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Tax preparers need to know about Earned Income Credit audits

The IRS announced on Monday that it had started accepting and processing returns. You are probably starting to get appointments from early filer - refund clients.

Preparing tax returns with Earned Income Tax Credit (EITC) refunds comes with delays this year. The IRS has taken a multi prong approach to cutting down on EITC fraud. Holding these refunds is one part of the crackdown.

Auditing taxpayers and preparers is another. For tax return preparers, this means you need to complete the proper due diligence or you could face an audit and significant civil penalties.

Due diligence: Asking follow up questions

If you are paid to prepare a tax return, you need to have a sound record keeping process for all EITC documentation. A form 8867 (Paid Preparer's Due Diligence Checklist) must be completed and submitted with any return with an EITC, Child Tax Credit, Additional Child Tax Credit or American Opportunity Tax Credit.

Tax preparers must make reasonable inquiries. Relying on what a client says without following up on inconsistent responses could expose you to liability. Some easy ways to set off red flags are:

  • Manufacturing dependents that don't exist
  • Claiming a dependent inappropriately
  • Adding a schedule C that shows a loss or income that places a taxpayer into a EITC sweet spot

Promises of the highest refunds are often what it takes to compete to get clients in the door. But bad record keeping or poor training and oversight of employees can be costly and open you and your tax prep firm to audit exposure.

Audits during the filing season

The IRS has already completed pre-filing season audits and sent out letters to preparers who have had a number of previous returns with errors. During tax season an agent could stop past at any time to complete a due diligence audit.

These audits look at business practices to ensure compliance with four due diligence requirements. An IRS employee will want to review due diligence records, questionnaires, checklists, worksheets and copies of client-provided documentation in addition to asking about questioning practices and how client responses are recorded.

When you are on notice of an audit, speak with a tax attorney to learn how you can limit your exposure.

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