More thoughts on Rachel Porcaro

Ms. Porcaro, the Seattle hairdresser and single parent of two boys who spent a lot of money contesting an IRS audit, has been much on my mind.

By coming forward to share her story, Rachel Porcaro has put a face on the faceless millions of low-income taxpayers who have been audited in the past decade. As I noted before, the IRS feels obligated to audit so many low-income taxpayers with refundable credits because there are very high error rates on their returns, some due to deliberate fraud, and some due to honest errors caused by the complexity of the tax code (all those bed buffaloes in the tax code!)

Of course, when the IRS chooses a return for audit, they can't know for sure, in advance of the audit, whether there are errors on that particular tax return, so inevitably some perfectly compliant, innocent, honest taxpayers are going to be caught up in the audit process, which can cost a lot of time, trouble, anxiety, and money to straighten out.

According to National Taxpayer Advocate Nina Olson, many honest compliant taxpayers just give up and don't even try to defend their position.

Rachel Porcaro provides a glimpse into the burdens that low-income taxpayers determined to prove their compliance may face.

She hired a CPA/attorney tax pro, Dante Driver, to help her with the IRS audit. According to the press coverage, the IRS was initially demanding $16,000 in additional taxes, interest, and penalties for her 2006 and 2007 tax returns. After spending $8,000 in legal/accounting expenses, she managed to get the IRS to agree to a lesser figure of $1,600.

That's a lot of legal fees for a low-income single mom to be spending. Her attorney, Dante Driver, has stated that even the final $1,600 was contestable, but the legal cost of fighting any longer was just not worth it.

Did she have any alternatives?

I've been thinking a lot about the alternatives that face low-income taxpayers like Rachel Porcaro, who are audited at rates much higher than the general public. Her story makes a good case study.

What can a low-income taxpayer in her situation do when faced with an IRS audit and a demand to pay back a very large sum of money, almost as much as she makes in an entire year?

Alternative #1: Get help from her original tax preparer
The Seattle Times reported that H&R Block prepared Ms. Porcaro's original tax returns. The H&R Block website states that it will provide a substantial amount of free assistance and support to any of its customers who are audited. They will also pay for any penalties and interest that resulted from errors made by their preparers. Customers who pay the optional $30 "Peace of Mind" fee are entitled to even more support. An IRS-credentialed Enrolled Agent employed by Block will represent Peace of Mind taxpayers at their audits, and Block will also pay up to $5,000 of additional tax liability assessed by the IRS at such audits.

Hindsight is 20-20, as they say, but in retrospect, it seems that Rachel Porcaro might actually have been at least a little bit better off if she'd opted for the $30 Block "Peace of Mind" plan in 2006 and 2007. (Of course, there is a good deal of fine print on those Block guarantees, and in order to collect the penalties and interest and $5,000 per year in additional tax liability reimbursement, she would have needed to establish that it was Block's errors that created the problem, not her own errors. Arguing with a tax pro about whose error was actually responsible for the additional tax liability could be a tough challenge for typical taxpayers. Also, it should be noted that any amounts reimbursed by Block under their Peace of Mind guarantees would constitute taxable income on her next year's tax return! So, the bottom line for the Peace of Mind guarantee isn't so clear after all.)

In any case, it's understandable that Rachel Porcaro didn't pay the $30 for the Block Peace of Mind program. Back at the time she filed her 2006 and 2007 tax returns, she probably did not realize that low-income taxpayers are audited at rates much higher than the general population.

Alternative #2: Get free help from a Low Income Tax Clinic As a low-income taxpayer, Rachel Porcaro was also entitled to contact a Low Income Tax Clinic (LITC). There are 168 LITC programs located around the country, mostly at law schools. These are private non-profit programs that receive funding from the IRS to assist taxpayers in audits and other IRS legal matters. Taxpayers with incomes up to 250% of the poverty level are eligible for assistance, so Rachel Porcaro would certainly have qualified.

Fortunately, because Rachel Porcaro lives in Seattle, she is close to one of the largest LITC programs in the country, the University of Washington Low Income Tax Clinic. The clinic received a $91,000 IRS grant this year, the largest such grant awarded in the country. The University of Washington Low Income Tax Clinic has also benefited from the generosity of the Gates family as it is located in a modern and well-equipped building named after Bill Gates' father, William H. Gates II, someone who clearly cares a great deal about tax equity.

