To help low- to moderate-income taxpayers, Congress created several refundable tax credits, such as the child tax Credit, the American opportunity tax credit, and the earned income tax credit. These credits are refundable in that they not only reduce a taxpayer’s liability but also can create a refund to the taxpayer. The credits are a form of social assistance executed through the tax code.
Recognizing the potential abuse of these credits, Congress created a due diligence mechanism in Section 6695(g) to hold taxpayers and tax preparers who file fraudulent returns accountable. Having represented tax preparers in cases brought by the IRS, I’m familiar with the repercussions for those who fail to implement the proper mechanisms to meet the due diligence requirements of Section 6695(g). These requirements mandate that:
- All taxpayers claiming the EITC must provide documentation to support their eligibility, including but not limited to proof of earned income, proof of residency in an eligible area, and documentation related to qualifying children.
- Tax preparers must document any requests, questions, and additional inquiries regarding taxpayers who claim the credit.
- IRS worksheets must be completed by tax preparers and maintained in the tax files to support the credit claimed.
- IRS Form 8867 must be completed in full and signed by both the taxpayer and the tax preparer before filing any returns associated with EITC claims.
- Tax preparers must maintain records regarding each taxpayer’s eligibility for at least three years following filing of returns associated with EITC claims. These should include a copy of all pertinent forms and documents submitted by the taxpayer, as well as any notes or conclusions made regarding the taxpayer’s eligibility for the credit.
- All tax preparers involved in preparing tax returns that claim refundable tax credits must complete annual due diligence training.
- The tax preparation firm should have written policies and procedures about the due diligence required for the refundable credits, and all firm staff should be familiar with these policies and procedures.
I raise this red flag because tax preparers trying to help low-income taxpayers often don’t have all these procedures in place. I’ve defended tax preparers who did nothing wrong but couldn’t prove that their staff completed the annual due diligence training and didn’t note in their files any additional inquiry made regarding the EITC claims.
It was lost on the IRS examiner that most of the low-income taxpayers looking to claim the credit knew exactly what was needed and came prepared. The mere fact that there was no indication of additional inquiry on any of the files implied the preparer was in cahoots with the taxpayers to file false claims, regardless of the file’sbackup documentation.
The financial penalty denoted in Section 6695(g) is $560 per return filed in violation with the due diligence requirements. This means that a tax preparer who assists 50 low-income taxpayers and who fails to have their staff obtain written proof of the annual due diligence training and doesn’t have written procedures could face a $28,000 fine. Incidentally, it’s a fine where the IRS can’t show that the tax preparer filed any false return or did anything untoward and where the taxpayers properly received their EITC.
It’s been my experience that tax preparers hate the fines but still don’t want to pay attorneys to challenge these penalties. What often happens is that tax preparers just pay the penalties to stop the interest and make the problem go away. In doing so, they make the situation worse. The Return Preparer Office will view their actions as an admission of guilt and will refer the tax preparer to the Office of Professional Responsibility, which can revoke the tax preparer’s license to practice.
While it’s important that tax preparers ensure proper controls are in place to prevent abuse of the refundable credits, they need to know what to do if the IRS does show up. The strategy is to challenge the proposed assessment by filing an appeal with the IRS’ Independent Office of Appeals. It may hurt to pay an attorney for help, but it’s critical that tax preparers don’t do anything that may be viewed as an admission of guilt. More than just financial penalties are riding on this bill from the IRS.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Eric Green is one of the managing partners of Green & Sklarz LLC, focusing his practice on civil and criminal taxpayer representation. He also is the founder of Tax Rep Network, which coaches accountants and attorneys on building their IRS Representation practices.
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