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THE EXPANDED PAID PREPARER’S DUE DILIGENCE CHECKLIST

By JAMES W. RINIER, CPA, EA, AND ANTHONY P. CURATOLA
February 1, 2017
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Form 8867, the Paid Preparer’s Due Diligence Checklist, is now needed for four tax credits. This adds more due diligence requirements for tax return preparers.

 

The informed tax return preparer knows that due diligence is required when preparing a client’s tax return. When a client is claiming the Earned Income Credit (EIC), part of that diligence has included completing Form 8867, the Paid Preparer’s Due Diligence Checklist, and including it with the client’s tax return. Failure to comply could result in a penalty being assessed to the tax preparer.

 

 

Beginning with the 2016 tax filing season, the checklist is now required for returns that include any of the following credits: the EIC, the Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), or the American Opportunity Tax Credit (AOTC). Moreover, the penalty for failing to comply is applied to each of the four credits independently.

 

To say that the Form 8867 checklist is expanded is an understatement. Far more returns will require the inclusion of this checklist, along with the additional work needed by the tax preparer to complete it. Preparers who prepare only a few returns and don’t use professional tax software should be additionally careful. If they use nonprofessional tax software—designed for those filing their own returns—the form can be easily overlooked. Since self-prepared returns don’t require the form, software designed for nonprofessionals generally doesn’t include it.

 

The Department of the Treasury has provided a summary and background for the temporary and proposed regulations concerning the expanded use of Form 8867 (see the December 5, 2016, Federal Register, 81 Fed. Reg. 87444 and 81 Fed. Reg. 87502). The expanded due diligence requirements for tax return preparers are effective for any return prepared on or after December 5, 2016, for tax years beginning after December 31, 2015.

 

The IRS has determined that the proposed rulemaking won’t have a significant economic impact to entities that already prepare tax returns for clients. Its reasoning is because the current regulations already require tax return preparers to complete Form 8867 when the EIC is claimed on a return. Although this sounds good in theory, preparers will need additional time to satisfy the documentation needed to comply with the checklist.

 

Though the proposed regulations are effective for the current tax filing season, Treasury has stated that consideration will be given to any written or electronic comments and requests for a public hearing before final regulations are issued. Comments are due by March 6, 2017 (81 Fed. Reg. 87502).

 

The temporary regulations amend Treas. §1.6695-2 to provide that one tax return or claim for refund may contain claims for more than one credit subject to the due diligence requirements. Moreover, each failure to comply with the due diligence requirements results in a penalty. Examples are included that illustrate how a federal income tax return claiming both the CTC and AOTC prepared by a tax preparer that did not meet the due diligence requirements for both of these claims would be subject to two penalties: one for failure to meet the due diligence requirements for the CTC and a second penalty for failure to meet the due diligence requirements for the AOTC. Yet if the due diligence requirements were met for the CTC but not the AOTC, the tax preparer would have only one penalty for failure to meet the due diligence requirements for the AOTC.

 

IRC §6695(g) provides the penalty of $500 per credit for failing to comply with the due diligence requirement. But this penalty is adjusted for inflation in accordance with IRC §6695(h): The Form 8867 instructions for 2016 list the penalty as $510 for each failure.

 

Tax preparers familiar with Form 8867 are aware of the necessity to have adequate knowledge of their clients and to retain adequate records to be compliant when claiming the EIC for their clients. Now with the inclusion of these additional credits, tax preparers may need to expand their knowledge of their clients and, more importantly, keep additional records.

 

As the requirements stipulate, the tax return preparer must not know, or have reason to know, that any information used to determine the taxpayer’s eligibility for, or the amount of, any claimed credit is incorrect. In other words, there’s clearly an increase of investigation needed in order to satisfy the due diligence requirement. From a business point of view, this means there’s an increase in scope of the engagement of the client when preparing that client’s tax return. The process becomes more of an audit, which the client may not appreciate. Several examples are provided in the temporary regulations that touch on the need for the tax preparer to make reasonable inquiries about such things as:

 

* The children’s parents, grandparents, residency, relationship to the taxpayer;

 

* A taxpayer’s business income and expenses; and

 

* Further inquiries for Form 1098-T regarding qualified tuition expense since it doesn’t contain all the necessary information for the AOTC.

 

In addition to Form 8867, the tax preparer will need to retain the worksheets for computation of the particular credit, any contemporaneous document in the files, and any inquiries made and the responses to those inquiries.

 

The first page of Form 8867 for 2016 has a three-column check-off list of the eight due diligence requirements as they apply to each tax credit. On page 2 of the form, questions 9, 10, and 11 ask specific check-off questions for each tax credit. Finally, item 11 lists the conditions necessary for the tax return preparer to comply with all the due diligence requirements, including:

 

* The form is completed truthfully, accurately, and completely.

 

* The form is submitted in the manner required (e.g., it’s filed with the return).

 

* The taxpayer was interviewed and asked adequate questions, responses are documented on the return and in the preparer’s notes, and adequate information was reviewed to determine eligibility to the credit.

 

* Form 8867, applicable worksheets, copies of taxpayer’s documents, and a record of how, when, and from whom the information to determine eligibility was obtained from the client. These materials need to be kept for three years from the latest of the due date of the return, the date the return was filed, or the date the return was presented to the client for signature.

 

* A record of additional questions that may have been asked to determine eligibility for and the amount of the credits claimed, and the taxpayer’s answers (a “catch-all” provision), also needs to be kept for three years.

 

Finally, the tax preparer must enter a “yes” in item 12 certifying that all of the answers are true, correct, and complete to the best of his or her knowledge.

 

Compared to the many other tax credits available, the overall dollar amounts may not be huge for the taxpayers that claim these credits. The cost to include these credits on tax returns may be greater considering the additional preparation time the tax preparer will need to fulfill the expanded due diligence requirements.

 

© 2017 A.P. Curatola

 

James W. Rinier, CPA, EA, is an assistant clinical professor of accounting at Drexel University. He can be reached at jwr29@drexel.edu.
Anthony P. Curatola is editor of the Taxes column for Strategic Finance, the Joseph F. Ford Professor of Accounting at Drexel University in Philadelphia, Pa., and a member of IMA’s Greater Philadelphia Chapter. You can reach Tony at (215) 895-1453 or curatola@drexel.edu.
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