What are the odds that the University of Washington Low Income Tax Clinic will be able to help a taxpayer like Rachel Porcaro?

Not very good.

According to the Brookings Institution EITC database of IRS statistics, Rachel was just one of out of 154,000 low-income taxpayers in the greater Seattle-Tacoma-Bellingham area served by the clinic who filed a tax return claiming EITC in 2006. Using figures from Nina Olson's 2007 Congressional testimony, we can estimate that 2.5% of those EITC tax returns were selected for audit.

That means that there were 4,000 other low-income working taxpayers like Rachel Porcaro whose returns were audited in the Seattle area last year.

The University of Washington runs the only low-income tax clinic in the greater Seattle area (Seattle-Tacoma-Bellingham metropolitan area). According to their website, "During 2008, the clinic handled 132 cases through the IRS administrative process and 67 cases in the United States Tax Court."

So the University of Washington assisted less than 200 taxpayers in 2008, and surely not all were EITC taxpayers. The clinic director mentions, for example, assisting senior citizens, who also need tax help but who typically would not be included in the EITC statistics since they rarely claim it.

Even if all 200 University of Washington cases had been EITC cases, that means that about 5% of the low-income EITC taxpayers like Rachel Porcaro whose returns were selected for audit last year got free help from the only LITC in greater Seattle.

So where does that leave Rachel Porcaro and the overwhelming majority of the EITC audited taxpayers that the clinic can't serve? Unfortunately, their remaining options are not very good. According to a recent study published National Taxpayer Advocate Nina Olson, the vast majority of low-income taxpayers go to their audits without any legal representation.

Alternative #3: Do-it-yourself approachRachel Porcaro could have tried contesting the audit on her own, but she's a hairdresser, not a tax expert. A hairdresser going into an IRS audit probably feels very much like she's in a David vs. Goliath situation.

Even TaxGirl Kelly Erb, an experienced tax lawyer who used to work for the IRS as an auditor herself, felt "that it was a "completely different feeling"" when she was preparing for her own audit recently.

It is, I must say, a completely different feeling.

For those of you who have never been audited, let me advise that the experience isn’t fun. The requests for information can be somewhat overwhelming – especially for a small business. Our bookkeeper has spent days and days putting together charts and reports. We’ve been printing out ledgers and bank account statements and desperately looking for supporting documentation. It’s all part of the examination process.

If an experienced tax lawyer like Kelly was daunted by her audit, how do you think a hairdresser like Rachel Porcaro would feel? Especially if the IRS is demanding $16,000 in taxes and penalties from someone making $10 per hour cutting hair.

National Taxpayer Advocate Nina Olson recently published a study showing that low-income taxpayers who go to an audit without representation are twice as likely to come out of the audit with negative results (i.e., losing their EITC and/or owing additional tax) as those who have legal assistance.

As noted above, Rachel Porcaro wound up hiring a very expensive CPA/attorney and spending $8,000 in fees to contest the IRS audit.

Such professionals are very expensive--and few of them specialize in the kind of tax law that applies to low-income working taxpayers like Rachel Porcaro.

Billing rates for attorney/CPAs can run hundreds of dollars per hour.

According to the press coverage, Rachel Porcaro made $10 per hour cutting hair at SuperCuts.

At that rate, it would take her 800 hours of cutting hair to pay off the legal bills run up during her audit.

Why do low-income taxpayers have IRS targets painted on their backs?

The blogosphere has been reverberating with comments on an article by reporter Danny Westneat in the Seattle Times, $10 an hour with 2 kids, IRS pounces. (Tax Prof Paul Caron post here, TaxGirl Kelly Erb here, The Wandering Tax Pro Robert D Flach post here.)

Here are the relevant facts as the Seattle Times reported them in the article:

1) Taxpayer Rachel Porcaro was a 32-year-old single parent.
2) She made $18,992 cutting hair at Supercuts at $10 per hour in 2007.
3) She and her two children, ages 8 and 10, lived with her parents.
4) She paid her parents $400 per month in rent.
5) She claimed Earned Income Credit based on her children.
6) She also claimed her two children as dependents.
7) She was audited by the IRS.

First of all, it's important to note that all facts reported in the article come from Rachel Porcaro, her family, and her tax advisor. The Seattle Times contacted the IRS to get its side of the story, but confidentiality rules prohibit the IRS from commenting on individual taxpayers that it audits.

