Preparer Due Diligence Requirements for
Determining Earned Income Credit Eligibility

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8798] RIN 1545-
AW74

TITLE: Preparer Due Diligence Requirements for Determining Earned
Income Credit Eligibility

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to
the due diligence requirements for paid preparers of federal income
tax returns or claims for refund involving the earned income credit.
The temporary regulations reflect changes to the law made by the
Taxpayer Relief Act of 1997. The temporary regulations provide
guidance to paid preparers who prepare federal income tax returns or
claims for refund claiming the earned income credit. The text of the
temporary regulations also serves as the text of the proposed
regulations set forth in the notice of proposed rulemaking on this
subject in the Proposed Rules section of this issue of the Federal
Register.

DATES: These regulations are effective December 21, 1998.

FOR FURTHER INFORMATION CONTACT: Marc C. Porter (202) 622-4940 (not
a toll free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

These regulations are being issued without prior notice and public
procedure pursuant to the Administrative Procedure Act (5 U.S.C.
553). For this reason, the collection of information contained in
these regulations has been reviewed and pending receipt and
evaluation of public comments, approved by the Office of Management
and Budget under control number 1545-1570.

Responses to this collection of information are mandatory.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.

For further information concerning this collection of information,
and where to submit comments on the collection of information and
the accuracy of the estimated burden, and suggestions for reducing
this burden, please refer to the preamble to the cross-referencing
notice of proposed rulemaking published in the Proposed Rules
section of this issue of the Federal Register.

Books and records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Background

This document contains amendments to the Income Tax Regulations (26
CFR parts 1 and 602) under section 6695(g) relating to the penalty
for failure of a preparer to be diligent in determining a taxpayer's
eligibility for the earned income credit (EIC). Section 6695(g) was
added by section 1085(a)(2) of the Taxpayer Relief Act of 1997,
Public Law 105-34 (11 Stat. 788, 955 (1997)) (the Act), effective
for taxable years beginning after December 31, 1996.

Section 6695(g) imposes a $100 penalty for each failure by an income
tax return preparer to meet the due diligence requirements set forth
in this regulation. The IRS may impose the section 6695(g) penalty
in addition to any other applicable penalty provided by law.

In Notice 97-65 (1997-51 I.R.B. 14 (December 22, 1997)), the IRS set
forth the preparer due diligence requirements for 1997 returns and
claims for refund involving the EIC. To avoid the imposition of the
section 6695(g) penalty for 1997 returns and claims for refund,
Notice 97-65 requires preparers to meet four requirements: (1)
complete the Earned Income Credit Eligibility Checklist attached to
Notice 97-65 (Eligibility Checklist), or otherwise record the
information necessary to complete the Eligibility Checklist; (2)
complete the Earned Income Credit Worksheet (Computation Worksheet),
as contained in the 1997 Form 1040 instructions, or otherwise record
the computation and information necessary to complete the
Computation Worksheet; (3) have no knowledge that any information
used by the preparer in determining eligibility for, and amount of,
the EIC is incorrect; and (4) retain for three years the Eligibility
Checklist and Computation Worksheet (or alternative records), and a
record of how and when the information used to determine eligibility
for, and amount of, the EIC was obtained by the preparer. This
information may be retained either as a paper record or in magnetic
media format consistent with Rev. Proc. 81-46 (1981-2 C.B. 621).

Notice 97-65 also requested comments on preparer due diligence
requirements for tax years after 1997. Two comments were received.
The commentators did not suggest alternative due diligence
requirements. One commentator suggested, however, increased
education for the public. The IRS and Treasury Department adhere to
the principle that education is an integral part of good tax
administration. Therefore, as part of its overall EIC strategy, the
IRS has established various educational tools and outreach programs
for taxpayers and preparers. These efforts are intended to provide
the public with the tools necessary to receive the full amount of
the EIC allowed by law.

The second commentator suggested that preparers should be able to
meet the due diligence requirements by using software reviewed and
approved by the IRS. The IRS does not approve commercial software.
The IRS is currently exploring, however, new opportunities for
partnership with outside stakeholders to reduce burden, enhance
customer service, and increase compliance.

As part of this effort, the IRS will continue to review this comment
and evaluate options.

