As a tax professional you want to provide your clients with the largest refunds possible so they feel comfortable using your services year after year. Tax credits like the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), and the American Opportunity Tax Credit (AOTC) make providing a larger refund possible to your qualifying clients. However, when claiming this return for your client it’s important to be aware that you, as the Tax Preparer, can be penalized for failing to meet Due Diligence Requirements, these penalties often taking the form of hefty fines levied against you or your tax business. In this week’s article we aim to inform and educate tax pros (just like you) how the new and current tax laws to avoid unnecessary fines and penalties, let’s dive right in!
The Law
The following paragraph is an excerpt from Section 6695(g) of the Internal Revenue Code. You can read the full code here.
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 (as defined in section 2(b)) on the return, or (2) eligibility for, or 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.
The amount of the penalty is adjusted for inflation. For returns filed in 2023, the penalty is $560 per failure per return.
It can apply to each tax benefit claimed on a return. That means if you are paid to prepare a return claiming all three credits and HOH filing status, and you fail to meet the due diligence requirements for all four tax benefits, the IRS may assess a penalty of $560 per failure, or $2,240.
Additionally, if your tax firm employs additional tax preparers and they fail to meet due diligence when claiming one of the previously mentioned tax credits then it is the firm itself, not the preparer, who is liable and will receive the penalties associated.
Four Due Diligence Requirements
Now let’s actually discuss the due diligence requirements (for additional information, relative links, and sources for this article click here).
Requirement
Your Responsibility
Complete and Submit Form 8867
Based on information obtained from your client or information you otherwise reasonably obtain or know, you must –
- Complete Form 8867, Paid Preparer’s Due Diligence Checklist,
And
- Electronically submit the completed Form 8867 to the IRS with the e-Filed return or claim.
- For a return not e-Filed, provide a copy of the completed Form 8867 to your client for inclusion with the filed return or claim.
- If you are the non-signing preparer, provide a completed electronic or paper copy of Form 8867 to the signing preparer for inclusion with the filed return or claim.
Compute the Credits
Based on information obtained from your client or information you otherwise reasonably obtain or know, you must –
- Complete the appropriate worksheets to compute each applicable credit, such as those found in the instructions for Form 1040 or Form 8863,
Or
- Complete the computations using your own similar worksheets and make sure to keep records showing what information you used and how you made the computations.
Knowledge
- You must not know or have reason to know that any information you used to claim the credits or HOH filing status is incorrect.
- You cannot ignore the implications of any information given to you or known to you.
- You must make additional reasonable inquiries, if a reasonable and well-informed tax return preparer, knowledgeable in the law, would conclude the information furnished appears incorrect, inconsistent or incomplete.
- At the time you interview your client, make and keep a record of these inquiries and your client’s answers.
- 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.
The Treasury Regulation gives eight examples of meeting the knowledge requirement.
Keep Records for Three Years
Keep a copy of –
- The completed Form 8867,
- The completed worksheets used to determine the amount of each credit,
- A record of how, when and from whom you received the information used to complete Form 8867 and the worksheets, and
- Any documents your client showed you that you relied on to complete Form 8867 or the worksheets.
- Any additional information you relied on.
- Keep these records for 3 years from the latest date of the following that apply:
- The due date of the tax return (not including any extension of time for filing), or
- The date the tax return or claim for refund was electronically filed, or
- If not electronically filed, the date you presented the tax return or claim for refund to your client for signature, or
- If you prepare it and another preparer completes and signs the return or claim for refund, the date you submitted it to the signing tax return preparer.
- Keep these records secure in either a paper or electronic format.
Consequences of Failing to Meet Due Diligence Requirements
If you or a team member at your tax firm fail to meet due diligence requirements when filing a return then a financial penalty between $500-$600 will be placed against the offending tax firm per due diligence failure, this could easily add up to $2,400 per tax return (assuming the preparer claimed every tax credit and failed to provide due diligence for each).
Additional consequences of due diligence failures include:
- Suspension/ Expulsion from E-filing.
- Criminal penalties in the case of fraud.
- Barred from preparing tax returns for others.
- Disciplinary actions taken by the IRS Office of Professional Responsibility
Watch out for yourself and your employees this tax season and make sure steps are taken to prevent fines and penalties from the IRS. If you need additional assistance then consider partnering with the professionals at Swift Financial Partners. We have a proven record of success in the tax industry and have helped many tax professionals achieve their business goals. If you’re ready to take the next step in your career and grow your tax business like never before then partner with SwiftFP today at the link below.
