The Earned Income Tax Credit, known as the EITC, is an important tax benefit for working taxpayers with low or moderate income levels. But complicated rules, regarding income limits and in many cases, qualifying children, must be closely followed.
Because the EITC has a direct impact on the amount of tax collected by either reducing the amount of tax a taxpayer owes or by qualifying the taxpayer for a refund, the IRS is very concerned that it only be taken by truly qualified taxpayers. Accordingly, federal tax law places specific due diligence requirements on tax preparers to help tighten compliance with EITC qualifications.
EITC preparer due diligence requirements
A federal law passed in 2015 called the Protecting Americans from Tax Hikes Act or PATH expanded the requirements tax preparers must meet when they prepare and file returns that claim the EITC. For example, when preparing a return for a taxpayer claiming the EITC, the tax preparer must meet four requirements:
- Acquire adequate professional knowledge of the law to correctly determine whether a client is eligible for the credit, to accurately calculate the amount, to follow up on questionable client information, to ask all necessary questions of the client to determine eligibility, and to document the client's answers "at the time of the interview."
- Maintain sufficient records to show compliance, including documentation of the answers to client interview questions; client records; the details regarding how supporting information was gathered; and more.
- Prepare and file IRS Form 8867 for every return claiming EITC or one of the other credits monitored or face a penalty for failure to file the form.
- Compute the credit using the appropriate IRS worksheets and keep the supporting records for the figures used.
Due diligence noncompliance
For returns filed in 2017, a tax preparer who does not adequately meet due diligence requirements for a return will be fined $510 per each wrongly taken credit. The IRS sends certain warning letters to tax preparers whose filed returns have raised red flags that something may be amiss.
The types of things that trigger these letters are often:
- Whether a child is truly qualifying
- Whether reported income from self-employment is correct
After sending these informational letters, the IRS will continue to monitor that preparer's returns to see if the "quality ... improves."
There may be additional contact from the agency if it does not feel the preparer has sufficiently responded based on the quality of future returns. Ultimately, the IRS may send Letter 5138, notification that the preparer will be audited regarding the EITC.
Talk to a tax lawyer
The stakes could not be higher. In additional to civil monetary penalties, a tax preparer could be subject to criminal investigation and prosecution in some situations. Potential charges could include fraud, false claims for refunds, false reporting of qualifying children, understating income and more. Conviction could bring prison time, supervised release, restitution to the IRS of money owed and more.
If you have received such a letter, you cannot wait, it's crucial to contact an experienced tax compliance lawyer for review of the situation, advice about how to respond and direction for handling EITC compliance issues going forward.