IRS must refund excessive PTIN fees it charged

A district court held that from 2011 to 2017 the IRS charged excessive fees to issue and renew preparer tax identification numbers (PTINs) and must refund the excessive fees charged to return preparers.

Background

From 1976 to 1998, tax return preparers were required by Sec. 6109(a) to list their Social Security numbers (SSNs) for identification purposes on returns they prepared. In 1998, Congress amended that statute to authorize the IRS to permit return preparers to list a separate identification number issued by the agency instead of an SSN, and in 1999 the IRS issued regulations creating the PTIN program and allowing, but not requiring, preparers to use a PTIN issued by the IRS instead of the preparer’s SSN on returns.

In 2010 and 2011, the IRS created a mandatory credentialing process for preparers who are not attorneys or certified public accountants, including a background check, a competency exam, and ongoing education requirements. As part of this program, the IRS made PTINs mandatory for return preparers. Also, purportedly under the rules of the Independent Offices Appropriations Act (IOAA), 31 U.S.C. Section 9701 (which governs what can be the basis of a user fee and the amount of the fee that can be charged by an agency), the IRS began charging a “PTIN fee” along with a “vendor fee” to obtain and renew a PTIN. The vendor fee was paid directly to a third-party contractor that was hired to develop, maintain, and operate the computer system responsible for PTIN registrations.

The IRS’s preparer credentialing program was unpopular with many return preparers, and a group of them sued the IRS in district court over the program. In Loving, 917 F. Supp. 2d 67 (D.D.C. 2013) , the district court invalidated the IRS’s credentialing requirement. The D. C. Circuit affirmed (Loving, 742 F.3d 1013 (D.C. Cir. 2014)). The district court’s decision invalidated many of the credentialing program activities that the PTIN fees funded. However, it did not invalidate the regulations requiring all return preparers to obtain and renew PTINs and to pay a fee do so.

While happy about the demise of the credentialing program, many return preparers were still displeased about the continuing mandatory PTIN requirement and the fees imposed for obtaining and renewing a PTIN. A suit was brought in the District Court of the District of Columbia, which was eventually certified as a class action for all individuals and entities who had paid an initial and/or renewal fee for a PTIN. The suit challenged the PTIN requirement and the fees and sought in part an award of restitution refunding the PTIN fees paid by the class members.

On cross-motions for summary judgment, the district court held that the Code authorized the IRS to require the use of PTINs and that its decision to do so was not arbitrary and capricious under the Administrative Procedure Act. The court also held that the IRS was not authorized to charge a fee for the issuance or renewal of PTINs because PTINs did not constitute a “service or thing of value provided by [an] agency,” within the meaning of 31 U.S.C. Section 9701(b), which was the only proper basis for the fee. Therefore, the court enjoined the IRS from charging PTIN fees going forward.

The IRS appealed the decision to the D. C. Circuit. The D.C. Circuit vacated and remanded the district court’s decision, holding that the IRS was authorized by the statute to impose a fee to recoup the costs of “generating PTINs and maintaining a database of PTINs” because the PTIN system was a service that provided return preparers the private benefit of protecting the confidentiality of their personal information. The IRS, which under the district court’s injunction had discontinued charging return preparers a fee for obtaining and renewing PTINs in 2017, began to charge a fee again.

On remand the district court sought to determine whether the PTIN and vendor fees the IRS had charged were excessive. The parties filed cross-motions for summary judgment on the issue. The return preparer class argued that the 2011 through 2017 PTIN and vendor fees were excessive as a matter of law. The IRS conceded that portions of the 2011 through 2017 PTIN fees were excessive but continued to defend other portions of the PTIN fees and all of the vendor fees. It further argued that it is entitled to an “offset” to any award of restitution based on the amount it could have charged return preparers from 2017 to 2020 but was unable to because of the court’s prior injunction against the collection of PTIN fees.

The district court’s decision

The district court held that the 2011 through 2017 PTIN and vendor fees were excessive as a matter of law and that the return preparer class was entitled to an award of restitution of the excessive fees they paid. It further held that the IRS was not entitled to an offset to the amount of the restitution award for fees it was unable to charge due to the district court’s prior injunction that was overturned by the D.C. Circuit. The court remanded to the IRS to determine an appropriate refund for the return preparer class.

The district court first answered the question of what, under the IOAA, the IRS could consider in determining the fee for providing or renewing a PTIN. The IOAA states that a fee for a service or thing provided must be fair and based on the costs to the government or the value of the service or thing to the recipient; the public policy or interest served; and other relevant facts. Based on D.C. Circuit precedent, the court found that there were two constraints on an agency regarding a fee: The agency could not charge more than the reasonable cost it incurs to provide a service, or the value of the service to the recipient, whichever is less; and, if the specific agency activity in question produces an independent public benefit, the agency must reduce the fee that it would otherwise charge by that portion of the costs attributable to the public benefit.