However, based on the facts reported in the article, I can say that situations like Rachel Porcaro's are very common, and very similar to many taxpayers whose situations are simple enough to qualify to use the free tax preparation services of a Volunteer Income Tax Assistance (VITA) site like the one we operate at Union College.

In fact, even the first level Basic VITA certification tests that my students will take in the first week of January will require them to demonstrate that they understand how to use the IRS-provided resources (Pub 4012 and Pub 17) to prepare an accurate tax return for taxpayers whose circumstances look very much like the article's description of Rachel Porcaro's situation.

The article reports that Rachel wondered why her return had been selected for audit:

"I asked the IRS lady straight upfront — 'I don't have anything, why are you auditing me?' " Porcaro recalled. "I said, 'Why me, when I don't own a home, a business, a car?' "The answer stunned both Porcaro and the private tax specialist her dad had gotten to help her. "They showed us a spreadsheet of incomes in the Seattle area," says Dante Driver, an accountant at Seattle's G.A. Michael and Co. "The auditor said, 'You made eighteen thousand, and our data show a family of three needs at least thirty-six thousand to get by in Seattle."

"They thought she must have unreported income. That she was hiding something. Basically they were auditing her for not making enough money."

Rachel Porcaro's curiosity is understandable, but the truth is that an individual taxpayer is not entitled to an answer to the question as to why her particular return was selected for audit. In fact, it's entirely possible that even the auditor did not even fully understand exactly why Rachel's particular return had been selected for audit.

Some of the IRS criteria for audit selection are classified, a closely guarded secret limited to a few high-level IRS employees. Rank and file auditors do not know all the details of the audit selection process. The IRS has considerable discretion in how it selects returns for audit. It is under no obligation to reveal why a particular individual's return was selected for audit, just as airport security is not obligated to reveal why it selected a particular airline passenger for a special inspection.

For research purposes, for example, the IRS may have good reason to select some returns entirely at random, in order to get information that will enable it to better target future audits. Alternatively, the IRS may want to select some tax returns entirely at random in order to discourage taxpayers from thinking that they can prevent detection simply by making their returns "look typical." That's the same reason that airport security occasionally chooses an innocent-looking 13-year-old girl or 90-year-old grandmother for a more extensive baggage inspection at the airport.

However, although the IRS won't reveal why it selected any particular individual's return for audit, it does release aggregate statistics showing the percentage of tax returns audited in various categories.

Those statistics show that the IRS audits a lot of taxpayers who look very much like Rachel Porcaro at rates much higher than the general public. The graph shown below demonstrates audit rates for EITC taxpayers at over double the rate of the average taxpayer.

TABLE 4. INDIVIDUAL INCOME AND EITC RETURN COVERAGE RATES (1997-2005)Source: Congressional Testimony National Taxpayer Advocate Nina Olson March 5, 2007


Rachel Porcaro's tax return was one of 25 million tax returns filed in 2007 claiming the Earned Income Tax Credit (EITC). Using the most recent statistics available on audit odds from the graph above suggests that about 625,000 EITC taxpayers like Rachel Porcaro had their 2007 tax returns selected for audit. Millions of EITC tax returns have been audited over the past decade. An IRS official has stated that only taxpayers with incomes above $200,000 have higher audit odds than EITC taxpayers.

Although we are not entitled to know specifically why Rachel Porcaro's return was selected for audit, American taxpayers are certainly entitled to inquire why EITC returns broadly similar to hers are selected for audit at such relatively high rates.

Rachel Porcaro's circumstances may sound straightforward, but the rules for figuring out whether she can claim her children on her tax return for a variety of benefits (dependent exemptions, child tax credits, additional child tax credits, child care tax credits, earned income tax credits, and Head of Household filing status) are surprisingly complex. I'll be talking about those rules in my posts over the next few days as I help my students prepare for the IRS VITA certification exam.

There is a good deal of evidence to show a very high error rate on simple tax returns that look very much like Rachel Porcaro's tax return. Some of that evidence comes from "Secret Shopper" visits to paid and volunteer tax preparers. Some of that evidence comes from studies of audited tax returns. Even highly credentialled tax preparers such as CPAs, attorneys, and enrolled agents have very high error rates on Earned Income Tax Credit returns. No matter who prepared the tax return, whether it was self-prepared, or prepared by a commercial preparer at a big chain like H&R Block, a volunteer at a VITA site, a small independent tax pro, credentialled or not, the error rates in studies are unacceptably high. I have previously posted about a recently released study that found the following EITC error rates on a random selection of EITC returns:


The error rates shown in the chart above range from 45% to 71%, depending on the type of preparer. The chart shown above is based on a random cross-section sample of 1999 tax returns, there are some methodological concerns, and the error rate has come down since then, but it is still too high. An IRS official recently quoted an estimate of 25% for the error rate on EITC returns.

