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EITC Due Diligence – Avoiding Pitfalls for Tax Preparers

Overview of EITC Due Diligence

The Earned Income Tax Credit (EITC) is fertile ground for the IRS to levy penalties against unwary tax preparers, with an EITC error rate ranging from 23%-28%.  The Internal Revenue Code specifically requires a tax preparer to exercise due diligence with respect to determining a taxpayer’s eligibility for the EITC, and each failure to comply may result in a $500 penalty against the tax preparer and his or her employer. Additionally, the IRS can assess a minimum penalty of $1,000 if the failure is due to an unreasonable position, or a minimum penalty of $5,000 if the failure is due to reckless or intentional disregard of rules or regulations. And that isn’t all, as the IRS may be able to permanently revoke the preparer’s status as a registered return preparer and suspend/expel you from IRS e-file. Tax preparers need to take appropriate measures to ensure that they avoid these penalties.

IRS Requirements for EITC Due Diligence

The IRS provides four due diligence requirements that mandates the tax preparer: (1) submit the EITC eligibility checklist, (2) compute the EITC, (3) pass the knowledge requirement, and (4) keep records. The knowledge requirement is the most important because 90% of the penalties the IRS assess are for failure to comply with the requirement.

The knowledge requirement provides that a tax preparer must not know, or have reason to know, that any information the preparer used to determine eligibility for the EITC, or to compute the taxpayer’s EITC, is incorrect. A consistency and reasonableness standard applies to the information the client provides. A preparer must make reasonable inquiries if a reasonable and well-informed preparer knowledgeable in the law would conclude that the information furnished to the preparer appears to be incorrect.

Preparers must be proactive to comply with the knowledge requirement. Asking the right questions can be crucial. The preparer should be able to recognize if any information is contradictory or incomplete and must make additional inquiries if so. For example, the preparer should ensure that a child is a qualifying child, that the taxpayer’s filing status is correct, and that the income is accurately reported. Any additional inquiries and the client’s responses to them must also be contemporaneously documented.

Employers of preparers can be liable for their employee’s lack of due diligence. Penalties may be imposed if the principal managers in a firm or regional office knew about the lack of compliance, the firm does not have reasonable and appropriate EITC compliance procedures, and the firm recklessly or willfully disregarded those procedures.

IRS Audits of Tax Return Preparers for EITC Due Diligence

Have you been notified by the IRS of an upcoming EITC Due Diligence Audit?  Unlike traditional IRS audits, EITC Due Diligence audits occur extremely quickly, which means that you may not have sufficient time to review your tax return files and workpapers and prepare for the audit.  Furthermore, the IRS may insist that the EITC audit take place at your office which can often interrupt your work and office, especially if the audit happens during tax season.  If you fail to respond to the IRS notice of audit, the IRS may either assess penalties on all tax returns you have prepared, or summons you to appear before the IRS.

How We Can Help

Our team of tax attorneys and CPAs are skilled and experienced in handling EITC Due Diligence audits.  As CPAs, we understand the ins-and-outs of the tax return preparation practice so that we can explain and convince the IRS that due diligence was exercised by you.  As attorneys, we are skilled negotiators and understand the EITC Due Diligence law so that you can rest assured that we will present the best possible arguments to the IRS auditor or appeal officer.  Furthermore, you are protected by the attorney-client privilege when dealing with our staff

You have a lot on the line so don’t make the mistake of defending your EITC Due Diligence audit alone and unrepresented.  Feel free to call us at 619-795-8000 to discuss how we can help defend and close out your audit.