Explanation of Provisions

The temporary and proposed regulations impose due diligence
standards on persons who are income tax return preparers with
respect to determining eligibility for, or the amount of, the EIC.
Consistent with existing regulations under section 6695, these
temporary regulations apply a modified definition of income tax
return preparer. Section 7701(a)(36) provides that, in general, the
term income tax return preparer means any person who prepares for
compensation, or who employs one or more persons to prepare for
compensation, any return or claim for refund of tax imposed by
subtitle A. The preparation of a substantial portion of a return or
claim for refund is treated as if it were the preparation of such
return or claim for refund. Persons are considered preparers if they
give legal advice concerning a return or claim for refund or if they
prepare another return which affects the return or claim for refund
(�301.7701-15(a)(2) and (b) and �301.7701-15(b)(3), respectively).
The regulations retain this definition of an income tax return
preparer, except that preparers who merely give advice or prepare
another return that affects the EIC return or claim for refund are
not preparers for purposes of the section 6695(g) penalty. Rather,
the due diligence standards are imposed only on paid preparers who
prepare the return claiming the EIC.

The temporary regulations essentially adopt the four due diligence
requirements in Notice 97-65. Thus, to avoid the penalty under
section 6695(g), a preparer must: (1) complete the Eligibility
Checklist (Form 8867, Paid Preparer's Earned Income Credit
Checklist, or such other form as may be prescribed by the IRS), or
otherwise record in the preparer's files the information necessary
to complete the Eligibility Checklist; (2) complete the Computation
Worksheet (Earned Income Credit Worksheet contained in the Form 1040
instructions), or otherwise record in the preparer's files the
computation and information necessary to complete the Computation
Worksheet; (3) have no knowledge, and have no reason to know, that
any information used by the preparer in determining eligibility for,
and amount of, the EIC is incorrect; and (4) retain for three years
the Eligibility Checklist and the Computation Worksheet (or
alternative records), and a record of how and when the information
used to determine eligibility for, and the amount of, the EIC was
obtained by the preparer.

The temporary regulations also provide that the income tax return
preparer may avoid the section 6695(g) penalty with respect to a
particular income tax return or claim for refund if the preparer can
demonstrate to the satisfaction of the IRS that, considering all the
facts and circumstances, the preparer's normal office procedures are
reasonably designed and routinely followed to ensure compliance with
the due diligence requirements of the regulations, and that the
particular failure was isolated and inadvertent.

The temporary regulations will be effective for taxable years
beginning after December 31, 1996. However, the Eligibility
Checklist contained in Notice 97-65 has been expanded in Form 8867.
Therefore, for taxable year 1997, the applicable Eligibility
Checklist is the Eligibility Checklist contained in Notice 97-65.
For taxable year 1998, a preparer may choose as the applicable
Eligibility Checklist either the Eligibility Checklist published in
Notice 97-65 modified however, by replacing, $9,770, $25,760,
$29,290, and $2,250 each time these figures appear on the 1997
Eligibility Checklist with $10,030, $26,473, $30,095, and $2,300,
respectively, or Form 8867. For taxable years beginning after
December 31, 1998, the applicable Eligibility Checklist will be the
Form 8867.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations.

Further, it is hereby certified, pursuant to sections 603(a) and
605(b) of the Regulatory Flexibility Act, that the collection of
information in these regulations will not have a significant
economic impact on a substantial number of small entities. This
certification is based upon the fact that the amount of time
necessary to record and retain the required information will be
nominal for those income tax return preparers that choose to use the
Alternative Eligibility Record and Alternative Computation Record.
Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not required.

Pursuant to section 7805(f) of the Internal Revenue Code, these
temporary regulations will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on their
impact.

Drafting Information

The principal author of these regulations is Marc C. Porter, Office
of Assistant Chief Counsel (Income Tax & Accounting).

However, other personnel from the IRS and Treasury Department
participated in their development.

List of Subjects

26 CFR Part 1 Income taxes, Reporting and recordkeeping
requirements.

26 CFR Part 602 Reporting and recordkeeping requirements.

Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602
are amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.6695-2T also issued under 26 U.S.C. 6695(g). * * *

Par. 2. Section 1.6695-2T is added to read as follows:

�1.6695-2T Preparer due diligence requirements for determining
earned income credit eligibility (temporary).

(a) Penalty for failure to meet due diligence requirements.

A person who is an income tax return preparer (preparer) of an
income tax return or claim for refund under subtitle A of the
Internal Revenue Code (Code) with respect to determining the
eligibility for, or the amount of, the earned income credit (EIC)
under section 32 and who fails to satisfy the due diligence
requirements of paragraph (b) of this section will be subject to a
penalty of $100 for each such failure. However, no penalty will be
imposed under section 6695(g) on a person who is an income tax
return preparer solely by reason of --

(1) Section 301.7701-15(a)(2) and (b) of this chapter, on account of
having given advice on specific issues of law; or

(2) Section 301.7701-15(b)(3) of this chapter, on account of having
prepared the return solely because of having prepared another return
that affects amounts reported on the return.