Some of the errors on EITC are deliberate and intentional fraud, but many are honest mistakes due to the complexity in the tax law, especially the rules for what the IRS calls "Qualifying Children." Those rules are surprisingly complex for children who may live and/or be supported by multiple adults, and, to make matters even more confusing, the rules for claiming Qualifying Children changed significantly as a result of the Working Families Tax Relief Act of 2004. Ironically, that act was designed to simplify the tax rules by creating the so-called "Uniform Definition of a Qualifying Child (UDOC)." It turns out those rules aren't as "uniform" as the U in UDOC suggests, creating the potential for continuing confusion.

IRS audit statistics also show a good deal of underreporting of Adjusted Gross Income on EITC tax returns. Again, some of that underreporting may be deliberate fraud and some may be honest misunderstanding about the types of income that need to be reported on a tax return (e.g., Social Security benefits) and the types of income that do NOT need to be reported on a tax return (e.g., Supplemental Security benefits).

Whether it's fraud or honest error, the IRS is obligated to audit tax returns to enforce the tax laws. As Rachel Porcaro's situation demonstrates, enforcement actions can create a lot of confusion, stress, and expense for vulnerable taxpayers.

Congress could do a lot to simplify the tax code to reduce the burden of enforcement on taxpayers like Rachel Porcaro. Part of the reason that low-income taxpayers have targets painted on their backs is that Congress has made the tax law so complicated by putting so many bed buffaloes in the tax code.

I'll have more posts on this topic in the coming days.

Thanks to Ms. Porcaro for coming forward and putting a face on millions of taxpayers who have been audited for EITC returns in the past decade. She paid hundreds of dollars to H&R Block to prepare her tax return, but statistics show that there is still a significant likelihood of error on her tax return. She spent thousands of dollars and a lot of hours and anguish trying to establish her rights to claim her own children on her tax return.

The difficulties Rachel Porcaro faced are part of the reason why I so strongly stress the need for scrupulously careful tax return preparation at our VITA site. Every tax return prepared at our VITA site is prepared by an IRS certified volunteer, double-checked by a second IRS certified volunteer, reviewed again by the original volunteer who walks the taxpayer line by line through her tax return, and then triple-checked by me prior to submitting the e-file tax return for processing. All of this takes a good deal of time, but we feel strongly about preparing accurate tax returns for our taxpayers. We want to secure all tax benefits to which they are legally entitled, but we do not want to create any problems down the road if and when their returns are selected for audit.

Compensating audited taxpayers: an idea whose time has come?

Ian Ayres and Barry Nalebuff, two Yale economists who write for Forbes, have proposed that the government pay taxpayers whose returns are selected for audit, especially taxpayers subjected to random exhaustive audits the IRS may conduct purely for research purposes.

Peter Pappas doesn't think much of the idea:

I’ll research this more, but here’s my initial response to Ayres and Nalebuff: What the hell have you two been smoking?

First, the IRS can simply pass these audit compensation fees back to the taxpayer by more aggressively disallowing tax deductions. Second, because IRS auditors and their group managers have discretion as to whether or not to assess penalties against taxpayers it’s reasonable to assume that they they will be more aggressive in assessing those penalties and denying reasonable cause abatements so as to offset the cost of compensating the auditees.

I hope American taxpayers are not stupid enough to trust a program that purports to compensate them for being audited when the compensator, the IRS, is the entity responsible for determining the amount of their indebtedness to the government.

Am I missing something here?

Ahem, well Peter, it wouldn't be the first time you've been missing something.

Economists have been talking about the idea of compensating audited taxpayers who are found to be fully compliant for their time and trouble for decades, probably since before you were born. I first encountered the idea in the 1970s, and it was not a new idea even then. I will admit to some mixed feelings about the idea, but I don't think you have to be "smoking something" to think it's an idea that deserves some consideration.

