Proposed Regs Would Alter Due Diligence Requirements for Determining EIC Eligibility

[IR 2011-98 , Preamble to Prop Reg 10/06/2011 , Prop Reg § 1.6695-2]

The IRS has issued proposed regs that would require paid tax return preparers to file a due diligence checklist, Form 8867, with any federal return claiming the Earned Income Credit (EIC). Under the existing regs, Form 8867 is only required to be completed and retained in a preparer's records. In an accompanying news release, IRS explains that this proposed requirement is to help ensure that the credit is only given to taxpayers who qualify.

Background. An “eligible individual” (in general, an individual who has a “qualifying child” for the tax year, or any other individual who doesn't have a qualifying child but meets the requirements set out in Code Sec. 32(c)(1)(A)(ii) ) is allowed as a credit against his or her tax for the tax year an amount equal to the “credit percentage” of so much of the taxpayer's “earned income” for the tax year as doesn't exceed the earned income amount. The EIC is phased out at certain levels of earned income. It is also refundable, and can provide a tax benefit to taxpayers who otherwise owe no taxes.

The credit percentage and earned income amount, and therefore the maximum EIC, depend on the number of qualifying children that the taxpayer has.

Existing regs. Under Reg. § 1.6995-2(b) , in order to avoid the Code Sec. 6695(g) penalty, a preparer must:

1. Complete Form 8867, Paid Preparer's Earned Income Credit Checklist, or other form prescribed by IRS, or otherwise record in the preparer's files the information necessary to complete the Eligibility Checklist;
   
2. Complete the Earned Income Credit Worksheet, contained in the Form 1040 instructions, or otherwise record in the preparer's files the computation and information necessary to complete the Computation Worksheet;
   
3. Have no knowledge, and have no reason to know, that any information used by the preparer in determining eligibility for, and the amount of, the EIC is incorrect; and
   
4. Retain for three years the Eligibility Checklist and the Computation Worksheet (or alternative records), and a record of how and when the information used to determine eligibility for, and the amount of, the EIC was obtained by the preparer. The three-year period runs from the June 30th following the date the return or claim for refund was presented to the taxpayer for signature.

Observation. Additionally, a preparer may avoid the penalty for a particular return or claim for refund if he can show to IRS's satisfaction that, considering all the facts and circumstances, his normal office procedures are reasonably designed and routinely followed to ensure compliance with the due diligence requirements, and that the particular failure was isolated and inadvertent. (“Facts and circumstances exception,” Reg. § 1.6695-2(c))

Proposed regs. The proposed regs would modify the existing regs as follows:

1. Require a tax return preparer to not just complete Form 8867 (or its successor) or otherwise record the required information, but also to submit the Form 8867 with the tax return or claim for refund claiming the EIC. ( Prop Reg § 1.6695-2(b)(1)(i) )
   
2. Change the three-year retention date to run for three years from the later of the due date of the return (determined without regard to any extension of time for filing), or the date the return or claim for refund was filed. ( Prop Reg § 1.6695-2(b)(4) )
   
3. Subject to the Code Sec. 6695(g) penalty all “return preparers,” whether an individual or firm, who determine eligibility for or amount of an EIC and fail to satisfy the due diligence requirements. ( Prop Reg § 1.6695-2(a) )

   Observation. In contrast, Reg. § 1.6695-2(a) only subjects a “signing tax return preparer” to the penalty.

4. Before imposing the penalty on a firm based on an employee's failure to comply with the due diligence requirements, establish that a member of its principal management (or the principal management of a branch office) participated in or knew of such failure. ( Prop Reg § 1.6695-2(c)(1) )
   
5. Subject a firm to the penalty if it has established reasonable and appropriate compliance measures, but disregarded same through willfulness, recklessness, or gross indifference in the preparation of a tax return or refund claim for which the penalty is imposed. ( Prop Reg § 1.6695-2(c)(2) )
   
6. Provide that a firm that is subject to the penalty under the special rules for firms under Prop Reg § 1.6695-2(c) cannot satisfy the facts and circumstances exception. ( Prop Reg § 1.6695-2(d) )

Comments requested. IRS requests comments on the clarity of the proposed regs and how they can be made easier to understand. Comments must be received within 30 days after publication. A hearing is scheduled for Nov. 7, 2011.

Effective date. The proposed regs would apply to tax returns and claims for refund for tax years ending on or after Dec. 31, 2011, that are filed after the date that they are published as final in the Federal Register.