SPECIAL REPORT

Preparer Due Diligence Requirements Expanded to Cover More Credits

Preparer Due Diligence Requirements Expanded to Cover More Credits 2

Paid return preparers, who fail to comply with the due diligence requirements with respect to any EIC, CTC or AOTC claimed on a return that they prepare, can be subject to a due diligence penalty of $510 per failure.

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The Protecting Americans from Tax Hikes (PATH) Act of 2015 expanded the preparer due diligence requirements (and penalty for failure to comply) to the Child Tax Credit (CTC), including the additional CTC, and the American Opportunity Tax Credit (AOTC). Previously, the requirements applied only to the Earned Income Credit (EIC). The preparer due diligence requirements are spelled out in Reg. 1.6695-2 (issued in 2011 with respect to the EIC) and Temp Reg. 1.6695-2T (issued in late 2016 to implement the expansion of the requirements to the CTC and AOTC). Under these requirements, paid return preparers must take specific steps to determine the taxpayer’s eligibility for, or the amount of, the EIC, CTC and AOTC. Failing to do so can result in a penalty of $510 per failure for taxable years beginning in 2016 or 2017.

Return preparers who prepare returns containing any of these credits must ask specific questions and perform specific tasks to protect themselves from the due diligence penalty. This may well entail going above and beyond what has historically been done when preparing Form 1040s — meaning the “same as last year” approach won’t cut it for returns containing the CTC or AOTC this year.

Preparer Due Diligence Requirements Expanded to Cover More Credits 3

THE DUE DILIGENCE PENALTY

Paid return preparers, who fail to comply with the due diligence requirements with respect to any EIC, CTC or AOTC claimed on a return that they prepared, can be subject to a due diligence penalty of $510 per failure. The penalty won’t apply if the facts and circumstances demonstrate that the tax return preparer’s normal office procedures are reasonably designed and routinely followed to ensure compliance with the due diligence requirements and the failure to meet the due diligence requirements was isolated and inadvertent.

A firm employing a tax return preparer subject to the due diligence penalty is also subject to a penalty if (1) one or more members of the principal management (or principal officers) knew of the failure to comply with the due diligence requirements; (2) the firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements or (3) the firm disregarded its reasonable and appropriate compliance procedures through willfulness, recklessness or gross indifference.

Bottom Line: Establishing appropriate procedures to ensure compliance with the due diligence requirements and then routinely following those procedures is paramount to avoiding the due diligence penalty.

Bottom Line: Establishing appropriate procedures to ensure compliance with the due diligence requirements and then routinely following those procedures is paramount to avoiding the due diligence penalty.

MULTIPLE DUE DILIGENCE PENALTIES CAN APPLY TO A SINGLE RETURN

The due diligence requirements apply to each credit claimed on a return. Therefore, since a return may now contain more than one such credit (the EIC, CTC and/or AOTC), multiple due diligence penalties can apply to a single return.

Example: Joe prepares a 2016 Form 1040 for a client claiming the CTC and the AOTC. Joe fails to meet the due diligence requirements for both credits. Unless he can qualify for an exception, Joe will be subject to a due diligence penalty of $1,020 ($510 × 2) — one penalty for failing to meet the CTC due diligence requirements and a second for failure to meet the AOTC due diligence requirements. If Joe had met the due diligence requirements for the CTC, but not for the AOTC, he would have been subject to a due diligence penalty of $510 for failing to meet the AOTC due diligence requirements.

Preparer Due Diligence Requirements Expanded to Cover More Credits 4

SATISFYING THE DUE DILIGENCE REQUIREMENTS To satisfy the due diligence requirements and protect themselves from the penalty, for each return claiming the EIC, CTC and/or AOTC, paid return preparers must:

1. Complete and submit Form 8867 (Paid Preparer’s Due Diligence Checklist) and complete the actions described on Form 8867 for each credit claimed.

2. Meet the knowledge requirement by interviewing the taxpayer, asking adequate questions, contemporaneously documenting the questions and the taxpayer’s responses and reviewing adequate information to determine if the taxpayer is eligible to claim the credit and in what amount. Under the knowledge requirement, the return preparer must not know, or have reason to know, that any information used in determining the taxpayer’s eligibility for, or the amount of, any EIC, CTC and/or AOTC claimed on the return is incorrect. In making this determination, the implications of information furnished to, or known by, the return preparer cannot be ignored. Reasonable inquiries must be made if a knowledgeable return preparer could conclude that the information furnished appears to be incorrect, inconsistent or incomplete. Any inquiries made and the responses to the inquiries must be contemporaneously documented in the files.