I don't know Ian Ayres (who happens to be a lawyer as well as an economist), but I spent a fair amount of time talking to Barry Nalebuff back in the 1980s. He is not your typical ivory tower economist. He knows a lot of mathematical economics (game theory and that sort of thing--he was a Rhodes Scholar and a former Harvard Junior Fellow, both very big deals), but he also knows and cares a lot about the real world. He runs a sideline business, which he and a former student founded in 1998. I understand it's quite a successful business: ten years after startup, Coca Cola bought a 40% share of the business for $43 million. That kind of real-world savvy alone sets him apart from most academic economists. You should read his books--I'm not saying that I agree with every single one of his offbeat ideas, but there's a lot of food for thought in them.

Paying audited taxpayers is clearly a controversial idea, and I'm not saying I'm ready to jump on the bandwagon, but I do think it's an idea that merits serious consideration. Your arguments, based on your extensive experience dealing with IRS auditors, are certainly worth taking into consideration, as well.

I don't know if you are old enough to have been practicing back when the IRS had its old Taxpayer Compliance Monitoring Program (TCMP) audits, but they seemed like thoroughly unpleasant affairs. As I understand it, they constituted a very major imposition on the time and energies of a hapless group of taxpayers selected entirely at random, in a stratified sample selected for research purposes.

In other words, the TCMP audits were exhaustive audits conducted on a random group of taxpayers about whom the IRS had absolutely no reason to suspect were any more guilty of non-compliance than the next guy. Why? Because the IRS believed it needed baseline data for research purposes in order to construct statistical models that would allow it to target all the rest of its audits more effectively.

That meant auditing a random cross-section of taxpayers, including some who were fully compliant, indeed, those TCMP audits even turned up a significant number of taxpayers who had overpaid their taxes. The IRS believes its duty is to enforce the tax law and to collect the correct amount of taxes from taxpayers, but not more than the government's due, so such taxpayers received refunds.

So what was a TCMP audit like? As I understand it from IRS researchers with whom I spoke back in the 1980s when they were still conducting such audits, if your return was selected for a TCMP audit, you were required to substantiate every line on your tax return, producing your marriage certificate if you were filing jointly, birth certificates for your children if you claimed them, evidence that you met the support tests and other tests to claim those dependents, and so on, line by line through every item of your return.

TCMP audits were understandably very unpopular with most taxpayers, although I understand that the IRS Commissioner kept a drawerful of letters from a minority of grateful taxpayers who found out from their TCMP audits that the government actually owed them money. They were the minority, of course, and a political clamor arose to discontinue those research audits, even though the IRS insisted that it needed that information to construct and updated accurate models for selecting the lion's share of its audits through the so-called Discriminant Function (DIF) model.

Congress listened to the aggrieved taxpayers and ordered the IRS to abandon the TCMP audits, and it's been almost two decades since there have been any TCMP audits. Without those TCMP audits, some statisticians believe the current DIF model used by the IRS is seriously out of date.

I'm not privy to the details of the DIF, nor am I privy to the classified data which causes those statisticians to claim that the IRS needs new research audit data to update its statistical models.

But, for the sake of argument, let's say those statisticians are correct, that the IRS does need to collect some audit data from a stratified random cross-section of taxpayers about whom the IRS has no particular reason to suspect non-compliance.

It doesn't seem entirely unreasonable to me that such taxpayers ought to be compensated for their time and trouble, if they are found to be compliant. In many jurisdictions, taxpayers are paid if they are selected for jury duty, albeit not very generously. In some states, jurors receive no pay for short trials (less than three days), but they do receive pay for serving on a long and complicated case. When I was growing up, young men drafted into the armed services were still paid for their work, again, not all that generously.

Random selection for a research audit is a burden more onerous than most jury duty assignments, and less burdensome than most military duty. There is a case to be made that a taxpayer whose return was randomly selected for a research audit has been "conscripted" into an important civic duty, and deserves at least some compensation from the government for his time.

There are ways to structure the incentives for the auditors so that those who conduct the research audits are rewarded for audits that are as accurate as possible, rather than audits that significantly favor the government. The old TCMP auditors were told not to worry about the dollar totals their audits collected, but rather to worry about making the audits as accurate as possible so the IRS would have the best possible data on which to build its DIF model.

