On November 7, 2018, Treasury issued final regulations to implement new due diligence requirements applying to tax return preparers making head of household eligibility determinations for their clients. The final regulations largely track the proposed regulations, which were issued July 18. They do clarify, however, that a preparer cannot rely on pre-existing knowledge acquired outside of a tax preparation engagement to meet the due diligence requirement. The regulations also affirm the importance of contemporaneous documentation.
The Tax Cuts & Jobs Act added yet another heightened due diligence penalty, this time for failure to use due diligence in preparing an income tax return on which head of household status is claimed. Tax return preparers have grown accustomed to the due diligence penalties already in place for the earned income credit, the child tax credit and additional child tax credit, and the American opportunity tax credit. Thanks to the TCJA, Form 8867 has another column and tax return preparers are subject to a $520 penalty for each misstep on every return. With this penalty, Congress continues to enlist preparers as the first line of defense for eliminating fraudulent returns.
IRC § 6695(g)(1) now states that any tax return preparer with respect to any return or claim for refund who fails to comply with due diligence requirements …with respect to eligibility to file as a head of household under IRC § 2(b) on the return shall pay a penalty of $520 (when adjusted for inflation) for each such failure.
The final regulations clarify the requirements of the new due diligence requirements. Treas. Reg. §1.6695-2(a)(1) summarizes the requirements, effective January 1, 2018:A person who is a tax return preparer (as defined in IRC § 7701(a)(36)) of a tax return or claim for refund under the Internal Revenue Code who determines the taxpayer’s eligibility to file as head of household under IRC § 2(b), or who determines the taxpayer’s eligibility for, or the amount of, the child tax credit (CTC)/additional child tax credit (ACTC) under IRC § 24, the American opportunity tax credit (AOTC) under IRC § 25A(i), or the earned income credit (EIC) under IRC § 32, and who fails to satisfy the due diligence requirements …will be subject to a penalty as prescribed in IRC § 6695(g) (indexed for inflation under § 6695(h)). A separate penalty applies to a tax return preparer with respect to the head of household filing status determination and to each applicable credit claimed on a return or claim for refund for which the due diligence requirements of this section are not satisfied.
The final regulations clarify that filing a completed Form 8867 is not enough. In addition, the preparer must meet the following requirements:
A tax return preparer who completes Form 8867 but fails to comply with one or more of these additional requirements has not satisfied the due diligence requirements of § 6695(g).
The final regulations add Example 6 to clarify that a tax return preparer who possesses pre-existing knowledge that was acquired outside the context of the preparer’s tax return preparation practice cannot meet the knowledge requirement. Rather, the preparer must make reasonable inquiries to determine the applicable facts, and the inquiries and responses to those inquiries must be contemporaneously documented in the tax return preparer’s files.
The final regulations also clarify that preparers must ask additional questions when the information provided by the taxpayer is incomplete. The regulations revise Example 5 to demonstrate this requirement more clearly.
Documentation to comply with the new head of household due diligence requirements will take a little longer this year, but the final regulations state that "the total time required should be minimal." With all the changes required for 2018, especially if your state requires dozens of adjustments, it sounds like death by a thousand cuts. But keep in mind that the due diligence provisions have teeth. A single return without due diligence claiming AOTC, CTC, EITC, and head of household status subjects the preparer to a $2,080 penalty. These requirements cannot be ignored. Firm procedures must be updated to comply. And remember, Form 8867 is not enough!
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