IRS Leaves Hundreds of Millions of Dollars in Preparer Penalties on the Table(Title A)

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Alternate Title: IRS Measured Response to Preparer Penalties Suggests a Deliberate Approach to Combat Egregious Errors (Title B)

Congress and IRS alike have looked to somewhat unorthodox ways to control for high error rates associated with refundable credits.  The IRS’s in-limbo plan to more directly regulate commercial preparers is partly attributable to Congress’ increased use of refundable credits to achieve non-revenue raising objectives.  The sweet of using the tax system to deliver benefits is low direct administration costs; the sour is typically higher error rates relative to other transfer programs.  One of the items from Senator Baucus’ tax administration reform proposals of late last year was adding specific statutorily-required due diligence requirements for the child tax credit.  The earned income credit (EIC) is the one specific targeted due diligence requirement in the Code.

In this post, I will describe the status of IRS efforts to enforce one aspect of the EIC due diligence rules, the requirement that a paid preparer checklist be submitted along with the tax return. I highlight it because a recent TIGTA report shows that despite evidence of rampant preparer noncompliance with the submission requirement in the last two filing seasons, IRS assessed no penalties against noncompliant preparers.

One can frame the IRS’s failure to assess as the IRS dropping the ball on the issue. On the other hand, the IRS is affirmatively reaching out to many preparers who have not complied, and has stated that it will sanction those who are most noncompliant. Given the scarce resources the IRS has, and the uncertainty surrounding the related issue of regulating paid preparers, I think its approach of educating is prudent, though to be most effective it will have to keep its powder dry and sanction the most egregious preparers.

Some context and brief description follows.

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Congress and IRS have been tinkering with the EIC due diligence rules to give them more teeth.  For example, per Section 6695(g), Congress has boosted the penalty for preparers who flunk the due diligence rules to $500 per failure, from $100 per failure. Through regulations under Section 6695, effective for the 2012 filing season, IRS now requires a preparer to submit Form 8867, the Paid Preparer’s EIC Checklist, with a filed tax return. Failure to submit a Form 8867 can trigger a $500 preparer penalty per failure.

Earlier this year,  TIGTA in a report discussing last year’s (2013) filing season faulted IRS for not assessing any penalties against preparers who failed to comply with the regulations’ checklist submission requirement even though thousands of preparers responsible for many EIC-claiming tax returns are not submitting any EIC checklists with the returns.

For example, TIGTA research showed that in the 2012-filing season (tax year 2011), “almost 534,000 (4 percent) tax returns with EITC claims totaling more than $1.5 billion were filed without the required Form 8867.”

The recent TIGTA report finds a similar state of noncompliance in last year’s filing season (tax year 2012), with as of late September the IRS still not having assessed penalties against noncompliant preparers.

Analysis of the more than 14.4 million tax returns with an EITC claim that were prepared by a paid tax return preparer as of May 2, 2013, identified 708,298 (5 percent) tax returns claiming more than $2 billion in the EITC where the IRS determined that the tax return preparer either did not include the required Form 8867, Paid Preparer’s Earned Income Credit Checklist, or included an incomplete Form 8867. These 708,298 tax returns were prepared by 122,133 tax return preparers who continue to not comply with EITC due diligence requirements.  (page 13)

 

According to TIGTA, IRS could assess approximately $354 million in preparer penalties for tax year 2012 stemming from preparer due diligence submission failures.

The IRS’s stated reason for not assessing penalties for tax year 2011 against noncompliant preparers was that the changes came in late in 2011, and that it wanted time to educate preparers who might not understand the new rules given that the submission requirement might not have been “fully disseminated.” (TIGTA Report, page 14)

For tax year 2012, IRS has taken a measured response to the failures. Starting last month, it sent letters to preparers it has identified as failing to comply with the submission requirements, and it previously sent warning letters to noncompliant preparers. IRS has posted sample letters here—though some of the letters address issues other than EIC, such as Schedule C.