By similar reasoning, accounting for the funds the government uses to compensate taxpayers could be done in a way that does not create perverse short-term incentives to maximize direct revenue collection from these exhaustive research audits. Such funds could come from a separate budget outside the direct control of the IRS. To serve their intended purpose, research audits need to focus on collecting the most accurate possible data, not the most revenue from the particular taxpayer who is audited. In other words, you don't want the taxpayer just throwing up his hands and saying, "Just get out of my hair. I'll pay whatever you tell me to pay." For a genuinely useful research audit, you want the taxpayer providing all the information needed to assess his tax bill accurately.

One could also, for example, ask the National Taxpayer Advocate's office to be involved in "auditing the research auditors" to make sure that they are conducting those very burdensome audits in an even-handed manner.

That said, I'm not necessarily willing to jump on the Nalebuff-Ayres bandwagon.

I still have some reservations about the idea of paying audited taxpayers. Paying people for complying with civic duties can sometimes be a two-edged sword. It might encourage so much cynicism and negativity that it could undermine what voluntary compliance remains among American taxpayers.

But I don't think you have to be "smoking something" to propose the idea for public consideration.

National Tax Bee: further thoughts

While the tax gap is a serious problem, and the complexity of US tax law places huge burdens on all Americans, Americans have a well-deserved reputation as some of the most law-abiding taxpayers in the world. Surveys show that most Americans actually want to comply with the tax law, and many take enormous time, trouble, and expense to do so.

Last year, an exchange student told me that her parents back home in another country do not need to file tax returns, because, as she put it, "The government just knows everything about you, and they just take the money away before you ever get it."

In some countries, cheating the government out of taxes is actually something of a national sport.

During World War II, most Americans took great pride in complying with tax law, which was relatively new for them. Before World War II, only a very small percentage of Americans paid income taxes. As the saying goes, during World War II, the income tax went from a "class tax" (on the wealth) to a "mass tax" (on almost everybody.)

Perhaps a National Tax Bee could celebrate and promote the fact that American taxpayers are actually among the most law-abiding in the world.

It's also important to promote the role of the many competent and conscientious tax preparers who help those taxpayers deal with the compliance burdens our tax law imposes.

We hear about the scofflaws and the incompetent, but it's really important to recognize the many honest taxpayers and the professionals who are doing their best to help them comply with our country's tax laws.

Role of Paid Preparers in Tax Compliance: New Evidence

The Leviner-Richison study contributes some fascinating new evidence on tax compliance by taxpayers who use different types of preparers. Some of their results present quite a contrast to the previous literature in the subject, which I discussed in my last post.

Leviner and Richison's new work analyzes a random cross-sections of 1999 tax returns claiming EITC that had been selected to study noncompliance with the Earned Income Tax Credit (EITC) rules. They initially divided those returns into nine different categories based on the type of preparer: (1) self-prepared, (2) CPA preparer, (3) attorney preparer, (4) Enrolled Agent, (5) HR Block/Jackson Hewitt (the two big national chains), (6) Other Professional Tax Preparer, (7) Friend/Relative, (8) IRS/VITA/TCE (volunteer free tax prep and IRS taxpayer assistance), and (9) Other.

The big chains (#5) and Other professional preparer (#6) accounted for 56% of the returns in the sample. Very few returns in the study sample were prepared by CPAs and attorneys that the authors decided to combine those categories for their analysis. That's not too surprising, since EITC recipients are low-income taxpayers and very few attorneys and CPAs specialize in serving that clientele, aside from those who volunteer in VITA.

Here's how they summarize their results:

As illustrated in Table 1 below, our analysis reveals that CPA/Attorney, HR Block/Jackson Hewitt, and IRS/VITA/TCE staff have the lowest percentage of returns with change (either positive or negative) to EITC when the original amount claimed on the returns is compared to that concluded by the IRS after audits and reviews....

"Change" is IRS-speak for finding an error rate in an audit. So a high change rate means a high error rate. They found both overclaim and underclaim errors, but, not too surprisingly, the overclaim error rate was about an order of magnitude greater than the underclaim error rate. That is, when the IRS found an error, it was far more likely to be that the taxpayer's return had claimed too much tax refund rather than too little refund.

An important note to keep in mind: the rules for claiming "qualifying children" on a tax return were quite different in 1999 than they are today. The rules are still complicated, confusing, and subject to abuse today, but this was arguably even more true of the rules that applied in 1999.

That said, this is a REALLY discouraging error rate. Bear in mind that these returns were a RANDOM representative set of returns filed in 1999.

