Section 7216, a part of the Internal Revenue Code since 1971, imposes criminal penalties on tax return preparers who knowingly or recklessly make unauthorized disclosures or uses of information furnished in connection with the preparation of an income tax return.A violation of the section is not to be taken lightly — it comes with a penalty of up to a year’s imprisonment or a fine of not more than $1,000, or both.

Newly issued regulations on this section, which apply beginning in January 2009, are the first updates to the rules since the dawn of the digital age. The rules seek to give taxpayers greater control over the use of their tax return information by prohibiting disclosure by the preparer without their “knowing and voluntary” consent.

A number of industry groups, vendors and practitioners are concerned that the regulations will not only make life difficult for the preparer, but are overreaching and will have a negative effect on two elements of many practices — outsourcing and refund anticipation loans.

Along with the new final regulations, the IRS issued a revenue procedure showing exactly what form a written consent must take to be valid, and a notice of proposed rulemaking seeking comments on a rule that would prohibit tax return preparers from using or disclosing tax return information for the purpose of soliciting, or the taxpayer obtaining, a RAL or certain other bank products.


A key provision affecting outsourcing is the rule that there can be no consent to the disclosure of a taxpayer’s Social Security number to a return preparer outside of the United States.

“You can’t ask for consent to show that,” said Dave Wyle, chief executive officer of Newport Beach, Calif., outsourcing concern SurePrep.

“From a practical standpoint, there are two areas a firm needs to be concerned with if they’re outsourcing offshore. They need to get the consent signed once a year, and they need to worry about how to mask the SSNs. It has to be masked in both the scanned images of the source document as well as the pro-forma tax file,” he explained. “From the accounting firm perspective, they need to be convinced the outsourcer has a reliable process in place if they’re going to be outsourcing offshore. If the outsourcing is done inside the U.S., then this doesn’t apply — you don’t need a consent and there’s no need to mask the SSNs.”

Wyle noted that offshore outsourcing has been more popular than onshore outsourcing because it is less expensive. “However, we expect that balance to change this coming year,” he said.

The purpose of the rule is not well-served by the prohibitions in the regulation, according to Wyle. “If the point of this is to keep taxpayer data secure and confidential, this doesn’t really do anything about it,” he said. “It makes the assumption that if a person sitting offshore sees your Social Security number, it’s a security breach, but if the person is onshore, that’s alright.”

“The regulation really misses the mark,” he said. “People can hack in from anywhere in the world. If they really want to protect taxpayers’ privacy, they should pass regs that mandate the level of care that firms need to exercise in handling the information.”

Marty Davidoff, incoming president of the American Institute of Attorney-CPAs, agreed.

“The regs say a consent must be voluntary, so if I say to a client that I won’t prepare their return unless I’m allowed to use information from the return to collect my bill, that’s involuntary — you can commit a crime if you give the account information to collect the bill,” he said. “I’m often asked by my clients for copies to be sent over, or to send to a banker or lawyer. I haven’t asked for consent. Am I in violation? Like anything with the IRS, they’re looking for the real offenders who have bad intentions, people who are abusing the system.”

Steven Ladd, chief executive of Andover, Mass.-based Copanion, said that hiding the Social Security numbers in tax software is fairly straightforward, but that source documents are a different issue.

“With a half-million returns being done overseas, and with source documents averaging 50 pages per return, you’re looking at 25 million pages that have to be sorted through to redact or cover those Social Security numbers,” he said. “Some of them are in more than one place and are in different formats, so there’s no easy way to redact all those numbers. We’ve developed our own version of redact software for internal use, because we don’t want any of our employees seeing any SSNs. The next step is to automatically redact everything before our software even looks at it. Sometimes [optical character recognition] is not perfect. A form has ‘noises’ on it, dirt smudges that a person might be able to read but a computer can’t.”

“A lot of the tax prep process is not a high value-added thing — you get the paperwork together, organize it, and so forth,” he added. “That’s not why people become CPAs, so it’s been a relief valve to be able to send that work overseas.”


Meanwhile, the advance notice of proposed rulemaking, issued along with the final regulations, takes dead aim at the marketing of refund anticipation loans.

The proposed regulations would make an exception to the general principle in the final regulations that taxpayers should have control over their tax return information by providing that a tax return preparer may not obtain a taxpayer’s consent to disclose or use tax return information for the purpose of soliciting taxpayers to purchase such products.

ANPRM Question No. 1 asks, “If RALs and certain other products create a direct financial incentive for preparers to inflate tax refunds, are there alternative approaches that would eliminate or reduce this incentive?”

