New Required Preparer Due Diligence: AOTC & Child Tax Credit

Annette Nellen

The addition of these two credits to the required due diligence of paid preparers in preparing a return that claims either or both was made by the PATH Act (P.L. 114-113, 12/18/15). The statutory language added at §6695(g) implied that regulations were needed. The IRS released draft Form 8867 and instructions in summer 2016, but did not release the regulations until 12/5/16. [TD 9799 (12/5/16) and REG 102952-16 (12/5/16)]

The regulations note that Form 8867 must be completed “and such other information as may be prescribed by the” IRS. The preparer must include relevant worksheets and Form 8863 and instructions (AOTC), or “otherwise record in one or more documents in the tax return preparer’s paper or electronic files the tax return preparer’s computation of the credit or credits claimed on the return or claim for refund, including the method and information used to make the computations.”

The regulations also include this rule about knowledge (§1.6695-2(b)(3)):

(3) Knowledge—(i) In general. The tax return preparer must not know, or have reason to know, that any information used by the tax return preparer in determining the taxpayer’s eligibility for, or the amount of, any credit described in paragraph (a) of this section and claimed on the return or claim for refund is incorrect. The tax return preparer may not ignore the implications of information furnished to, or known by, the tax return preparer, and must make reasonable inquiries if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information furnished to the tax return preparer appears to be incorrect, inconsistent, or incomplete. The tax return preparer must also contemporaneously document in the files any inquiries made and the responses to those inquiries.

Form 8867, lines 3 and 4, address the “knowledge” requirement. The instructions for these lines provide:

As a paid tax return preparer, when determining the taxpayer’s eligibility for, or the amount of, a credit claimed on a return or claim for refund, you must not use information that you know, or have reason to know, is incorrect. You may not ignore the implications of information provided to, or known by you, and you must make reasonable inquiries if the information provided to you appears to be incorrect, inconsistent, or incomplete. You must make reasonable inquiries if a reasonable and well-informed tax return preparer, knowledgeable in the tax law, would conclude that the information provided to you appears to be incorrect, inconsistent, or incomplete. You must also contemporaneously document in your files any reasonable inquiries made and the responses to these inquiries.

You must know the tax law for each credit claimed on a return or claim for refund you prepare and use that knowledge to ask your client the right questions to get all the relevant facts to determine your client’s eligibility for the credit(s) and the correct amount of the credit(s).

Here are a few questions I’d suggest are appropriate for determining if someone is eligible for the child credit (not a complete list).

  • How old are your children? When were they born?
  • Where do they go to school? What grades are they in?
  • For a single parent, where does the child live? If the child lived the majority of the time with the parent who is your client, ask if he/she signed a Form 8332 to allow the other parent to claim the child.
  • If a client tells you they have a signed Form 8332 from the other parent, ask if it has been revoked (did they receive notice of revocation from the other parent)?

A few questions for someone who appears eligible to claim the AOTC for their dependent child and whose income is below the phase-out range (also see Form 8863 and instructions, along with IRC 25A and information on the IRS website (regulations addressing AOTC are still in proposed form – REG-131418-14 (8/2/16)):

  • When did they start college?
  • How many units did they take each semester? (student needs to be at least a half-time student for at least one semester; also see Box 8 of Form 1098-T)
  • Please provide me the Form(s) 1098-T the child received. If it shows amount billed rather than amount paid (see boxes 1 and 2), ask when the tuition was paid. You should also verify that the 1098-T is correct. Be sure Box 9 is not checked (student is a graduate student, indicating they are likely no longer in their first four years of collect).
  • How much is the tuition?
  • Did your child receive any scholarships or grants?
  • Do you have a 529 or 530 plan for the child? (If yes, was it used?) Is the taxpayer/child eligible for other education tax benefits that may be more beneficial? Did they receive any tax-free education assistance from his/her employer?

Here are some tougher questions for the AOTC:

  • Did you child receive academic credit for at least one semester of the tax year? This is a tough one as parents might not know the answer, particularly if the child dropped out after the refund period. Box 8 on Form 1098-T asks if the student was at least a half-time student. Perhaps that being checked is sufficient. Also, if not enrolled per how that term is defined at the university, a 1098-T likely should not have been issued. So, this might be a tough question if there is no 1098-T and the parent insists the child was in college during the year.
  • Does the student have a felony conviction for possession or distribution of a controlled substance?