The authors have additional cautionary notes to bear in mind in interpreting this data:

An examination of the Adjusted Gross Income line (AGI, Table 2) reveals a nearly 50 percent rate of returns with change for CPAs/Attorneys, and over 60 percent for Enrolled Agents. It is possible that the financial circumstances EITC claimants have are complex enough to confuse even the most trained of preparers. Paid preparers usage is believed to be more common among taxpayers with complicated returns which may go some way toward explaining errors on returns filed by preparers (as opposed to taxpayers filing for themselves) generally. This might be particularly the case with regards to taxpayers engaging the most trained and experienced preparers such as those who are CPAs and Attorneys. Even so, errors made on paid prepared returns do not necessarily mean that these errors are the result of the preparer’s, as opposed to taxpayer’s, misconduct.

In other words, it's important to bear in mind the correlation vs. causality problem here. It's entirely possible that the higher error rate of Enrolled Agents vs. unenrolled preparers may reflect the greater complexity of the returns they prepare rather than a lesser degree of competence or conscientious adherence to the law.

They also looked at patterns of error in AGI reported by different types of preparers, summarized here:

The types of preparers to exhibit the highest rate of change in claimed AGI are: Other Professional Tax Preparer, Other Preparer, and CPA/Attorney, (in that order). HR Block/Jackson Hewitt and IRS/VITA/TCE have almost half that rate of change and are the most accurate compared with other preparer types.

Again, we need to keep in mind the previous cautionary note about correlation vs. causality, because the types of taxpayers who patronize different types of preparers are not necessarily the same.

This study was intended as exploratory rather than conclusive, but it certainly provides some interesting data for consideration.

Role of Paid Preparers in Tax Compliance: Literature Review

TaxProf Paul Caron posted a link to an interesting new paper available on SSRN,
The Role Paid Preparers Play in Taxpayer Compliance in the United States: An Empirical Investigation with Policy Implications

Here's a fascinating excerpt from their literature review:

Using 1979 Taxpayer Compliance Measurement Program (TCMP) database, Erard (1993) found that noncompliance was greater on paid, than self, prepared returns, with the highest predicted mean level of noncompliance occurring on CPA or lawyer-prepared returns. If a taxpayer’s preparation mode changed from self to using a CPA or lawyer, noncompliance increased by a factor of about 4.5! In contrast, the noncompliance of a taxpayer switching from self to some other preparer increased by only 15 percent.

More recently, the IRS reported a higher error rate on paid (56 percent)—as compared with self—prepared (47 percent) returns. This disparity in error rates translated to different dollar amounts taxpayers owed after audit. For Tax Year 2001 taxpayers using a paid preparer were liable for a median of $363 after audit, while those who self-prepared owed a median of $185 per return.

The authors of the study are Sagit Leviner, a law professor at Tel Aviv University, and Kyle Richison, an IRS researcher. (IRS Office of Research, Analysis, and Statistics) have posted The Role Paid Preparers Play in Taxpayer Compliance in the United States: An Empirical Investigation with Policy Implications

After making the observation above, they observe the possible negative externality effects from spreading "infectious" negative attitudes towards tax compliance. In other words, when tax pros encourage their clients to violate tax law, their clients may spread those attitudes to others in casual discussions.

As an important aside: the evidence cited above from the old TCMP study is especially interesting because the TCMP data was based on a random selection of returns for audits. In other words, TCMP audits are not subject to sample selection bias.

This is all quite interesting. I will need to go look at the original sources the authors cite as their sources for the passages above. One of the sources may be an IRS internal research study not available to the public, however.

Here are the footnoted sources for the passages above:

Brian Erard, Taxation With Representation: An Analysis of the Role of Tax Practitioners in Tax Compliance, 52(2) JOURNAL OF PUBLIC ECONOMICS 163 (1993).

Id; see also Internal Revenue Service, Survey of Tax Practitioners and Advisers (1987); Ayres et al. (1989), supra note 11. But cf. Andrew D. Cuccia, The Effects of Increased Sanctions on Paid Tax Preparers: Integrating Economic and Psychological Factors, 16(1) THE JOURNAL OF THE AMERICAN TAXATION ASSOCIATION 41 (1994); Richars G. Broody and John J. Masselli, Tax Preparers: Whose Team Are They On?, 41 THE NATIONAL PUBLIC ACCOUNTANT 18 (1996).

National Research Program (2001)

This is just their literature review of prior work done by others. In my next post, I'll go on to discuss the results of their new contribution to the literature.