After years of prodding from outside watchdogs, the Internal Revenue Service said Monday that it will require anyone who prepares federal tax returns for pay to register, pass a minimum competency test and be subject to continuing education requirements and ethics rules.

"This is a game-changing event for the tax system,'' said IRS Commissioner Doug Shulman, who acted after the agency spent six months studying and holding hearings on the idea.

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An estimated 900,000 to 1.2 million individuals now prepare returns for pay, but only those licensed as lawyers, certified public accountants, or IRS "enrolled agents" have had to meet standards nationwide. California, Oregon and Maryland regulate other preparers, and New York is requiring them to register for the first time during the current tax season. In other states, anyone can hang out a shingle and hold him or herself out as a tax pro.
National Taxpayer Advocate Nina Olson has been arguing since 2002 that "untrained and unscrupulous preparers" are a big problem for ordinary taxpayers. The Government Accountability Office and Treasury Inspector General for Tax Administration have both found incompetence and unethical practices among unlicensed tax preparers.

In a joint statement Monday, Senate Finance Committee Chairman Max Baucus, D-Mont., and Sen. Charles Grassley, R-Iowa, noted that back in 2006 they'd held hearings on the problem--after GAO employees, posing as taxpayers, visited 19 outlets of commercial chain preparers and found 17 made substantive mistakes that affected the refund amount. During hearings last year, the nation's two largest tax preparation chains, HRB) and

"This is long overdue,'' Shulman said. "In most states you need a license to cut someone's hair."

As Congress has made the tax code ever more complex, more taxpayers have found themselves turning to paid preparers, whatever their training. For the 2007 tax year, about 60% of the 143 million individual tax returns filed with the IRS were done by paid preparers.

Taxpayers who do their own returns now mostly rely on software, such as

The tax preparer registration requirement won't be in effect during the 2010 tax filing season, when 2009 1040s are prepared, but should be in place for 2011. After that, the IRS plans to give preparers up to three years to pass the new competency tests so as not to disrupt the industry. "This is not going to happen overnight, when we're talking about bringing a million professionals into a new regulatory apparatus,'' Shulman said.

The IRS anticipates two levels of tests to start. The lower one will allow a preparer to do only those returns which report no business income. (CPAs, lawyers and enrolled agents won't have to take the new tests.) The IRS also plans to establish a public database which will allow taxpayers to confirm whether a preparer is registered and has passed an exam. While the IRS must go through a public comment period to put its proposals in place, the agency doesn't believe it needs new authority from Congress to act, Shulman said.

Meanwhile, in the coming weeks, the IRS will step up both education and enforcement efforts to ensure preparers are providing proper advice about the preparation of 2009 returns. As part of that effort, Shulman said, "thousands of preparers" will be visited by IRS revenue agents, with the agents posing as taxpayers in some cases.

They could be in for a surprise. Today, William J. Comiskey, the head of tax enforcement at the New York State Department of Taxation and Finance, published a startling report in Tax Notes on the results to date of an ongoing two -year-old program. It involves undercover New York agents, outfitted with tape recording devices, who visited 177 preparers. So far, 57 or 32% of the preparers have either coached the undercover "taxpayers" on how to cheat on their returns or have urged them not to file at all.

"We were amazed at how comfortable they (the tax preparers) were talking about this to total strangers who were paying them just a few hundred dollars,'' Comiskey said in an interview.

Comiskey noted, however, that this bad behavior hasn't been limited to unlicensed preparers and that 17 of the 57 "fraud coaches" were CPAs. One CPA, for example, bragged that he specialized in creating "plain vanilla" returns that would allow the agent to cheat without triggering an audit. Another CPA generated draft tax returns that gave the agent a choice of paying 25%, 50%, 75% or all the tax owed.

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