An Unregulated Tax Preparation Industry Harms Maryland Families

April 18, 2017 by Natalie Neill in Blog, Budget and Tax

Last Saturday, I was finishing preparing a client’s tax return at the Volunteer Income Tax Assistance (VITA) site in west Baltimore that I run. As we were completing the signature pages, she asked me if preparers could file your taxes without your signature.

I told her that was illegal but that it does happen. Usually the paid preparer incorrectly lists the return as “self-prepared.” Lo and behold, it had happened to her.

In 2014, she made the mistake of trusting a friend who referred her to a tax preparer who only required pictures of her W-2 to file. She was surprised how large her refund was considering she only worked part of the year, and when she asked why, the preparer assured her it was correct, because she had children. She never saw, let alone signed, her tax forms. She did not find out the truth until the IRS contacted her months later, with questions about her business as a chef, a business completely fabricated by the tax preparer.

By falsifying the client’s income, the preparer put her in the sweet-spot for the maximum Earned Income Tax Credit, resulting in a refund about $5,000 larger than it should have been. That became a $5,000 liability, plus fees and interest, for the client, whose income in 2016 was just over $13,000.

The tax preparer pocketed a large chunk of the fraudulent refund and disappeared, unlikely to be held accountable in any way.

In 2016 the Comptroller of Maryland reported flagging 27,000 fraudulent returns worth $40 million, more than 40 times as many flagged in 2007. The good news is this is indicative of a growing effort to combat fraud and identity theft, and accordingly Maryland passed a law giving much-needed teeth to tax prep fraud enforcement this year. The Comptroller’s office will now have police powers relating to income taxes, and a number of technical changes make it easier to prosecute tax fraud cases, including extending the statute of limitations from three to six years.

Filing taxes in the United States is notoriously complicated. With no mention of withholdings, credits or deductions in our public education curriculum, it is no wonder most people don’t fully understand their tax returns.

For those with access to qualified preparers or reputable computer software, this is not really a problem. But for low- and moderate-income families, whose neighborhoods tend to fill up every winter with storefront paid tax prep offices, the industry can feel like the Wild West.

Earned Income Tax Credit refunds – an important tax credit that helps families who work but struggle to get by on low wages – make lower-income filers an attractive target for businesses charging high fees. People who qualify for the EITC have very low incomes and are often counting on their tax refund to cover a major expense, such as a car repair or class registration fee.

Most people don’t know they could have their taxes done for free at a Volunteer Income Tax Assistance (VITA) office if they make less than $54,000 for the year. Unfortunately, many don’t learn about VITA sites in their community until after they have been the victim of fraud.

In most parts of the country, there are no rules about who can market themselves as a paid tax preparer. Fortunately for Marylanders, we became the fourth state requiring paid preparers to pass a certification test in 2014. On the other hand, volunteer tax preparers in every state have been required to pass certification tests since VITA started in 1971.

While cases of overt fraud are rare, many paid preparers targeting low-income communities make minor errors and charge exorbitant prices for simple returns. One study found EITC filers in Baltimore paid storefront paid preparers an average ranging from $309 at H&R Block to $509 at Liberty Tax Services. This worked out to be between 13 and 22 percent of their refunds, which averaged $2,335. Tax preparers tend to advertise their lowest rates, typically less than $200, that do not apply to EITC filers.

The aggressive marketing of the paid tax preparation industry is effective – nationally only 3 percent of EITC recipients used the free tax sites like VITA they are eligible for; 68 percent used a paid preparer. According to IRS data, returns filed by paid preparers incorrectly over-claimed EITC at a rate double returns filed by VITA offices. It is of course the taxpayer who has to pay back any excess credit when the IRS or state realizes the mistake, often months later with fees and interest.

Earned Income Tax Credit fraud is rare, IRS data shows the majority of overpayment comes from unintentional errors due to the complexity of the credit’s rules, and many paid tax preparers are professional, qualified and operate within the law. However, an unregulated industry leaves taxpayers vulnerable to identity theft and reckless errors. Whether through willful fraud or honest mistakes, a small minority of unqualified paid preparers can cause extreme financial damage, especially to low-income filers. The complicated nature of our tax code lends itself to this type of abuse. The fact that until a few years ago there was no certification process at all for tax preparers (unlike, for example, hair stylists) is ludicrous. Maryland should continue leading the way towards a fair framework and effective enforcement of paid tax prep regulation.