Arnold v. Commissioner -- A Strong Case for Regulation of Unlicensed Tax Return Preparers

I have been regularly reading Tax Court Decisions, in preparation of taking the Tax Court exam for admission of non-attorneys. It is considered one of (if not the) most difficult tests in the field of taxation. Yesterday, the U.S. Tax Court released TC Memorandum 2007-168 Arnold V. Commissioner. This case involves a tax accountant husband and a realtor wife who each operated separate S-Corporations for which neither paid themselves W-2 wages, each corporation deducted a myriad of expenses for which no substantiation existed, and to top all of that on their 2002 and 2003 income tax returns claimed Earned Income Credits of $352,854 and $489,827 (the earned income credit is a welfare vehicle to provide an income supplement to low income Americans that has a maximum allowable credit of around $5,000)

The most interesting move the court and the IRS made in regards to this case is treatment of owner compensation. S-Corporation officer-shareholders are required to be paid as employees however in this case the IRS and the Tax Court determined that the Arnolds were each subcontractors of their separate S-Corporations liable to SE tax rather than back FICA tax. The decision is unclear if they had appointed employees as officers, but generally this issue is one where the IRS will reclassify distributions as wages an add on much heavier employer quarterly penalties.

The most unbelievable part of this case is the amounts claimed EIC for 2002 and '03 of a third of a million and a half million dollars respectively. One of the first things any tax preparation class will teach you is the earned income credit is only worth five thousand dollars, and only if your income is in a narrow range is the EIC worth even that amount. For anyone to claim as much EIC as Mr. Arnold claimed is laughable, but for a man who others come to for their tax advise to commit such a brazen act of fraud is alarming. If this man were licensed I am sure his license will soon be (if not already) revoked. However, unless this man is enjoined by a court and without legislation, he can still prepare tax returns without a license (after his jail time, I assume he will do time)

Congress has been debating, and last I heard, is expecting to pass a requirement for all individuals engaged in the practice of tax return preparation to pass a written examination and be subject to the same ethical and continuing education requirements in tax practice to which CPA's, attorneys, and enrolled agents are obligated. This is a strong step in adding oversight to a sector whose conduct has blackened the reputation of a needed and valuable industry. I hope Congress broadens licensing to all tax preparers so that anyone practicing tax at least has to meet a minimal competency requirement, and the IRS will have greater strentgh in keeping unscrupulous swindlers from continuing to use tax as a vehicle for their malfeasance.