EIC Due Diligence Requirements for Paid Preparers
© by Greta P. Hicks, CPA
Effective for any returns prepared after 1-1-97, a $100 penalty was added to
Internal Revenue Code Section 6695 for failure to be diligent in determining eligibility
of taxpayers for earned income credit. Define due diligence? What is due diligence? How
does a return preparer exercise due diligence? The search for the IRS definition of due
diligence started with the Internal Revenue Code where the term "due diligence"
is mentioned in five separate code sections, as follows:
Sec. 6695, Other assessable penalties with respect to the preparation of income
tax returns for other persons. FAILURE TO BE DILIGENT IN DETERMINING ELIGIBILITY FOR
EARNED INCOME CREDIT- Any person who is an income tax return preparer with respect to any
return or claim for refund who fails to comply with due diligence
requirements imposed by the Secretary by regulations with respect to determining
eligibility for, or the amount of, the credit allowable by section 32 shall pay a penalty
of $100 for each such failure.
Sec. 21. Expenses for household and dependent care services necessary for
In the case of a failure to provide the information required
under the preceding sentence, the preceding sentence shall not apply if it is shown that
the taxpayer exercised due diligence in attempting to provide the
information so required.
Sec. 129. Dependent care assistance programs, Identifying information required
with respect to service provider.
In the case of a failure to provide the
information required under the preceding sentence, the preceding sentence shall not apply
if it is shown that the taxpayer exercised due diligence in
attempting to provide the information so required.
Sec. 5006. Determination of Tax on Distilled Spirits. Where there is evidence
satisfactory to the Secretary that there has been access, other than as authorized by law,
to the contents of casks or packages stored on bonded premises, and the extent of such
access is such as to evidence a lack of due diligence or a failure
to employ necessary and effective controls on the part of the proprietor
Sec. 6323. Validity and priority (of Federal Tax Liens) against certain
Actual notice or knowledge
For purposes of this subchapter, an
organization shall be deemed for purposes of a particular transaction to have actual
notice or knowledge
if the organization had exercised due diligence.
An organization exercises due diligence if it maintains reasonable
routines for communicating significant information to the person conducting the
transaction and there is reasonable compliance with the routine. Due diligence does not
require an individual acting for the organization to communicate information unless such
communication is part of his regular duties or unless he has reason to know of the
transaction and that the transaction would be materially affected by the information.
Congress in IRC 6695 has given the IRS the authority to write the regulations
to define due diligence. Until those regulations are complete, return preparers will need
to look elsewhere for guidance. IRC 5006 and 6323 provide some hint to the definition of
due diligence but added insight is gained from searching current IRS publications, notice
and existing regulations.
Circular 230 And Due Diligence
Sec. 10.22 Diligence as to accuracy.
Each attorney, certified public accountant, enrolled agent, or enrolled actuary
shall exercise due diligence in (a) preparing or assisting in the preparation of,
approving, and filing returns, documents, affidavits, and other papers relating to
Internal Revenue Service matters; (b) determining the correctness of oral or written
representations made by him to the Department of the Treasury; and (c) determining the
correctness of oral or written representations made by him to clients with reference to
any matter administered by the Internal Revenue Service
Sec. 10.34 Standards for advising with respect to tax return positions and for
preparing or signing returns. Standards of conduct
Relying on information furnished
A practitioner advising a client to take a position on a return, or preparing
or signing a return as a preparer, generally may rely in good faith without verification
upon information furnished by the client. However, the practitioner may not ignore the
implications of information furnished to, or actually known by, the practitioner, and must
make reasonable inquiries if the information as furnished appears to be incorrect,
inconsistent, or incomplete.
For More Information Read Due
Diligence I.T. Temporary Regs. 35a.9999-1 Through 3.
Suggested Steps Leading To Due Diligence
Until the Secretary defines due diligence as it applies to IRC 6695, preparers
must look to the above notices, announcements, temporary regulations, and code sections in
order to piece together actions that a return preparer should
take in order to have exercised due diligence with regards to earned income credit. Since
actions, routines and controls seem to be the key words, here are some suggested actions
the return preparer may want to take:
- Design and employ necessary and effective controls. (Set up a system for
interviewing clients and preparation of returns.)
- Maintain reasonable routines (The preparer follows the systems, controls, and
routines he/she has in place.)
- Exercise reasonable compliance with the routine.
- Communicate significant information to the client. (Explain the law to the
- Determine the correctness of oral or written representations made by preparer to
the client. (Know the law.)
- Document attempts to secure the necessary information from the client. (Show
record of attempts to secure information and/or documents.)
- Use the clients information unless the preparer knows or has reason to know that
the information on the document is incorrect
- Make reasonable inquiries of the client if the information as furnished appears
to be incorrect, inconsistent, or incomplete.
- Do not ignore the implications of information furnished to, or actually known
by, the preparer.
- Use the same care in processing the information provided by the client that a
reasonably prudent preparer would use in handling client information.
- Exercise care in using the required information to prepare the return.
To qualify for earned income credit, the primary facts the return preparer is
to establish are:
- Verify name of taxpayer and child
- Verify accuracy of the social security numbers
- The relationship of child to the taxpayer
- Age of child
- Taxpayer is citizen or resident alien
- Child is resident of United States
- Child lived in the taxpayers residence more than half the year
- Taxpayer provided for the costs of the residence more than half the year
In the past, preparers have relied upon the oral evidence provided by the
client. The new due diligence requirement appears to make it necessary to have a routine
in place for requesting copies of documents from clients. Another key factor in
determining due diligence is the asking for alternate documents when primary documents are
not available. Until preparers are given better guidance, a combination of the following
documents may be used as an argument to show that a preparer exercised due diligence in
attempting to furnish the required information:
- Birth certificate
- Social Security card
- School records
- Insurance records
- Day care records
- Medical records
- Rental contracts
- Green Card
To avoid the $100 return preparer penalty for failure to exercise due diligence
and possible greater future problems, the preparer should be informed on current tax laws,
advise the client of the laws, ask questions of the client, have a routine in place that
requires the client to provide documents, and follow that routine. It is recommended that
the preparers routine, procedure or system be in writing, such as in the form of a
procedures manual, and that the preparer keep a record of the client interview and follow
up questions and answers.
Just do the good job youve always done but now write down.
Keep a paper trail and hope that you never need it.
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GRETA P. HICKS, CPA and former IRS manager, concentrates in solutions to IRS problems and advises business and tax professional on IRS policies
and procedures. Ms Hicks is owner of TAX SOLUTIONS, Inc., a company providing
educational materials and programs on solutions to IRS problems and is
a nationally known speaker and writer on solutions to IRS problems. To
arrange for consultation contact:
Greta's web site: http://www.gretahicks.com
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