The Issue of Due Diligence …

“An estimated $24.3 billion in refundable tax credit payments were issued improperly during Fiscal Year 2016,” said J. Russell George, Treasury Inspector General for Tax Administration (TIGTA).  “As such, it is imperative that the IRS effectively implement the PATH Act provisions that are intended to reduce such payments,” he added. This directive from TIGTA emphasizes combined with the IRS matching efforts to identify income sources prior to releasing refundable credits the focus the IRS will be taking regarding refundable tax credit processing for the future filing season. 

The due diligence requirements for the Earned Income Tax Credit has been a long-standing practice. However, last season saw the addition of a due diligence checklist for the Child Tax Credit, the Additional Child Tax Credit and the American Opportunity Tax Credit. According to the instructions for Form 8867, “Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return.” The renewed emphasis on the due diligence requirements should serve as a reminder of the three-fold enforcement actions the IRS is positioned to take regarding these credits.

The first enforcement is against the taxpayer that cannot justify their eligibility for these credits. This could result in taxpayers facing a large bill to repay the erroneous refunds, including interest and penalties. In some cases, they may even face criminal prosecution. Additionally, they will lose the ability to claim legitimate refundable credits on future returns.

Failure to meet the due diligence requirements for claiming the EIC, the CTC/ACTC or the AOTC could result in a $510 penalty for each failure. For example, if you are paid to prepare a return claiming the EIC, the CTC/ACTC, and the AOTC, and you fail to meet the due diligence requirements for all of these credits, you could be subject to a penalty of $1,530.

Additionally, the IRS can assess penalties against a firm that employs others to prepare tax returns if the employee does not meet due diligence requirements for the EITC, the CTC or the AOTC. But, only if one of the following applies:

  • Management participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements; or
  • The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements; or
  • The firm establishes appropriate compliance procedures but disregards those procedures through willfulness, recklessness, or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate or figure out the employee was not complying.

If you employ other preparers, here are some examples of how you can protect yourself from penalties for not meeting due diligence penalties when preparing returns with a claim of the EITC, the CTC, or the AOTC:

  • Review your current office procedures to make sure they address all appropriate due diligence requirements.
  • Review your procedures with your employees to make sure they clearly understand their responsibilities and your expectations of them.
  • Conduct annual due diligence training or instruct your staff to complete the online module that we offer in both English and Spanish.
  • Test your employee’s knowledge of due diligence and your procedures.
  • Perform recurring quality review checks on your employee’s work including credit computations, questions they asked clients, documents they reviewed, and the records kept.