Court Says IRS Cannot Prevent Contingent Fee Arrangements for Refund Claims

Editor: Sally P. Schreiber, J.D.

Court Decisions

The U.S. District Court for the District of Columbia granted a motion of summary judgment and issued an injunction to prevent the IRS from regulating contingent fee arrangements for the preparation and filing of ordinary refund claims under Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10) (Ridgely, No. 1:12-cv-00565 (CRC) (D.D.C. 7/17/14)).

In 2007, the IRS amended Circular 230 to prohibit tax practitioners who are subject to its rules from charging contingent fees for services related to preparing, filing, or presenting tax returns or refund claims (Circular 230, §10.27). (Contingent fees were prohibited for preparing tax returns starting in 1994, but were allowed for amended returns and refund claims until the 2007 amendment.)

The plaintiff, Gerald Ridgely Jr., CPA, sued the IRS, arguing that the agency exceeded its statutory authority when it attempted to regulate contingent fee arrangements for the preparation and filing of ordinary refund claims (refund claims made after the taxpayer has filed a tax return but before the IRS has started an audit of that return). The suit specifically focused on whether the IRS had the statutory authority to regulate fee arrangements between a taxpayer and a CPA regarding ordinary refund claims before the IRS had started adversarial proceedings and before the CPA was formally representing the taxpayer.

Like the Loving case (Loving, 742 F.3d 1013 (D.C. Cir. 2014), aff’g 917 F. Supp. 2d 67 (D.D.C. 2013)), which held that the IRS does not have statutory authority to regulate tax return preparers, this case turned on the IRS’s authority under 31 U.S.C. Section 330. Subsection (a)(1) of that statute allows the secretary of the Treasury to “regulate the practice of representatives of persons before the Department of the Treasury.” The plaintiff argued that preparing and filing ordinary refund claims does not constitute practice before the Department of the Treasury because such claims arise before the IRS has begun to audit the return.

The court looked to the Loving decision’s interpretation of “representative” and “practice.” The Loving court said that a “representative” was someone “with authority to bind others” (742 F.3d at 1016) and excluded tax return preparers from the definition because they have no “legal authority to act on behalf of taxpayers” (id. at 1017). The Ridgely court reasoned that practitioners preparing ordinary refund claims are in the same situation and therefore are excluded from the definition of “representative.”

The Loving court excluded tax return preparation from the definition of “practice” because it does not involve “practice during an investigation, adversarial hearing, or other adjudicative proceeding” (id. at 1018). The Ridgely court noted that preparing and filing an ordinary refund claim likewise takes place before the IRS has made any adversarial assessment of the taxpayer’s liability, and therefore it also does not constitute “practice.”

The court did not accept the IRS’s argument that because the plaintiff is a CPA he is therefore subject to the rules of Circular 230. The court rejected the idea that, because CPAs practice before the IRS at times, the IRS has authority to regulate all of their conduct.

Therefore, the court held that the IRS lacked statutory authority to promulgate contingent fee restrictions on practitioners preparing and filing ordinary refund claims and granted the plaintiff a permanent injunction to stop the IRS from forbidding contingent fee arrangements for the preparation and filing of ordinary refund claims.