Posted 10/24/11

EITC DUE DILIGENCE PENALTY INCREASED TO $500

President Obama has signed into law a trade bill which increases the penalty on preparers who do not exercise "due diligence" when determining eligibility for and the amount of a client's earned income tax credit (EITC). The measure, Public Law 112-41, the United States-Korea Free Trade Agreement Implementation Act, increases the penalty from $100 to $500 for each failure. The increase applies to returns that must be filed after 2011.

On October 6, the IRS issued proposed regulations spelling out the EITC due diligence requirements, including filling out the Form 8867 checklist, sending the checklist in with returns, and maintaining the checklists in the client files. See the "IRS News & Information" section of the NSTP website for an article on the proposed regulations.

Observations: As one of our Board members commented, preparers may be facing a $500 penalty for answering just one of the Form 8867 questions incorrectly. With questions such as--" Could the taxpayer, or the taxpayer's spouse if filing jointly, be a qualifying child of another person for the year on line 1?" and "Did the child live with the taxpayer in the United States for over half of the year?"–a heavy burden is being placed on tax preparers to personally investigate the family circumstances of the taxpayer. Where does this duty to investigate the taxpayer end? The IRS makes the following statement in Question 22 of the Form regarding a tax preparer's duties:

"To comply with the knowledge requirements, you must not know or have reason to know that any information used to determine the taxpayer's eligibility for, and the amount of, the EIC is incorrect. You may not ignore the implications of information furnished to or known by you, and you must make reasonable inquiries if the information furnished appears to be incorrect, inconsistent, or incomplete. At the time you make these inquiries, you must document in your files the inquiries you made and the responses you received."

It remains to be seen how stringently the IRS will enforce these Draconian rules against preparers. This provision was included as a tax offset to help pay for the trade bill, so there is a revenue number associated with the penalty increase. In short, the government plans to bring in money with this increased penalty provision.