3. Keep copies of Form 8867 and the following documents:

a. The applicable worksheets for any credits claimed

Note: According to the Form 8867 instructions, preparers must complete the applicable IRS worksheet for the EIC, CTC and/or the AOTC (or their own worksheet that provides the same information), as well as all required forms and schedules for each credit claimed on the return.

b. Any taxpayer documents on which the preparer relied to determine eligibility for, and the amount of, the credit

c. A record of how, when and from whom the information used to prepare Form 8867 and worksheet was obtained

d. A record of any additional questions the preparer may have asked to determine eligibility for and amount of the credits and the taxpayer’s answers

4. Retain this information for three years from the latest of:

a. The due date of the tax return (not including extensions)

b. The date the return was filed (if the preparer signed the return and filed it electronically)

c. The date the return was presented to the taxpayer for signature (if the preparer signed the return and did not file it electronically)

d. The date a nonsigning tax return preparer submitted to the signing preparer the part of the return for which he was responsible

Preparer Due Diligence Requirements Expanded to Cover More Credits 5

CONCLUSION

Form 8867, reproduced in Appendix 1, contains a series of specific questions that must be asked and tasks that must be performed by the preparer to ensure that the client is entitled to claim the EIC, CTC and/or AOTC. At the bottom of page 2, the preparer must certify that taxpayer was eligible for any such credits claimed on the return. For clients claiming the CTC and AOTC, this may well require asking questions and probing deeper into the client’s situation than you have in the past. Because of this, it’s a good idea to flag clients who will likely claim one of these credits and plan the engagement accordingly. You’ll want to cover this at the client’s interview or set up a specific time to do so. The critical thing is to have and document these specific discussions with the client so that you “can certify that all of the answers on this Form 8867 are, to the best of your knowledge, true, correct and complete.” You’ll also want to ensure that everyone in the firm is aware of and complies with these requirements.

Warning: The preparer due diligence requirements for the EIC have been in place for a number of years and the IRS has taken enforcement of them very seriously. They have established a Refundable Credit Preparer Compliance Program, under which they have annually sent out letters to preparers who have filed returns claiming the EIC where the Form 8867 was not attached and conducted office visits and unscheduled due diligence audits of preparers who prepare returns claiming questionable EICs. The Refundable Credit Preparer Compliance Program has now been expanded to include CTC and AOTC. Therefore, this same level of scrutiny will presumably apply to preparers who prepare returns claiming the CTC and/or AOTC. Taking time now to ensure you have procedures in place to deal with these new requirements will be time well spent. As the old adage goes, an ounce of prevention is worth a pound of cure.

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Form 8867, reproduced in Appendix 1, contains a series of specific questions that must be asked and tasks that must be performed by the preparer to ensure that the client is entitled to claim the EIC, CTC and/or AOTC.

Preparer Due Diligence Requirements Expanded to Cover More Credits — Appendix 1 6

Form 8867Department of the Treasury Internal Revenue Service

Paid Preparer's Due Diligence ChecklistEarned Income Credit (EIC), Child Tax Credit (CTC), and American Opportunity Tax Credit (AOTC)▶ To be completed by preparer and filed with Form 1040, 1040A, 1040EZ, 1040NR, 1040SS, or 1040PR.

▶ Information about Form 8867 and its separate instructions is at www.irs.gov/form8867.

OMB No. 1545-1629

2016Attachment Sequence No. 70

Taxpayer name(s) shown on return Taxpayer identification number

Enter preparer's name and PTIN

Due Diligence Requirements

Please complete the appropriate column for all credits claimed on this return (check all that apply). EIC CTC/ACTC AOTC

1 Did you complete the return based on information for tax year 2016 provided by the taxpayer or reasonably obtained by you? . . . . . . . Yes No Yes No Yes No

2 Did you complete the applicable EIC and/or CTC/ACTC worksheets found in the Form 1040, 1040A, 1040EZ, or 1040NR instructions, and/or the AOTC worksheet found in the Form 8863 instructions, or your own worksheet(s) that provides the same information, and all related forms and schedules for each credit claimed? . . . . . . . . . . . . . . . . . . . . . No Yes Yes No Yes No

3 Did you satisfy the knowledge requirement? Answer “Yes” only if you can answer “Yes” to both 3a and 3b. To meet the knowledge requirement, did you: Yes No Yes No Yes No

a Interview the taxpayer, ask adequate questions, and document the taxpayer’s responses to determine that the taxpayer is eligible to claim the credit(s)? . Yes No Yes No Yes No

b Review adequate information to determine that the taxpayer is eligible to claim the credit(s) and in what amount? . . . . . . . . . . . . . . . Yes No Yes No Yes No