Question No. 2 asks, “If the marketing of RALs and certain other products exploit or have the potential to exploit certain taxpayers, is the approach described in this ANPRM better viewed as protecting taxpayers from exploitation or as restricting taxpayers’ ability to control their tax return information?”

“I think it might have been borderline reckless for the IRS, in the way certain questions were posed, to issue an advance notice of proposed rulemaking that assumes an industry is guilty without ever soliciting the facts,” said Joe Sica, government relations spokesman for Santa Barbara Bank & Trust, one of the largest providers of RALs.

“By using incomplete facts, IRS statistics that are known to be wrong, and overcharged emotion, [certain consumer groups] have done an admirable job convincing state and federal officials and lawmakers that RALs are simply a bad deal. The people who use them, who know they are a loan, who know what they cost and understand them in comparison to their other credit choices, if any, will be harmed the most.”

“Further, decoupling the process, as the Taxpayer Advocate has suggested, will remove years and layers of embedded electronic controls that compliment in every way the same compliance standards that the IRS seeks for those preparing taxes,” he said. “If successful, that separation may help re-spawn ‘refund discounters,’ a real predatory process in which a desperate tax payer is at the mercy of an unregulated loan shark.”

The notice does not outlaw RALs and similar products; it merely forbids the tax preparer from facilitating them, according to comments by Phil Drake and Tim Hubbs, chairman of the board and president, respectively, of Franklin, N.C.-based Drake Software. “If someone else in the same office or in an office next door can provide this service, then it would appear that the change proposed would just create a situation where a preparer would prepare a copy of the return, the taxpayer would then take it down the hall, next door or across the street to get it electronically filed and to obtain a bank product,” they stated. “In our view, the ANPRM would not drastically reduce the number of bank products selected; instead, it would likely increase the cost, in both time and money, to both the taxpayer and the preparer. This set-up would also preclude the small one-man/woman offices from providing bank products. It appears that no one would benefit from the implementation of the proposed rules.”

Both the Electronic Tax Administration Advisory Committee and the Council for Electronic Revenue Communication Advancement commented on the advance notice.

ETAAC, formed by the Internal Revenue Service Restructuring Act of 1998, specified that it does not believe that RALs and related financial products create financial incentives for preparers to inflate refunds. “Tax preparers earn income principally through tax preparation fees charged by the tax preparer,” it noted. “The typical tax preparation firm offering bank products earns approximately $150 to $200 from tax preparation. Tax preparation fees, by IRS regulation, may not be linked to the size of the refund.”

Moreover, banks offering RALs have lending rules that are designed to identify suspicious applications with a low probability of IRS funding. And all banks offering RALs have proactive preparer oversight programs to identify preparers who have high levels of unfunded loans, or are filing fraudulent returns.

CERCA, a nonprofit trade association founded in 1994, represents a broad cross-section of the electronic tax filing and IRS systems modernization communities. It observed that the IRS already regulates RALs through Code Sec. 7216, Revenue Procedure 2000-31 and IRS Publication 3112. A tax return preparer who is an electronic return originator cannot also be a lender under these rules, according to CERCA.

“But beyond these existing rules and sanctions, there are also significant disincentives to inflate refunds, because the tax professionals who offer these products either receive no financial incentives for the products, or their financial incentives are directly related to the accuracy of the returns they prepare,” it explained.

“Most of the tax professionals offering RALs to their clients work in independent, small businesses and their only direct payment for these products, if they receive one at all, comes through a nominal fee that the bank may pay for each bank product. These fees, where they exist, are fixed, usually about $4 for a funded [refund anticipation check] and $5 for an approved RAL. These very modest fees remain the same regardless of the size of the refund (as required by the IRS), so there is no incentive for the tax preparer to inflate tax refunds,” it stated.

Tax professionals receive no payment if the RAL is not approved by the lending bank or not funded by a refund from the IRS, which acts as a further disincentive to inflate refunds, according to CERCA.

“If there are abuses in RALs, they should be cleaned up,” said Santa Barbara Bank & Trust’s Sica. “Our bank is for a national standard under which RALs would be guided. But we aren’t for regulations that would raise prices for consumers or put consumers possibly in harm’s way.”

Sica noted that extensive marketing studies show that consumers of RALs understand the concept and that over 70 percent are repeat customers and 95 percent are satisfied with the transaction.

“It’s cheaper than wiring money through Western Union — a transaction with no risk,” he noted. “We hope an open airing on the complete facts on RALs will raise awareness that they are offered responsibly to people who need them and that, if anything, until the IRS can deliver refunds quicker, they support a national standard for RALS, rather than go down a path that would lessen government’s ability for oversight of them.”

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