Refundable Credit Due Diligence Law

Section 6695 of the Internal Revenue Code and related regulations set out the refundable credit due diligence requirements and the penalties for failure to comply with them. The refundable credits subject to due diligence are the earned income tax credit (EITC), child tax credit (CTC), the refundable part of the CTC, additional child tax credit (ACTC, the nonrefundable part of the CTC, credit for other dependents (ODC) and American opportunity tax credit (AOTC). The Tax Cuts and Jobs Act of 2017 amended code section 6695 to add due diligence requirements for the head of household (HOH) filing status.

Statute

Section 6695(g) of the Internal Revenue Code as amended in 2017 states:

Any person who is a tax return preparer with respect to any return or claim for refund who fails to comply with due diligence requirements imposed by the Secretary by regulations with respect to determining (1) eligibility to file as head of household, or (2)  eligibility for the amount of, the credit allowable by section 24 (CTC/ACTC/ODC), 25A(a)(1) (AOTC) or 32 (EITC) shall pay a penalty of $500 for each such failure.

Under section 6695(h), the amount of the penalty is adjusted for inflation after 2015. The penalty for returns filed in 2019 is $520 per failure.

Treasury Regulations

Section 1.6695-2 of the regulations and proposed regulations describe the due diligence requirements. Generally, if you are paid to prepare a claim for the EITC, CTC/ACTC/ODC, AOTC or HOH filing status, you must:

  • Complete and submit the Form 8867, Paid Preparer's Due Diligence Checklist, as directed for all paper and electronic tax returns and all other claims for the EITC, CTC/ACTC/ODC, AOTC and/or HOH filing status.
  • Complete all the necessary worksheets or similar documents showing how you computed each of the credits.
  • Know the tax law and ask questions until you have all the information you need to determine eligibility for, and the amount of, the credits, and eligibility for the HOH filing status. In evaluating  information provided by the taxpayer, the tax preparer is held to a standard of making reasonable inquiries, if a reasonable and well-informed tax preparer, knowledgeable in the law, would conclude that  the information seems incorrect, inconsistent, or incomplete,. Be sure to note the questions you asked and the answers your client gave you at the time of the interview.
  • Keep a copy of all of the above, along with a record of how and when you obtained the information to determine eligibility for, and the amount of, the credits, and eligibility for the HOH filing status. You must also keep a copy of all the client's documents you reviewed and used to determine eligibility for and the amount of the credits.

 

You could be penalized for each time you fail to meet the due diligence requirements for one of the tax benefits claimed on the return. That means if you are paid to prepare a return after 2018 claiming all three credits and the HOH filing status, and you fail to meet the due diligence requirements for each of these four tax benefits, the IRS could assess a penalty of $520 for each failure to meet the requirements for each tax benefit, or $2,080.

You can find the tax preparer due diligence regulations, (Treas. Reg. §1.6695-2), on the Government Printing Office site and the proposed regulations on the federal register site. Watch our Hot Topics for Return Preparers for news on the new regulations.

The Four Due Diligence Requirements

Requirement As a paid tax return preparer, you must:
1. Complete and Submit Form 8867
  • Complete Form 8867, Paid Preparer's Due Diligence Checklist, for each EITC, CTC/ACTC/ODC, AOTC and/or HOH filing status claim you prepare.
  • Complete the checklist based on compliance with due diligence requirements and information provided by your client(s).
  • Submit the completed Form 8867 to the IRS with every electronic return you prepare claiming the EITC, CTC/ACTC/ODC, or AOTC and/or the HOH filing status.
  • Attach the completed Form 8867 to every paper return or claim for refund you prepare for the EITC, CTC/ACTC/ODC, AOTC and/or the HOH filing status and send to the IRS.
  • For every paper return or claim for refund you prepare for the EITC, CTC/ACTC/ODC, AOTC and/or the HOH filing status, advise your client of the importance of sending it with the return or claim for refund to the IRS. Find out more about the Form 8867 here.
Requirement As a paid tax return preparer, you must:
2. Compute the Credits

Complete the appropriate refundable credit worksheets from the instructions for Form 1040. Publication 972 or the Form 8863 instructions (or complete document(s) with the same information). The worksheets show what to consider in the computation.

  • Keep the records showing how you did the computations.
  • These worksheets are included with most tax preparation software.

 

Requirement As a paid tax return preparer, you must:
3. Knowledge

Not know or have reason to know any information used to determine a client's eligibility for, or the amount of the refundable credit is incorrect.

  • Not ignore the implications of any information given by the client or known and must make additional inquiries, if a reasonable and well-informed tax return preparer, knowledgeable in the law, would conclude the information is incomplete, inconsistent, or incorrect.
  • Know the law and use that knowledge of the law to ensure you are asking your client the right questions to get all relevant information.
  • Document any additional questions you ask and your client's answer at the time of the interview.

 

The Treasury Regulations give examples of the application of the knowledge requirement. Find the regulations for tax return preparer due diligence requirements on the Government Printing Office site and the proposed regulations on the federal register site.

 

Requirement As a paid tax return preparer, you must:
4. Keep Records
  • Keep a copy of the Form 8867 and the worksheets used to determine credits.
  • Keep a record of all additional questions you asked your client to comply with your due diligence requirements and your client's answers to those questions.
  • Keep copies of any documents your client gives you on which you relied on to determine eligibility for, or the amount of, the credits.
  • Keep a record of how, when and from whom you obtained the information used to complete the return.
  • Keep your records in either paper or electronic format but make sure you can produce them if the IRS asks for them.
  • Keep these records for 3 years from the latest date of the following that apply:
    • The original due date of the tax return (this does not include any extension of time for filing.), or
    • If you electronically file the return or claim for refund and sign it as the return preparer, the date the tax return or claim for refund is filed, or
    • If the return or claim for refund is not filed electronically and you sign it as the return preparer, the date you present the tax return or claim for refund to your client for signature, or
    • If you prepare part of the return or claim for refund and another preparer completes and signs the return or claim for refund, you must keep the part of the return you were responsible to complete for 3 years from the date you submit it to the signing tax return preparer.
  • Keep these records in either a paper or electronic format in a secure place to protect your client’s personal information.

 

Additional Due Diligence Topics

 

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