Teasing out the information in the TIGTA report suggests that not all preparer violations are equal—some of the preparers are likely to be responsible for multiple failures. Likewise, TIGTA distinguishes between preparers who submit an improperly completed Form 8867 from those who submit no Form 8867.

The vast majority of those not complying are submitting incomplete checklists, rather than none at all. For example, last year, when it came to preparers who submitted no checklists, there were 52,000 paid preparers responsible for over 158,000 tax returns with $362 million EIC claimed, with a potential penalty amount of over $79 million.  Of those who submitted an incomplete checklist, there were about 69,000 paid preparers responsible for over 549,000 returns with $1.67 billion in EIC claimed, with a potential penalty amount of almost $275 million.

TIGTA’s report throws down the gauntlet and prods the IRS to start to sanction preparers who continue to violate the submission requirements.  TIGTA also suggested that IRS reach out to noncompliant preparers early in the filing season to allow preparers to become compliant and thus reduce the amount of potential penalty.  IRS in its response to the TIGTA report indicated that it was sending warning letters and would assess penalties against egregious or habitually noncompliant preparers. IRS believes that the TIGTA submission error rate is not accurate, and may not fully reflect software glitches that some preparers claimed was causing incomplete checklist submissions.

Some Parting Thoughts

I think that targeted due diligence requirements tailored to areas of systemic tax problems is generally a good idea.  Specific due diligence tailored to areas where research shows high error rates can increase accountability and visibility, two of the main drivers for tax compliance. Asking preparers to verify some essential facts and submit answers to specific questions about facts smokes out fibs and forces taxpayers to more directly misstate information to preparers.  It likely chills preparers who might turn a blind eye to circumstances that suggest a taxpayer is not entitled to a claimed benefit. More prominently highlighting facts relating to EIC eligibility will increase the psychological costs of cheating, and help preparers avoid unintentional mistakes.  Tax administrators have vastly underestimated the importance of psychological costs, a point I emphasized in an earlier post on Senator Baucus’ plan to include due diligence rules for child tax credits. That post highlights some of the insights of Duke Professor Dan Ariely, who draws heavily from behavioral psychology and other disciplines in an effort to nudge policymakers away from the notion of traditional rational actor compliance models.

The due diligence model comes with costs, including increased preparation time and likely higher fees for taxpayers visiting preparers. That cost also increases the attraction of black market or ghost preparers, something that Kelly Phillips Erb (Taxgirl) wrote about in an excellent piece last year on the Forbes blog.

My colleague Keith Fogg points out another cost associated with the due diligence rules. If the IRS penalizes all of the preparers TIGTA has identified, it places a significant burden on its system.  IRS may be looking at its available resources and waiting until it can budget for the employee time it will take to sort through that many penalties.  It might also be waiting to see what happens to the Loving case.  If it wins that case, it has different tools at its disposal to deal with preparers.

Notwithstanding what happens with Loving, absent an about-face, Congress will likely continue to use the tax code to achieve social policy. For those who are concerned with the integrity of our tax system, the due diligence rules are an innovative way to approach systemic problems.  A deliberate approach that uses the rules to root out the worst preparers initially in my mind makes good sense.  So, I would go with Title B to this post, though the success of the efforts to leverage preparers to reduce error rates will be dependent upon IRS efforts not only to educate, but to also punish those preparers who violate the rules.

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. James T Marsh EA says

    I find Professor Book’s comments and reasoning interesting but incomplete. I am in the course of representing several tax preparers who are in Appeals contesting 6695(g) penalties that average $100,000 or more. The TIGTA data unfortunately does not seem to keep up with the development of these contested cases. The people I am dealing with in Appeals have requested of National information regarding any court cases which could be of use in formulating guidance, and the reply so far is that National is unaware of any pending cases, but is most interested in finding out if any are in the offing.

