Following a damning government report, lawmakers opened fire on the nation's commercial tax preparers, charging that the current "tax preparation system is severely breaking down," and that "bad practices seem to be pervasive and systematic in the industry."The sharpest criticism levelled against the paid preparer companies came from the one lawmaker that tax services can't afford to alienate - Senate Finance Committee chair Chuck Grassley, R-Iowa.

During hearings on the issue before his committee, Grassley said that Congress is getting reports that a growing minority of tax preparers "are doing a disservice to the American public. Some through bad advice. Some through incompetence and some through taking advantage of the public by unscrupulous means."

The Capitol Hill scrutiny was triggered in part by a new Government Accountability Office investigation that found widespread and serious problems with the services provided by national tax prep firms.

GAO undercover staff members who brought federal tax returns to 19 offices of unidentified tax preparation services in a major metropolitan area found that 10 of the 19 failed to report side income, seven failed to itemize or claim all available deductions, five of the preparers claimed "unwarranted extra refunds of up to almost $2,000," and two others cost taxpayers more than $1,500 by not properly completing returns. In addition, an ineligible child was claimed for the earned income credit in five out of 10 applicable cases, while in three out of nine cases, preparers failed to take the most advantageous post-secondary education tax benefit. In seven of nine cases, preparers either failed to itemize deductions, or failed to claim all available deductions.

As a result, the GAO asked the Internal Revenue Service to conduct further research after looking into the characteristics of tax returns most often completed by paid preparers, what government regulations exist for paid preparers, and what specific issues taxpayers might encounter in using them.

The report said that according to the most recent reliable data, about 56 percent of all the individual tax returns filed for tax year 2002 used a paid preparer, with higher paid preparer usage among taxpayers with more complicated returns, such as those claiming the earned income credit.

After reviewing the GAO's findings, IRS officials said that many of the preparers would have been subject to penalties for such things as negligence and willful or reckless disregard of tax rules.

Grassley's concerns were echoed by the committee's ranking Democrat, Sen. Max Baucus of Montana, who called the problems of the tax prep industry a "warning signal" that the nation's entire voluntary tax system is in jeopardy. "It's like a canary in a coal mine," he said. "I am sorry to report that the canary is dying."

Adding to lawmakers' concerns are charges that H&R Block, the nation's largest preparer, is breaching its fiduciary duty to customers by using a sales force of inadequately trained preparers to peddle IRAs and financial counseling services. Those allegations are part of a lawsuit filed by the New York Attorney General on the heels of a recent settlement by Block to resolve charges of nondisclosure of fees for refund anticipation loans.

But in his testimony before the senate committee, H&R Block vice president Robert Weinberger pointedly defended his company's efforts to market a variety of financial services to taxpayers who seek help with their returns.

According to Weinberger, the fact that roughly 60 percent of all taxpayers now use paid preparers is only partially due to the complexity of the income tax code. Taxpayers also seek help with their returns because it is an "opportunity to receive financial education and counseling," he said.

"There is increasing recognition that tax time is an opportunity for an annual financial check-up," he told Congress. "In addition, we use the opportunity to alert low-income clients to their eligibility for a variety of government benefits that can improve their family's finances, including children's health insurance, food stamps and prescription drug discounts."

Other witnesses at the hearing were less charitable in describing the practices of commercial tax prep services.

IRS National Taxpayer Advocate Nina Olson, for one, told Congress that, "The tax preparation field has increasingly become a vehicle for cross-marketing of non-tax goods and services," and that the government "should take steps to professionalize the tax preparation industry to protect both taxpayers and the tax system itself."

Citing problems with refund anticipation loans from storefront tax preparers "who disappear without a trace after April 15th," Olson said that, "Taxpayers have no way of knowing whether these purveyors of products are in any way qualified to prepare federal income tax returns."

National Association of Enrolled Agents president Francis X. Degen, EA, painted an even darker picture of the problems created by unlicensed commercial tax preparers. Non-compliant returns prepared by these practitioners range from "the blatantly fraudulent" to "the merely inaccurate due to gross incompetence," he said.

Citing widespread "preparer shopping" during each tax season, Degen said that EAs regularly encounter taxpayers who "gather up their tax documents and walk out because someone down the street has guaranteed them a minimum refund" of "$1,000, $3,000 or even higher."

In other cases, Degen said, EAs find that, "The taxpayer wants the preparer to help him or her create phony business or unreimbursed employee business expenses, incorrectly report expenses or income from rental property, or not report 'under-the-table' income."

To combat these problems, Degen said that the NAEA supports "regulating all paid return preparers, requiring an initial test for competency, background checks, annual minimum continuing education requirements and compliance with the current Circular 230 ethical standards."

H&R Block's Weinberger said that his firm would support such requirements: "We believe IRS certification of paid tax return preparers - which would require validation of applicable tax knowledge, criminal and tax-filing background checks, and minimum levels of continuing tax education - would benefit the public."

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