In February 2014, we published a blog detailing the IRS’s new campaign to up the ante when enforcing the Earned Income Tax Credit (EITC) duty of due diligence. At that time, the Internal Revenue Service penalized tax preparers who failed to meet their duty of due diligence $50 per return. Now, that penalty is a whopping $500 per return. Additionally, whereas the IRS rarely enforced the penalty when it was at a mere $50, once it jumped to $500 the IRS began pounding the pavement, looking for anyone who had neglected to meet their due diligence requirements, often catching them completely unaware.
Recently, the 2015 PATH Act was enacted; expanding the due diligence requirements to also include the Child Tax Credit (CTC) and the American Opportunity Tax Credit (AOTC). These new addendums also carry the hefty $500 per return penalties that the EITC carries.
If you are a paid tax preparer, you are legally obligated to ensure that any of your clients who are looking to take advantage of the EITC, the CTC and/or the AOTC, are actually entitled to do so. Meeting your due diligence requirement goes above and beyond simply taking their word for it. There are four standards that must be met in order to meet your due diligence requirement. Allow us to elaborate.
1. Form 8867
If your client wishes to take advantage of any of the credits mentioned prior, you, as a preparer, must complete and submit Form 8867 – Paid Preparer’s Due Diligence Checklist to the Internal Revenue Service (IRS) along with the tax return or claim for refund. It is imperative that you answer each question on Form 8867 based on information from your client and information you know to be true.
You must also personally answer question 12, Credit Eligibility Certification which reads “Do you certify that all of the answers on this Form 8867 are, to the best of your knowledge, true, correct and complete?” I do not think it is necessary for me to elaborate on how important it is to answer this question truthfully and only after having done your due diligence in order to ensure that you are being truthful.
Claiming ignorance won’t work as a defense strategy if the IRS comes knocking on your door inquiring about any clients of whom you may have allowed to take any of these credits when in fact, they didn’t meet the proper requirements.
2. Compute the credit in accordance with IRS standards
This second standard is pretty straight-forward. You simply need to complete the applicable worksheet(s) or your own worksheet(s) with the same information for any EITC, CTC and AOTC claimed on the return. Most professional tax return prep software includes the necessary worksheets.
3. Keep detailed records
This particular requirement may seem rather obvious, but we will say it anyway because it is of the utmost importance, and also to ensure that we did our due diligence in informing you about your due diligence requirements (see what I did there? Never mind…moving on). As I was saying….it is very important that you keep thorough records of all your tax prep work – especially for those who claimed the EITC, CTC or AOTC. It does not matter if said records are electronic or paper, as long as you have them.
Be sure to retain the following: Form 8867; the applicable worksheets for EITCs, CTCs and AOTCs on any return; any documents you may have relied on to complete the Form 8867 or documents you relied on to determine eligibility for, and the amount of, the credits; a record of how, when, and from whom you obtained the information to prepare the tax return and worksheet(s); and a record of any additional questions you asked, along with your client’s answers, to determine eligibility for, and the amount of, the credits.
Keep these documents for at least three years and be sure to keep a backup of these records in a separate, secure location. You will be expected to produce them if the IRS requests that you do so.
4. Investigate thoroughly
The final requirement of the tax credit due diligence is a bit of a doozy. According to the IRS, you must “not know, or have reason to know, that any information used to determine if your client is eligible for or to compute the amount of the credit(s) is not correct, not consistent or not complete.” In other words, if the information given by your client seems incorrect, inconsistent, or incomplete in any way, you must ask them additional questions and investigate the matter more thoroughly.
If it appears in any way that you simply looked the other way, rather than getting to the bottom of the issue, you will have to answer to an auditor and will likely face severe penalties. Also, if you did ask additional questions, you must have documented proof from the time of the interview including the questions you asked and the answers your client provided. Anything short of this will not fly.
What to do if you are contacted by the IRS
There may come a time where you are questioned by the Internal Revenue Service about the EITC, CTC or AOTC’s and your clients. Or perhaps you are being questioned for completely different reasons. In any event, our advice remains the same: CONTACT A TAX ATTORNEY IMMEDIATELY. Do not make the mistake of thinking that just because you are familiar, or even well-versed, in tax matters that you are fully capable of talking to an auditor without representation.
Tax attorneys are not only experts on tax laws, but they are also trained in the art of negotiating with the IRS. Having a representative who is unbiased, well-informed and most importantly – bound by law to keep anything you tell him/her completely confidential – is invaluable to your defense.
At Ayar Law, we have helped countless tax preparers from all over the United States handle due diligence audits and other confrontations with the IRS. We have seen the IRS assess penalties amassing tens of thousands of dollars to tax preparers (at times, even more) and we have successfully negotiated significant reductions of those penalties.
If you are a tax preparer and are facing a due diligence audit by the IRS, do not waste any more time! Interest and penalty charges will continue to accrue until you take action. Let us help you put this matter to bed once and for all so that you can finally breathe easy and move on with your professional and personal life!