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Changes Are Coming to Form 8867 and Preparer Due Diligence Requirements

By Aaron P. Borden on November 27, 2018

Significant changes are coming to Form 8867, Paid Preparer’s Due Diligence Checklist, and the associated requirements for the 2019 filing season. On November 5, 2018, the IRS issued final regulations under Treas. Reg. § 1.6695-2 to clarify when and how return preparers must conduct due diligence.

The final regulations provide several examples of situations in which the return preparer may rely on his familiarity with a taxpayer to satisfy his due diligence obligations (i.e. when the return preparer conducted the necessary inquiries in the prior year). The regulations also clarify that the return preparer may not rely on knowledge acquired from prior social interactions or dealings that are otherwise unrelated to the preparation of tax returns. The following example from § 1.6695-2 illustrates this distinction:

In 2019, S engages Preparer E to prepare his 2018 federal income tax return. During Preparer E's standard intake interview, S states that he has never been married and that his niece and nephew lived with him for part of the 2018 taxable year.  Preparer E believes S may be eligible to file as head of household and claim each of these children as a qualifying child for purposes of the Earned Income Tax Credit and the Child Tax Credit, but the information furnished to Preparer E is incomplete.  Preparer E knows from prior social interactions with S that the children resided with S for more than one-half of the 2018 tax year and that the children did not provide over one-half of their own support for the 2018 tax year.  To meet the knowledge requirement, Preparer E must make the reasonable inquiries to determine whether S is eligible to file as head of household and whether each child is a qualifying child for purposes of the Earned Income Tax Credit and the Child Tax Credit, including reasonable inquiries about the children's residency, S's relationship to the children, the children's income, the sources of support for the children, and S's contribution to the payment of costs related to operating the household, and preparer E must contemporaneously document these inquiries and the responses.[1]

As the above example demonstrates, a return preparer must contemporaneously document the relevant inquires made and the taxpayer’s responses to those questions to satisfy the knowledge requirement of due diligence. During the comment period for the regulations, commenters requested revisions that would allow a return preparer to establish his or her diligence by alternative methods in the absence of contemporaneous documentation. This request was rejected. Thus, it appears that the Service intends to strictly enforce the contemporaneous documentation requirement. This conclusion is supported by the preamble to the final regulations, which states that contemporaneous documentation is critical to improving compliance and reducing the error rate on tax returns completed by return preparers. 

Consequences of insufficient due diligence, as required by Treas. Reg. § 1.6695-2, include the possibility of a return preparer compliance audit and the imposition of a $500 penalty per instance of lack of diligence.

In light of recent changes to due diligence standards, a return preparer must conduct additional due diligence regardless of the return preparer’s existing knowledge of the client’s situation from social interactions, and contemporaneously document those inquiries and the client’s responses.

For questions regarding return preparer due diligence, or any other tax-related matters, please feel free to contact Aaron Borden at (214) 749-2402 or aborden@meadowscollier.com.

[1] Treas. Reg. § 1.6695-2(b)(3)(ii)(F).