adjusted gross income. This trend decreases fairness, but it has the political benefit of keeping the “sticker price” statutory tax rates lower than they would otherwise have to be.