The district court then addressed the deference it was required to give to the IRS’s fee determination. The court concluded that it should not defer to the IRS’s determination of whether the activities used to justify the PTIN and vendor fees were sufficiently related to the provision of PTINs to return preparers, but it should defer to the IRS’s estimation of how much it costs to carry out those activities.

Accordingly, the district court then considered whether the activities that were included in the determination of PTIN fees were sufficiently related to the provision of PTINs. Of the various activities whose costs were included in the composition of the fee during the period at issue, the activities the IRS chose to defend were certain direct and indirect costs of the Return Preparer Office (RPO) compliance department (compliance costs); the costs incurred by the RPO Suitability Department to verify the self-reported credentials of CPAs and attorneys working as return preparers, to perform prisoner list and specially designated national list checks, and to process suitability referrals from taxpayers or IRS departments of preparers who purportedly should not be able to obtain or maintain PTINs (suitability costs); and costs for certain RPO customer support, communication, IT, and operational support activities (support activities).

After reviewing all these activities, the district court only agreed that some of these activities’ costs could be included in the PTIN fee. The court found that, of the compliance costs the IRS wished to charge for, the only sufficiently related costs that could lawfully be included in the PTIN fee were the direct and indirect costs of investigating “ghost” preparers; handling complaints regarding the improper use of a PTIN, the use of a compromised PTIN, or the use of a PTIN obtained through identity theft; and composing the data to refer those specific types of complaints to other IRS business units. It found that the support costs could only be included to the extent that they funded activities supporting the provision of PTINs and the maintenance of the PTIN database that conferred the private benefit to the return preparer class of identity protection, as opposed to the support activities that conferred an independent benefit to the IRS and the public. Finally, it determined that none of the suitability costs could be included in the PTIN fee.

The district court then separately analyzed the vendor fees. It determined that only the portion of these fees that were related to the issuance, renewal, and maintenance of PTINs and support for those activities could be charged to return preparers. The IRS did not dispute that some of those fees were not allowable. It argued, however, that this did not matter because the fees were initially set by contract in 2010, before many of the capabilities in the system provided by the third party for activities that were not allowable activities were implemented. The court said “[t]hat argument is unpersuasive” (slip op. At 30). Thus, to the extent the vendor fees went beyond funding the portions of work related to the issuance, renewal, and maintenance of PTINs and charged return preparers to cover portions of that work that benefited only the agency and the public, the fees were excessive and must be refunded.

The district court then turned to the question of the propriety of an offset. The IRS also argued that if the court found the IRS owed some amount of restitution to the class, it was entitled to an offset of the restitution amount of reasonable PTIN fees it could have charged return preparers, and vendor fees it would not have had to pay itself, during 2018 through 2020 because of the court’s injunction against charging fees for providing and maintaining PTINs, which the D. C. Circuit reversed. The court stated: “That argument is riddled with problems, and the Court cannot accept it” (slip op. At 31).

The district court noted that, as a general rule, it was well established that one had the right to recover what one has lost by the enforcement of a judgment that is subsequently reversed and, accordingly, courts have recognized claims in restitution for money paid pursuant to a court order that is later reversed. However, the court found that the IRS was not asserting a counterclaim for restitution, and, if it was, it was not seeking restitution for money it had paid to the return preparer class but for the value of the work of providing and maintaining the PTINs during the injunction period for which it was not compensated. The court found that the primary case the IRS cited in support of this proposition involved “an entirely different scenario,” and otherwise there was no support for an offset for a restitution award based on an amount that a defendant could have charged a plaintiff but for an injunction that was later invalidated.

Without any support for what the IRS was requesting, the district court reasoned that the IRS was asking the court to approve a new type of offset. The court stated that this was not automatically impermissible, as an award of restitution was an equitable remedy that the court could reduce if equity so required. However, whatever its authority to order an offset as “an exercise of equitable discretion,” it declined to do so.

Reflections

Here, the district court, dutifully applying the D.C. Circuit’s mandate, correctly determined that, under the rules of the IOAA, the IRS overcharged for the PTIN services it provided to return preparers and that it is obligated to refund the amount it overcharged. While a fee in line with what it costs to issue PTINs and maintain the PTIN database is perfectly unobjectionable under the IOAA, a fee that includes numerous extra costs for the IRS to do other things not directly related to those tasks is clearly excessive.

Steele, No. 1:14-cv-1523-RCL (D. D.C. 2/21/23)

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.