Perhaps it would be best to put these questions on a checklist for the client to complete and sign. It should include the reason why the question is asked. You might want to refer clients to the AOTC information in Publication 970 and FAQs.

The AOTC includes amount paid for books and related materials that are required by the university, even if not paid to the university. Before making any effort to determine these amount, see if the tuition paid for the year is high enough to max out the AOTC. In most cases, it will be (unless the student attends a community college in California). You max out the AOTC with $4,000 of tuition paid for the year (the credit is 100% of the first $2,000 and 25% of the next $2,000 for a maximum credit of $2,500).

The questions asked by the paid preparer and the answers/documents received from the client must be kept for three years after the return is filed. The Form 8867 is attached to the client’s return to avoid a $510 penalty to the preparer. Do note that even with the attached form, a preparer can still be subject to the penalty for not doing the required due diligence. This reminder is in the “what’s new” section of the Form 8867 instructions (although this is not new):

“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.”

I think the Form 8867 will help improve compliance with the child credit and AOTC as it will likely lead many preparers to review these credits in more detail and some may find that there were parts that they were not aware of before (such as that the AOTC is only for the first four years of college, even if that is only the first fall semester, if the student was at least half-time, that is a year of college). If a student attended a California community college for the first two years of college, parents might feel cheated because the tuition paid is not enough to max out the AOTC for those years (although books and other required materials, perhaps even a computer will help – see FAQ7). So, they might want to use the AOTC when the child transfers to a more expensive university, but it doesn’t work that way. The AOTC is only for the first four years of college. So, that parent (or student) doesn’t max out the AOTC, but they also aren’t paying a lot of tuition!

On a policy note, if a state university or college isn’t charging enough tuition to max out the credit, the California Legislative Analyst described this as the state giving a reverse subsidy to the federal government (that is, to students in other states). [See LAO’s February 1998 report]

Should the Form 8867 due diligence documentation requirement to avoid a penalty be expanded to other complex items claimed on a tax return? I don’t’ think so. Preparers already have required due diligence requirements such as the preparer penalty of §6694. Many preparers are also subject to licensing rules and those of professional organizations they belong to, as well as Treasury’s Circular 230. Congress likely expanded the §6695(g) penalty to these additional credits due to errors in claiming them. But, there are other solutions to address tax law complexity: (1) simplification, (2) required continuing education for all preparers (to address those not covered by licensing requirements for continuing education), (3) some assurance that paid preparers have adequate training including research skills and access to resources beyond IRS pubs and form instructions, and (4) due diligence checklists from the IRS to help preparers (and the IRS).

The PATH Act also requires the Treasury Department “to conduct a study evaluating the effectiveness of tax return preparer due diligence requirements for the EITC, child tax credit and AOTC. The study with respect to the EITC shall be completed one year from the date of enactment (December 18, 2015), and the study regarding the child credit and the AOTC shall be due two years from the date of enactment.” [JCT Bluebook to 2015 legislation, page 231]

The only study I find (at 12/24/16; 6 days after the 12/18/16 due date for the EITC report) is a 27-page report issued by Treasury in July 2016. It addresses preparer due diligence, but doesn’t reference the PATH Act. Per House Report 114-194, the July report is tied to this request: “The Committee directs the Office of Tax Policy (OTP) and the IRS Office Research, Analysis and Statistics to conduct data-driven analysis to improve EITC compliance in collaboration with the tax preparation community. Successful analysis will identify solutions effective for both paid preparers and self-preparers, ensure ease of taxpayer understanding. The Committee directs OTP and IRS to submit a report to the Committees on Appropriations in the House and Senate not later than six months after enactment of this Act on meeting this goal.” The report explains various initiatives the IRS used to improve EITC compliance (a subject for a future blog or article – looks interesting). So, it seems that we are still waiting for the §6695(g) EITC report due 12/18/16.

What do you think? (about the expanded due diligence for preparers for 2016 returns, preparer obligations in general, complexity, or anything else in this post)

Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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