    For those interested, here are the issues that have been developed in the Appeals process so far:

    1. There is a question of the intent of Congress and the size of the penalty. Note that the penalty actually turns out to be $1,000 PER RETURN in practice ($500 on the individual preparer and $500 on the firm) and that the usual minimum sample for a site visit on this issue is 50 returns. At this level, there is not much “educational” effect; imposition of the full penalty amounts in the cases in Appeals will undoubtedly wipe out most of the preparers involved. This may be the intent of Congress, to get rid of “bad apples”. But it may also be an unintended result of overzealous drafting.

    2. As written, the statute does not seem to provide much discretion for the IRS in enforcement. There is no explicit “safe harbor” rule as there is for 6662 penalties in Section 6664. Again, this may be a drafting oversight or it may be an intentional policy.

    3. The standards for applying the penalty in the IRM as indicated in the worksheets provided examiners in reporting penalty cases seem to be over-broad and often lack in sufficient detail to determine what the exact violation is. For example, one of the penalty codes is for “failure to provide information requested”. The “violator” is only provided a worksheet summary with the name and TIN of the return and the penalty codes that being applied.

    4. There is a bit of ambiguity as to whether this penalty is a “divisible” penalty in which the preparer can pay one penalty on one return, file a Form 843 for a refund, and then be able to seek court review. Tax Court does not have jurisdiction over these cases so the issue of having to pay the penalty in full prior to adjucation is an important one.

    I would be most interested to see Professor Book’s thoughts, and those of any others, on these concerns.

    • James,
      Thanks so much for the comments. Les is out of town this weekend, but we have shared some emails on this topic today. I will paraphrase what we have discussed below, which largely has to do with the divisible nature of the tax. Les or Keith may provide more insight over the next few days.

      We all believe payment of the penalty is somewhat divisible, meaning you can pay just the penalty for one return and then make a refund claim after exhausting your administrative remedies. I do not know if that would be one $500 payment or one $1000 payment. I assume you have reviewed Treas. Reg. 1.6696-1, and the other Regulations under Section 6695. There may be language in the Regulations indicating payment is only needed for one penalty imposition before a refund claim can be made. You may have also found Nordbrock v. US, 86 AFTR2d 2000-6546 (DC AZ 2000), which stated that Section 6695(d) was a divisible penalty. The following Chief Counsel Notice may also be helpful: http://www.irs.gov/pub/irs-wd/1150029.pdf. Assuming it is divisible, the government will make a counterclaim for the remaining outstanding amounts, so that it will have its full judgment if it wins.

      • James T Marsh EA says

        Thanks for the citations and analysis! I haven’t double-checked, but I think these are the same citations National gave my Appeals Officer. If I have some you did not list, I will post them soon. As I said, the IRS seems to be in a bit of a quandry over this as much as we are. I get the impression there are a couple thousand cases in the system already and the numbers are big.

        I am also curious as to how many folks out there have run into this program or know someone who has.

        • Don’t forget that you can litigate the penalty without making any payment by simply awaiting a notice of intention to levy to collect it or a notice of federal tax lien filing. Either notice can be the subject of an Appeals CDP proceeding, subject to Tax Court review. Of course, I am assuming that Appeals has not offered a prior opportunity for you to contest the penalty.

  2. Dear Friends,
    IRS recently sent me a letter along with nearly $50K penalty for failing to submit Form 8867, Paid Prepare’s EIC Check List in Tax 2012.
    I am very concerned, can someone help me on this matter that how to handle with it in order to remove the penalty?
    Thank you so much,

    • Frank, I would suggest you speak with a tax professional who is familiar with the penalty. You can find my email address under my bio, and if you email me with your location, I’ll try to give you a good referral. For various reasons, we do not provide specific legal advice through the blog.

      • Dear Stephen,

        I was recently visited by IRS agent for the “Due Diligence” examination after 9 years of preparing taxes. The agent was professional but I felt that he just wanted to find reason to impose penalties without looking at the big picture (considering current procedure in place and my effort to documents my customer’s responses).