(b) Due diligence requirements. A preparer must satisfy the
following due diligence requirements:

(1) Completion of eligibility checklist. (i) The preparer must
either --

(A) Complete Form 8867, Paid Preparer's Earned Income Credit
Checklist, or such other form as may be prescribed by the IRS
(Eligibility Checklist); or

(B) Otherwise record in the preparer's paper or electronic files the
information necessary to complete the Eligibility Checklist
(Alternative Eligibility Record). The Alternative Eligibility Record
may consist of one or more documents containing the required
information.

(ii) The preparer's completion of the Eligibility Checklist or
Alternative Eligibility Record must be based on information provided
by the taxpayer to the preparer or otherwise reasonably obtained by
the preparer.

(2) Computation of credit. (i) The preparer must either --

(A) Complete the Earned Income Credit Worksheet in the Form 1040
instructions or such other form as may be prescribed by the IRS
(Computation Worksheet); or

(B) Otherwise record in the preparer's paper or electronic files the
preparer's EIC computation, including the method and information
used to make the computation (Alternative Computation Record). The
Alternative Computation Record may consist of one or more documents
containing the required information.

(ii) The preparer's completion of the Computation Worksheet or
Alternative Computation Record must be based on information provided
by the taxpayer to the preparer or otherwise reasonably obtained by
the preparer.

(3) Knowledge. The preparer must not know, or have reason to know,
that any information used by the preparer in determining the
taxpayer's eligibility for, or the amount of, the EIC is incorrect.
The preparer may not ignore the implications of information
furnished to, or known by, the preparer, and must make reasonable
inquiries if the information furnished to, or known by, the preparer
appears to be incorrect, inconsistent, or incomplete.

(4) Retention of records. (i) The preparer must retain --

(A) A copy of the completed Eligibility Checklist or Alternative
Eligibility Record;

(B) A copy of the Computation Worksheet or Alternative Computation
Record; and

(C) A record of how and when the information used to complete the
Eligibility Checklist or Alternative Eligibility Record and the
Computation Worksheet or Alternative Computation Record was obtained
by the preparer, including the identity of any person furnishing the
information.

(ii) These items must be retained for three years after the June
30th following the date the return or claim for refund was presented
to the taxpayer for signature, and may be retained on paper or
electronically in the manner prescribed in applicable regulations,
revenue rulings, revenue procedures, or other appropriate guidance.

(c) Exception to penalty. The section 6695(g) penalty will not be
applied with respect to a particular income tax return or claim for
refund if the preparer can demonstrate to the satisfaction of the
IRS that, considering all the facts and circumstances, the
preparer's normal office procedures are reasonably designed and
routinely followed to ensure compliance with the due diligence
requirements of paragraph (b) of this section, and the failure to
meet the due diligence requirements of paragraph (b) of this section
with respect to the particular return or claim for refund was
isolated and inadvertent.

(d) Effective date. (1) In general. This section applies to income
tax returns and claims for refund for taxable years beginning after
December 31, 1996. This section expires on, December 21, 2001. For
the applicable Eligibility Checklist see paragraph (d)(2) of this
section.

(2) Eligibility Checklist--(i) For the 1997 taxable year.

For taxable year 1997, the applicable Eligibility Checklist is the
Eligibility Checklist published in Notice 97-65 (1997-51 I.R.B.14)
December 22, 1997. (See �601.601(d)(2)(ii)(b) of this chapter.)

(ii) For the 1998 taxable year. For taxable year 1998 the applicable
Checklist is either--

(A) The Checklist published in Notice 97-65 (1997-51 I.R.B.14)
December 22, 1997, modified however, by applying the figures
$10,030, $26,473, $30,095, and $2,300 in place of $9,770, $25,760,
$29,290, and $2,250, respectively, each time these figures appear on
the 1997 Checklist; or

(B) Form 8867, Paid Preparer's Earned Income Credit Checklist.

(iii) For taxable years after 1998. For taxable years beginning
after December 31, 1998, the applicable Eligibility Checklist is the
Eligibility Checklist contained in Form 8867, Paid Preparer's Earned
Income Credit Checklist, or such other form as may be prescribed by
the IRS.

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 3. The authority citation for part 602 continues to read as
follows:

Authority: 26 U.S.C. 7805.

Par. 4. In �602.101, paragraph (c) is amended by adding the
following entry in numerical order to the table to read as follows:

�602.101 OMB Control numbers.

* * * * *

(c) * * *

CFR part or section where Current OMB identified and described
control No.

* * * * *

1.6695-2T .......................1545-1570

* * * * *

Acting Deputy Commissioner of Internal Revenue
David S. Mader
Approved: December 9, 1998
Assistant Secretary of the Treasury
Donald C. Lubick

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