Tax Preparer Due Diligence Penalties—Part II

To avoid the Tax Preparer penalties imposed under Section 6695(g) that are $635 per violation, a preparer must:

• Complete and submit Form 8867.

• Compute the Credit using the appropriate worksheets.

• Verify the taxpayer’s eligibility with adequate documentation.

• Keep the records for at least 4 years (e.g., copies of Form 8867, worksheets, documents provided by client, and records of how eligibility was determined).

The Internal Revenue Service expects preparers to make reasonable inquiries if the information furnished to her appears to be incorrect, inconsistent, or incomplete. These inquires must be documented (e.g., written notes) and records retained so that upon audit the IRS can verify the preparer’s actions. Preparers must do the following at a minimum as additional requirements could apply depending on the underlying issue:

1) Verify social security numbers with physical documentation for each person reported on that taxpayer’s return and retain them in taxpayer’s file.

2) Make inquiries to each taxpayer regarding each taxpayer’s marital status in order to verify that the taxpayer’s filing status. Preparers must record the taxpayer’s responses to the inquiries and keep the records/notes in the taxpayer’s file.

3) Make inquiries to each taxpayer that ensure that any person reported as a qualifying child is taxpayer’s child, or other relative. Preparers must record the taxpayer’s responses to those inquiries and maintain those records/notes in taxpayer’s file.

4) Maintain documentation in the taxpayer’s file showing that any person reported as a qualifying child is: a) Under 19 years of age; or b) Younger than the taxpayer and is under 24 years of age at the end of the tax year for which the return is being prepared through documentation (e.g., child’s birth certificate). Documentation verifying that the qualifying child was a full-time student for five months during the tax year for which return is being prepared (e.g., letter/document from school. c) Permanently and totally disabled, such that he or she cannot engage in any substantial gainful activity because of a physical or mental condition and a doctor has determined that that the condition has lasted or can be expected to last continuously for at least one year or can lead to death, through documentation from a doctor or from the social security administration that verifies that the child was determined to be eligible for disability benefits for the tax year for which the return is being prepared.

5) Make inquiries to each taxpayer that ensure than any person reported as a qualifying child lived with the taxpayer for more than six months during the year for which the return is being prepared and record/document the taxpayer’s responses to those inquiries, and maintain in taxpayer’s file those inquiries and responses.

6) Make inquiries to each taxpayer that ensure any person reported as a qualifying child cannot file a joint return for the year for which a return is being prepared, record the taxpayer’s responses and maintain those inquiries.

7) Make inquiries to each taxpayer that ensure that no other personal claims the reported qualifying child as a qualifying child including inquiries to ensure that the taxpayer may properly claim the child under the tiebreaker rules if they apply, record the taxpayer’s responses and maintain the inquiries and responses in the taxpayer’s file.

If a tax preparer penalty is assessed, the preparer can rebut it by claiming the failure was due to reasonable cause and not willful neglect. To establish reasonable cause, a preparer should demonstrate that they: a) Acted in good faith; b) Had adequate systems and procedures in place to ensure compliance; c) Relied on credible documentation and asked appropriate questions; d) Made an isolated error, not a pattern of non-compliance. Documentation is critical: Preparers should maintain thorough notes of client communications. Having internal procedures and compliance systems shows an effort to comply. Preparers should be able to provide an IRS auditor with an audit trail of notes, client documents, procedures and systems verifying their client’s returns.

If a penalty is assessed the preparer may appeal through the IRS Independent Office of Appeals. The preparer can submit their appeal with documentation and have a conference call with an Appeals Officer. If the matter is unresolved, the preparer may pay the penalty and sue for a refund in District Court or the U.S. Court of Federal Claims.

Gene M Bowman, Tax Attorney

Bowman Law Firm, Huntsville, Alabama