        I have met all due diligence requirement but
        1. Complete and Submit Eligibility Checklist
        2. Compute the Credit

        And all of the

        3. Knowledge
        4. Keep Records

        Except that I did not document or fell short on documenting the additional info I was asking my client, even though I did feel any inconsistent, incorrect from their responses. My clients mostly consist of the local refugee who immigrated to US recently (1-5 years) in which majority of them are low income and qualify for EITC.
        Examples:

        1. Tax payer claiming his niece/nephew who lived with dependents and was present with his sister/brother (father of the niece/nephew) at the time of the filing his/her taxes.
        2. Single mother/father who claiming their children who their spouse past away in civil war (He wants to penalize me because I did document where is the spouse)
        3. Older sibling claiming his younger siblings who the parent did not work and was present at the time of the filing
        4. Parent claiming full time student son/daughter (I did not specifically stated what school name he/she attends)

        The agent evaluated 38 return the first time around and two weeks later the remaining 37 return, total of 75 returns and he initially concluded 47/75 returns could possibly have penalties but he will re-evaluate them and number might be reduced. The agent even told me that he feels bad and he is 100% sure that my office is asking all necessary questions to validate eligibility of EITC but my documentation was not enough.

        The two weeks period between the first visit and second visit I was able to call majority of my clients whose returns evaluated during the first visit and 24/38 responded to me and wrote a notarized letter with their and dependent’s SSN/DOB and detail information to my office stating all the answers for the question I usually ask initially. (Where the parent of niece/nephew, did they live together, where your spouse, why you income is low, do you receive welfare assistant, and many other questions along with copy of SS card and birth certificates for those children who born in U.S).

        I showed the agent the notarized letters during the second visit; he was surprised but said he only considers what was available at the time of the visit.

        I am still waiting for final report of his findings. The agent even suggested to me that I should reject any penalties proposed and go through the appeals process, which is first meeting with his manager during next phase then appeals office after manager meeting if the manger did not make any changes.

        Penalty of 47 * 500 = $23500 is a lot of money to pay for not writing less than half line sentence for example; “The dependent attended ABC college” equals to $500.00 penalty.

        Any inputs or help of how should I prepare to fight any penalties imposed?

        While the penalty appeals in process will that have any negative impact on filing taxes for clients next year 2014 or will my clients refund be delayed in result?

        Thank you
        Ismail

        • Did you appeal, and how did it come out? I have an appeal pending for a client in the same situation.

          Thanks, Fred

          • STEPHANIE BOYLES says

            I am in the same situation, I am working on my response which has to be completed by 2/15/16, I received my evaluation on January 15, 2016 in the mist of tax season beginning and 30 days to respond. I passed 3 of the 4 parts of due diligence requirements and was told that I fail 78 of 92 files on the (4) knowledge-
            because I did not asked or document the correct questions. At 500 a file, that is $39,000 it is ridiculous.

  3. Leanne Pearson says

    I received a letter from the IRS letting me know that I prepared a return that did not have the Form 8867 attached. The form was present in the eletronic record. Unfortunatley the return was rejected because this tax payer’s mom claimed her exemption. No the mom did not have the right to the exemption. The return had to be filed on paper. I cannot prove the form 8867 was present when the return was mailed. I have been preparing taxes for 13 years and have never had an issue until now. Will the IRS impose the $500.00 penalty?

    • While we do not provide legal advice on any particular situation, I direct you to the regulations, which provide exceptions to the imposition of penalties in the case of isolated and inadvertent failures:

      1.6695-2(d) Exception to penalty. The section 6695(g) penalty will not be applied with respect to a particular tax return or claim for refund if the tax return preparer can demonstrate to the satisfaction of the IRS that, considering all the facts and circumstances, the tax return 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 tax return or claim for refund was isolated and inadvertent. The preceding sentence does not apply to a firm that is subject to the penalty as a result of paragraph (c) of this section.

  4. Dear Friends,

    I was recently visited by IRS agent for the “Due Diligence” examination after 9 years of preparing taxes. The agent was professional but I felt that he just wanted to find reason to impose penalties without looking at the big picture (considering current procedure in place and my effort to documents my customer’s responses).

