Circular 230’s Bar on Contingent Fees Only Applies Once Taxpayer’s Relationship With IRS Becomes Adversarial or Matter in Issue Is Disputed

July 18, 2014 | Roger A. McEowen

Earlier this year, the D.C. Circuit Court of Appeals invalidated an IRS regulation that said the IRS could regulate previously unregulated tax return preparers.  IRS had claimed that tax return preparation meant that the tax return preparer was “representing” the taxpayer before the IRS such that IRS had regulatory power over the preparer.  Based on that claim, IRS began subjecting previously unregulated preparers to testing and certification requirements.  However, the court said that tax return preparers are not representatives because tax return preparation does not involve practice before the IRS.  Simply preparing a tax return does not involve an adversarial proceeding that involves “representation.”  There is no contested proceeding. 

Other IRS regulations involving tax preparers are contained in Circular 230.  One of these other rules (§10.27 of Circular 230) prohibits a tax preparer from charging a contingent fee for the preparation of a return, including refund claims.  

In this case, a CPA prepared a refund claim for a client on a contingent fee basis.  IRS claimed the fee arrangement violated Circular 230 because the regulatory authority of IRS covered “tax planning and advice, preparing or filing or assisting in preparing or filing returns or claims for refund or credit…”  IRS sought to penalize the CPA in accordance with its regulation (31 C.F.R. 10.27(b) and the CPA fought back, claiming that the regulation was invalid because it exceeded the statutory authority of the IRS given to it by the Congress under 31 U.S.C. §330(a)(1).  The court agreed, holding that the preparation and filing of a tax return or claim for refund does not involve “representation” before the IRS.  “Representation,” the court held, is only invoked once the IRS responds to the claim for refund and the preparer submits a power-of-attorney form to the IRS.  There is no adversarial relationship until that point in time.  The court stated, “tax return preparers neither “possess legal authority to act on the taxpayer’s behalf” and cannot “legally bind the taxpayer by acting on the taxpayer’s behalf.”  The court noted that the D.C. Circuit in the Loving case specifically held that the definition of “tax return preparers” included preparers that prepared refund claims.  Preparing a return as well as a claim for refund is substantively different from “practice” or “adjudicating cases” the court noted.  The court also disagreed with IRS’s claim that it could regulate all conduct of CPAs because a CPA is automatically subject to Circular 230 irrespective of whether “representation” was involved. 

The court granted summary judgment for the CPA.  Ridgely v. Lew, No. 1:12-cv-00565 (CRC),2014 U.S. Dist. LEXIS 96447 (D. D.C. Jul. 16, 2014).