4 Did any information provided by the taxpayer, a third party, or reasonably known to you in connection with preparing the return appear to be incorrect, incomplete, or inconsistent? (If “Yes,” answer questions 4a and 4b. If “No,” go to question 5.) . . . . . . . . . . . . . . . . . . . . . . Yes No Yes No Yes No

a Did you make reasonable inquiries to determine the correct or complete information? . . . . . . . . . . . . . . . . . . . . . . No Yes Yes No Yes No

b Did you document your inquiries? (Documentation should include the questions you asked, whom you asked, when you asked, the information that was provided, and the impact the information had on your preparation of the return.) . . . . . . . . . . . . . . . . . . . . . . . . Yes No Yes No Yes No

5 Did you satisfy the record retention requirement? To meet the record retention requirement, did you keep a copy of any document(s) provided by the taxpayer that you relied on to determine eligibility or to compute the amount for the credit(s)? . . . . . . . . . . . . . . . . . . . . . . . No Yes Yes No Yes No In addition to your notes from the interview with the taxpayer, list those documents, if any, that you relied on.

6 Did you ask the taxpayer whether he/she could provide documentation to substantiate eligibility for and the amount of the credit(s) claimed on the return? No Yes Yes No Yes No

7 Did you ask the taxpayer if any of these credits were disallowed or reduced in a previous year? . . . . . . . . . . . . . . . . . . . . . .(If credits were disallowed or reduced, go to question 7a; if not, go to question 8.) Yes No Yes No Yes No

a Did you complete the required recertification form(s)? . . . . . . . . Yes No Yes No Yes No 8 If the taxpayer is reporting self-employment income, did you ask adequate

questions to prepare a complete and correct Form 1040, Schedule C? . . . Yes No Yes No Yes No For Paperwork Reduction Act Notice, see separate instructions. Cat. No. 26142H Form 8867 (2016)

Preparer Due Diligence Requirements Expanded to Cover More Credits — Appendix 1 7

Form 8867 (2016) Page 2

Due Diligence Questions for Returns Claiming EIC (If the return does not claim EIC, go to question 10.)

EIC CTC/ACTC AOTC

9a Did you explain to the taxpayer the rules about claiming the EIC when a child is the qualifying child of more than one person (tie-breaker rules), and have you determined that this taxpayer is, in fact, eligible to claim the EIC for the number of children for whom the EIC is claimed? . . . . . . . . . . Yes No

b Did you explain to the taxpayer that he/she may not claim the EIC if the taxpayer has not lived with the child for over half the year, even if the taxpayer has supported the child? . . . . . . . . . . . . . . . . . . Yes No

Due Diligence Questions for Returns Claiming CTC and/or additional CTC (If the return does not claim CTC or Additional CTC, go to question 11.)

10a Does the child reside with the taxpayer who is claiming the CTC/ACTC? (If “Yes,” go to question 10c. If “No,” answer question 10b.) . . . . . . . Yes No

b Did you ask if there is an active Form 8332, Release/Revocation of Claim to Exemption for Child by Custodial Parent, or a similar statement in place and, if applicable, did you attach it to the return? . . . . . . . . . . . . Yes No

c Have you determined that the taxpayer has not released the claim to another person? . . . . . . . . . . . . . . . . . . . . . . . Yes No

Due Diligence Questions for Returns Claiming AOTC (If the return does not claim AOTC, go to Credit Eligibility Certification.)

11 Did the taxpayer provide substantiation such as a Form 1098-T and receipts for the qualified tuition and related expenses for the claimed AOTC? . . . . . Yes No ▶ You have complied with all due diligence requirements with respect to the credits claimed on the return of the

taxpayer identified above if you:

A. Complete this Form 8867 truthfully and accurately and complete the actions described in this checklist for all credits claimed;

B. Submit Form 8867 in the manner required;

C. Interview the taxpayer, ask adequate questions, document the taxpayer’s responses on the return or in your notes, review adequate information to determine if the taxpayer is eligible to claim the credit(s) and in what amount(s); and

D. Keep all five of the following records for 3 years from the latest of the dates specified in the Form 8867 instructions under Document Retention.1. A copy of Form 8867,2. The applicable worksheet(s) or your own worksheet(s) for any credits claimed,3. Copies of any taxpayer documents you may have relied upon to determine eligibility for and the amount of the credit(s),4. A record of how, when, and from whom the information used to prepare this form and worksheet(s) was obtained, and5. A record of any additional questions you may have asked to determine eligibility for and amount of the credits, and the

taxpayer’s answers.▶ If you have not complied with all due diligence requirements for all credits claimed, you may have to pay a $510

penalty for each credit for which you have failed to comply.

Credit Eligibility Certification

12 Do you certify that all of the answers on this Form 8867 are, to the best of your knowledge, true, correct and complete? . . . . . . . . . . . . . Yes No

Form 8867 (2016)

T-601005_1/2017_PD

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