    I have met all due diligence requirement but
    1. Complete and Submit Eligibility Checklist
    2. Compute the Credit

    And all of the

    3. Knowledge
    4. Keep Records

    Except that I did not document or fell short on documenting the additional info I was asking my client, even though I did feel any inconsistent, incorrect from their responses. My clients mostly consist of the local refugee who immigrated to US recently (1-5 years) in which majority of them are low income and qualify for EITC.
    Examples:

    1. Tax payer claiming his niece/nephew who lived with dependents and was present with his sister/brother (father of the niece/nephew) at the time of the filing his/her taxes.
    2. Single mother/father who claiming their children who their spouse past away in civil war (He wants to penalize me because I did document where is the spouse)
    3. Older sibling claiming his younger siblings who the parent did not work and was present at the time of the filing
    4. Parent claiming full time student son/daughter (I did not specifically stated what school name he/she attends)

    The agent evaluated 38 return the first time around and two weeks later the remaining 37 return, total of 75 returns and he initially concluded 47/75 returns could possibly have penalties but he will re-evaluate them and number might be reduced. The agent even told me that he feels bad and he is 100% sure that my office is asking all necessary questions to validate eligibility of EITC but my documentation was not enough.

    The two weeks period between the first visit and second visit I was able to call majority of my clients whose returns evaluated during the first visit and 24/38 responded to me and wrote a notarized letter with their and dependent’s SSN/DOB and detail information to my office stating all the answers for the question I usually ask initially. (Where the parent of niece/nephew, did they live together, where your spouse, why you income is low, do you receive welfare assistant, and many other questions along with copy of SS card and birth certificates for those children who born in U.S).

    I showed the agent the notarized letters during the second visit; he was surprised but said he only considers what was available at the time of the visit.

    I am still waiting for final report of his findings. The agent even suggested to me that I should reject any penalties proposed and go through the appeals process, which is first meeting with his manager during next phase then appeals office after manager meeting if the manger did not make any changes.

    Penalty of 47 * 500 = $23500 is a lot of money to pay for not writing less than half line sentence for example; “The dependent attended ABC college” equals to $500.00 penalty.

    Any inputs or help of how should I prepare to fight any penalties imposed?

    While the penalty appeals in process will that have any negative impact on filing taxes for clients next year 2014 or will my clients refund be delayed in result?

    Thank you
    Ismail

  5. NANCY GARZA says

    Hi my name is NANCY I HAVE PREPARE I INCOME TAX SINCE 2005. I ALREADY GONE THRU TWO AUDITS, 2012 AND 13. MY PENALTIES WERE 71,000 and 19,000. I agree with you all, irs agents penalized me because I fail to document additional questions. Ex. I provided proof of income, form 8867, intake sheet of all questions asked, shedule C question sheet, and all identity paper work.well, to make it shirt, the file failed because The client was HOH made 15674.00 income was divorced had two kids of her own, her mom help her with the care of children, recieved 286.00 food benefits but I fail to document who else helped her with the support. Well, I explained on the file that the income she made plus food was the only support. The auditor still fail the file because did not document who else helped the taxpayer with the support. Do you get it, they are to get us for any thing they can find. I think they all are trained to get us because they have a total to collect from all of us. All auditors are trained to talked to us and make us think that even though we are tying to comply, we are still not completing well the due diligence. I think we are ment not to pass it. The auditors also advise me that till I stop making this kind of errors they will stop coming for visits. I think we should all get together and make irs lower the penalty to the way it was before, because no matter what our efforts are they will not stop, on my personal and other prepairers thay I know experiences. Thank you and text me if you feel like asking me something.

  6. L. Harrison III says

    Is there any link or reference to the bill passed by congress to give the IRS said authority? I know it’s part of the IRC, but when was it proposed and passed?

