Study of the Role of Preparers in Relation to Taxpayer Compliance with Internal Revenue Laws

Abstract

The use of paid tax return preparers has grown steadily. All paid return preparers, including those who are not regulated by any licensing entity or subject to competency or continuing education requirements, must comply with certain requirements in connection with the preparation of a tax return, including signing the return and providing a copy of the return to taxpayers. Preparers are also subject to civil and even criminal penalties for improper conduct and the Code provides that the United States may bring a civil action to enjoin tax preparers if preparers engage in certain types of impermissible conduct.

As discussed in this article, the research to date regarding how paid preparers affect tax compliance is inconclusive. Some research suggests that practitioners can use their expertise to exploit legal ambiguities. Research also suggests that practitioners in effect play a dual role; that is they serve to exploit ambiguity, but also tend to serve as enforcers of the law when the law is relatively clear. Reflecting, in part, this research, policymakers and academics alike have emphasized practitioners' role in noncompliance when there is the opportunity to take advantage of legally ambiguous issues.

Much of the compliance literature and a great deal of governmental efforts directed at return preparers are aimed at tempering practitioner's appetites for exploiting ambiguity. Notwithstanding the importance of understanding and reducing the gap that is associated with practitioners' role in exploiting ambiguities, a significant amount of the tax gap relates to items that are not characterized by legal ambiguities. Recent tax gap data suggests that this duality approach is not nuanced enough to capture the true dynamics between taxpayers and practitioners, especially when one views the significant tax gap figures associated with relatively unambiguous areas of the law. This report focuses on the reporting of sole proprietor income and the proper claiming of the EITC, two areas in the individual tax gap characterized by complicated but fairly straightforward rules.

This report reviews the literature relating to the practitioners' influence on tax compliance. Rather than identify practitioners as exploiters or enforcers, this report examines from a ground-up perspective the underlying causes of errors associated with two systemic issues that have had widely reported and studied noncompliance problems: the reporting of sole proprietors' income and the claiming of the earned income tax credit. Drawing on a wide range of sources, including existing third-party empirical, behavioral, and theoretical research, IRS studies, and my own experiences as a director of a Low Income Taxpayer Clinic (LITC), this report considers in a more nuanced manner a typology of the practitioners' role in sole proprietor and EITC noncompliance.

Keywords: tax gap, tax compliance, civil penalties, income tax return preparer