Hamill: Who’s the real tax auditor?

I just read a new bill introduced by two United States senators. The bill would eliminate the Internal Revenue Service’s Direct File system.

Direct File allows people to file electronically for free using an IRS-provided site. The IRS is making this more attractive by adding more state filings this year.

So why eliminate it? These senators say, “By taking on the role of both tax preparer and tax auditor, the IRS created an undeniable conflict of interest.”

Well, that doesn’t sound good. I checked the word “undeniable.” It means “unable to be denied or disputed,” per Oxford Languages. Pretty strong stuff.

Direct File handles only straightforward tax returns. It reports items that, if omitted or not reported properly, lead to correspondence letters from the IRS seeking adjustments.

These correspondence letters are a form of an audit. Direct File, in one sense, can be viewed as eliminating one step in the taxpayer-IRS correspondence system.

Tax returns that most professional preparers handle often have issues that require research and interpretation of the laws. Those returns cannot be prepared using Direct File. IRS lacks the resources to audit all returns that have “issues.”

This means the preparer of those returns may be the last line of defense against mischief. Preparers must be convinced the resolution of these tax issues satisfies a defined standard of care.

When I started in practice that standard was “reasonable basis.” It then became a “realistic possibility of success.” It is now “substantial authority.”

These terms probably mean nothing to you. You may not know which is the strongest and which is the weakest.

The standards have, in fact, risen over time. Reasonable basis is the weakest, and substantial authority the strongest.

Reasonable basis was interpreted to mean a 20-25% chance of success if challenged. Substantial authority means a 40-45%.

That’s about double. A regulated tax return preparer now needs to be surer of his or her position than in years past.

The interesting result of this is that most reviews of tax return positions are conducted only by the tax return preparer trying to meet this standard of care.

The IRS audit rate is so low that the government deliberately raised the standard to pass off the responsibility of review to the preparer.

As a tax adviser and tax return preparer, I now take on the role of both tax return preparer and “auditor.”

I don’t mean IRS auditor. I mean someone who “reviews and verifies accuracy of financial information and ensures compliance with the laws.”

Ensures means makes certain. So, I make certain that the tax return, as presented, complies with the standards of care.

This is different than saying that I make certain that the return is “right.” But that’s only because many tax return positions cannot be said to be right.

Laws, tax or otherwise, are seldom clear. That’s why we have courts. Reasonable people can and will disagree.

Even when the Supreme Court of the United States decides something, not everyone agrees with the holding.

Tax return preparers are charged only with verifying that substantial authority exists for the positions taken.

In 1995, the IRS had 112,024 full-time equivalent, or FTE, positions. Less than 120 million tax returns were filed.

In 2005, the IRS had 94,282 FTEs. Over 132 million returns were filed. In 2015, the IRS had 79,890 FTEs and 148 million returns to process.

By 2020, IRS personnel dropped to 75,773 FTEs handling 158 million returns. Recently proposed new funding would raise the agency’s FTEs to 88,000 over 10 years.

This is now in danger. Funding was reduced in January. Hiring is frozen. IRS employees are being offered the Musk “fork in the road” to retire.

Without agreeing to be forked, 20% of IRS personnel are currently eligible to retire. Within six years, 63% of IRS personnel will be eligible to retire.

The new funding was largely to replace expected retirements. Tax preparers increasingly are the primary source of verifying substantial compliance with the law.

Yes, my fellow preparers and me are both preparers and auditors. Is that situation unable to be denied or disputed as a conflict of interest?

I think not. Yet, Congress should make that clear by providing the IRS with resources to carry out its proper audit role.