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WASHINGTON (Reuters) - In a surprising blow to the U.S. Internal Revenue Service, a federal judge on Friday barred the agency from regulating thousands of non-professional tax return preparers, throwing into doubt a multimillion-dollar enforcement program already underway.
The implications for the upcoming tax season were not immediately clear. But an attorney representing plaintiffs in the case said the decision would allow unregulated tax preparers to once again file taxes beginning on January 30.
The decision from the U.S. District Court for the District of Columbia granted the plaintiffs a permanent injunction to stop the 2011 IRS tax return preparer regulatory program.
The ruling could affect up to 700,000 tax return preparers - ranging from independent "mom and pop" preparers to employees for H&R Block Inc and Jackson Hewitt.
Regulating tax preparers was a top priority for former IRS Commissioner Doug Shulman before he stepped down in November.
An IRS spokesman had no immediate comment late on Friday.
Shulman in 2009 called for an IRS effort to root out tax preparation fraud. The IRS Return Preparer Initiative began in 2011. It requires tax preparers to register with the IRS. It also requires preparers, especially those without other professional credentials, to pass competency tests and take classes to maintain their IRS registration.
The agency requested $35 million from Congress for the program in President Barack Obama's fiscal 2013 budget and has already awarded federal contracts for the program.
A key question ahead for the government will be whether or not to appeal the decision, said Robert Kerr, senior director of government relations for the National Association of Enrolled Agents, a tax-preparers trade group.
"Clearly the decision will be surprising to the tax preparation community," Kerr said. "It does raise fundamental questions about what happens next," adding it would be surprising if the government does not appeal the decision.
In March 2012, three independent tax preparers and the Institute for Justice, a conservative civil-liberties advocacy group, challenged the program's legal authority. They accused the IRS of enforcing the requirements without congressional approval.
The IRS said a law dating to 1884 gave it that authority, but the court disagreed.
"With an invalid regulatory regime on the IRS's side of the scale and a threat to plaintiff's livelihood on the other, the balance of hardships tips strongly in favor of plaintiffs," wrote Judge James Boasberg, who was nominated by Obama in 2010.
"The IRS was really overstepping its statutory authority," Dan Alban, an attorney for the Institute for Justice, said in an interview on Friday. The Return Preparer Initiative "was a straight-up power grab."
"The decision came down in time for tax preparers who otherwise would have had to close their shops (to) open back up again and operate in the 2013 tax season," Alban said.
The IRS wants to weed out dishonest tax preparers who can abuse their access to clients' sensitive financial data. Before the IRS launched its program, there was no federal oversight of the tax preparation industry.
The case is Sabina Loving, et al, v. Internal Revenue Service, U.S. District Court for the District of Columbia, No. 12-cv-385.
Reporting by Patrick Temple-West; Editing by Eric Beech