  7. Laura Gelhar says

    Hi,
    I am preparing taxes since 2002 and I received a letter from the IRS regarding not attached form 8867 to 17 returns and my explanation was not accepted. They still want to impose a penalty. What do you think if all these returns will be amended and the reason for amendment will be shown as previously not included form 8867 by the taxpayer. I gave this form to my clients, but it was not attached to the return. I do not remember exactly if it was attached only to clients copy or just given separately. I would appreciate all aomments

  8. JANET REYES PINA says

    Hi, my name is Janet. I received a letter from the IRS in December 2014 letting me know that they were going to be auditing my files for DUE DILIGENCE in January 2015. The examiner came to my office at 8:30 in the morning for the audit. Michael (the examiner) came in with his laptop and at first interviewed me on my practices of interviewing my clients. I told him that I have a questionnaire 13614-c that the IRS issues that my clients fill out. I ask for id cards, and social security cards for all. I also ask for 1 of these school record, shot records or birth certificates to show that they live with the client. If they are claiming grandchildren etc. I ask for the parents to accompany the client to the interviews. When the return is filed it has all 8867 sheets included. The examiner then gave me a list of the 25 clients that he wanted ME to pull the files so that he could look at them. He got on his computer, I opened each packet as he called out the name of the client. He never asked any names of dependents or anything else for that matter. HE NEVER ONCE LOOKED AT ANY FILE, NEVER TOUCHED ANY PAPERWORKS OR ANYTHING ELSE IN THE FILE. He just asked me did I have this or that in the file. I answered his questions yes or no. He then pointed out 3 of the 25 that he said that he thought should have had more information in them. It was now 11:30 and he was breaking for lunch. He gave me the list of 25 more clients to pull for him and then left for lunch. He got back and hour later and we proceeded the same way for the next 2 1/2 hours which he pointed out 4 additional filed that needed more information. After 2 weeks I received a letter from him asking me to sign the penalty agreement and send it back to him for $17,500 of penalties. I filed an appeal. ARE THESE PEOPLE CRAZY!!! That is close to $3200 an hour that he was earning for the IRS. GOOD JOB MICHAEL, YOU MUST WORK ON COMMISSION. Plus he did not touch anything. The only time he touched anything was when he put the files on the floor in a stack when we were done with them. WHAT KIND OF AUDIT IS THAT. Why did he point out just the 7 that needed more information. WHY DID’NT THEY JUST PENALIZE ALL 50 AND QUIT WASTING MY TIME. I AM FURIOUS AT THE WAY THAT THEY HANDLED THIS AUDIT. I would appreciate any answers to this dilemma.

  9. Dear Friends,
    I recently received the letter 1342 from IRS stating that IRS assess $12,825 of the proposed $85,500.00 penalty for the reasons:
    Failure to comply with the first of EITC for year 2012 due diligent requirement

    In fact, IRS has penalized me $85,550.00 originally and I disagreed. They wanted me to send all 2013 returns with EIC and Form 8867. I sent all. After a week process they called me and said we reduce the penalty from $85,500 to $12,825.00.
    Can any friends help me how to write the letter to remove the penalty as I totally disagree? for reasons I did not get any letter 5364 from IRS during 2012 to alert Tax Prepare about missing or omitting Form 8867. I think IRS should initially send Tax Prepare the Letter 5364 when they receive the return without Form 8867. Am I right?
    I’d appreciate much your immediate attention. Thank you for your advice.

  10. aridaman arora says

    I found that I made errors in 8867 , section 111 of 2017 8867.. when AOTC alone is there , I
    need to complete, but 8867 form has shaded that area, and my software did not show as an
    error. but IRS will not listen. So I have decided to amend client return ( client signing) and attached properly filled 8867 and mailing. Hope they take that into consideration and hopefully they will see that I took care. what is your opinion as to my decision to fix before they catch me.– reposting it with full name.

  11. I am going through the due diligence audit for 2018, she picked 25 files and we reviewed only 11 today, one of the files was my brother’s and I told I am non paid preparer do I have to apply the same due diligence rule there? also documentation was the other issue on three files out of 11, she is coming next week I think she will pick different 25 files?
    any comments anybody with fairly newer experience?

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