How to regulate tax preparers? Part I: the Enrolled Agent system

Nina Olson, the National Taxpayer Advocate, has been a voice crying in the wilderness calling for regulation of the commercial tax preparer industry for many years. For years, starting with her first report in 2001, she has called attention to the unregulated preparer problem in her annual reports to Congress.

I'm proud to say that I was a classmate of Nina's. She and I were in the same graduating class at Bryn Mawr College (200 students!), so I've been reading and heeding her words over the past decade that she's been the Taxpayer Advocate, and calling my students' attention to them as well.

As I've pointed out to students in my service-learning income tax class over and over again, in 48 47 states anyone can hang out their shingle as a "professional tax preparer." Only California and Oregon restrict entry into the tax preparation business. [UPDATE: Apparently Maryland now regulates preparers as well.] In the remaining 48 47 states, even a convicted criminal can legally set himself up in the tax prep business, where he has routine access to SSNs, dates of birth, bank and brokerage account numbers, and other sensitive taxpayer information. Moreover, there is absolutely no requirement that paid preparers in those 48 47 states do anything whatsoever to demonstrate even the most minimal knowledge of tax law, or even basic literacy and numeracy.

Finally, last month, the administration showed it was listening to Nina, when IRS Commissioner Doug Shulman testified before the House Ways and Means Committee that the IRS was working to draft legislation on preparer regulations to submit to Congress by the end of 2009.

So now the $64,000 question is how should preparers be regulated?

There are two existing models of preparer regulation already in place that might be adapted to preparers: one is the certification process currently required of Enrolled Agents (EAs), and the other is certification process for Volunteer Income Tax Assistance (VITA) volunteers.

Enrolled Agents are currently the only tax professionals licensed by the IRS. They can certify as enrolled agents either by working as an IRS employee in certain kinds of jobs for a minimum amount of time OR by passing an initial series of three computerized tests covering various aspects of tax law. Like attorneys and CPAs, a preparer who has certified as an Enrolled Agent has the privilege of representing his clients in many tax proceedings at the IRS, including audits and appeals.

The Enrolled Agent tests are given only at Prometric testing centers under high security. Each test in the series costs $97 to take, so the expense to become an EA is at least $291, and could be higher if he fails one or more parts and needs to retake. (Up to four re-takes per part per year are allowed.) Of course, most EAs also incur considerable costs for study materials and/or fees for exam prep classes.

The amount of time taken by the EA test is also very considerable. Each of the three parts of the test can take up to 3.5 hours, which means that enrolled agent status can take a minimum of 10.5 hours, and more if re-takes of some parts are required.

It would clearly be impractical to require all paid preparers to take the currently available Enrolled Agent exams. Prometric has a limited number of secure testing facilities with secure computers in place. Moreover, the current Enrolled Agent exams cover a number of esoteric topics that many tax preparers will rarely or never see.

For example, a tax preparer who works in a low-income inner city neighborhood does not need to know all the ins and outs of estate tax law. Since current tax law exempts an estate under $3.5 million from estate tax, very few taxpayers anywhere in the country need to file an estate tax return, and it's a pretty safe bet that it's highly unlikely that any of the executors for those returns are going to drop into an inner-city tax corner tax preparation shop to have their estate tax return prepared. A preparer working out of an inner city shop doesn't actually need to know by heart all the gory details about generation-skipping taxes. All a tax preparer in that situation really needs to know to deal with that unlikely situation that someone consults him about estate tax matters is that he should refer anybody who might be liable to file an estate tax return or a gift tax return to a preparer with more advanced credentials.

Other problems with the Enrolled Agent exam include the fact that it is always a year out of date. The EA exam covering 2008 tax law (i.e., the law that applied to returns most people filed by April 15 2009) was not even available for anyone to take until May 1, 2009.

Another problem is that EA's do not need to take any further certification tests after they pass the first series of tests. They do need to take continuing education classes, but there's no need for them to pass any tests as part of that continuing education. So, for example, an EA suffering from early stage Alzheimer's disease could be conscientiously sitting through his continuing education classes without actually absorbing much about important changes in tax law.

The following post will look at a different model of regulation, the one applied to VITA volunteers.