Earned Income Credit and Due Diligence

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For those familiar with the Earned Income Tax Credit (EITC), you (hopefully) are familiar with the preparer’s due diligence checklist.  This is a checklist that the preparer uses to help determine if the taxpayer’s circumstances are in keeping with the conditions that are required to be met in order to be eligible for the credit.

In the past, this checklist has been filled out by the preparer and kept in the preparer’s files.  Recently this fact has changed a bit – the IRS changed the requirements, such that now the due diligence checklist must be filed along with the return.  This filing requirement is the only thing that has changed, the due diligence is the same as before.

The checklist

Here’s what the checklist asks:

Is the taxpayer’s status Married Filing Separately? (if this question is answered “Yes”, the taxpayer is not allowed to file for EITC)

Does the taxpayer (and the taxpayer’s spouse if filing jointly) have a social security number (SSN) that allows him or her to work or is valid for EIC purposes? (if this question is answered “No”, the taxpayer is not allowed to file for EITC)

Is the taxpayer filing Form 2555 or 2555-EZ (relating to the exclusion of foreign earned income)? (if this question is answered “Yes” the taxpayer is not allowed to file for EITC)

Was the taxpayer a nonresident alien for any part of the tax year in question?  Is the filing status Married Filing Jointly? (if the first question is answered “Yes” and the second question answered “No”, the taxpayer is not allowed to file for EITC)

Is the taxpayer’s investment income more than the limit for the tax year? (for 2011 the limit is $3,100) (if this question is answered “Yes” then the taxpayer is not allowed to file for EITC)

Could the taxpayer or the taxpayer’s spouse if filing jointly be a qualifying child of another person for the year? (if this is answered “Yes”, the taxpayer is not allowed to file for EITC)

If the taxpayer gets past these gatekeeper questions, then the questionnaire moves on to qualifying children.  Each qualifying child must be identified and then several questions answered:

• Is the child the taxpayer’s son, daughter, stepchild, foster child, brother, sister, stepbrother or stepsister, or a descendant of any of them?
• Is the child unmarried, or married but can be claimed as the taxpayer’s dependant and not filing a joint return (or is filing it only as a claim for refund)?
• Did the child life with the taxpayer in the United States for over half of the year?
• Was the child under age 19, or under age 24 and a fulltime student (at the end of the tax year for either age), and younger than the taxpayer (or the taxpayer’s spouse if filing jointly)?  If not, and the child is totally and permanently disabled at any age, this question can be answered “Yes”.

If all four of the questions can’t be answered “Yes”, the child is not the taxpayer’s qualifying child.  These questions must be answered “Yes” for each qualifying child counted.

Next, the possibility of each child’s being qualified for more than one taxpayer is checked.  If any other person could answer “Yes” to all four questions for a child, the following information is required:

• If “tiebreaker rules” are used, is the child treated as the taxpayer’s qualifying child? (If the answer is “No”, this child is not a qualifying child for the taxpayer filing this form. If the answer is “Don’t Know”, this child might not be considered a qualifying child – the IRS will determine this.)

Now on to more qualifying questions about the child.

Does the qualifying child have an SSN that allows him or her to work or is valid for EIC purposes?  (if answered “No”, the child is not allowed as a qualifying child)

If you’ve answered “No” to the above two questions for a particular child, only that child is disqualified – if there are other children that might qualify, answer the questions for those children, but no more than three total children can qualify (any above that number doesn’t matter to the calculations).

And now, the question is asked about the taxpayer’s earned income and adjusted gross income – are these amounts less than the limit that applies to the taxpayer for the tax year? (these limits are listed in Publication 596) (if this question is answered “No”, then the taxpayer is not eligible to apply for EITC)

If you don’t have a qualifying child, additional questions are asked:

Was the taxpayer’s main home and the main home of the taxpayer’s spouse if filing jointly in the United States for more than half the year?  (Military personnel on extended active duty outside the US are considered to be living in the US during that duty period.) (if the answer to this question is “No”, the taxpayer cannot take the EITC)

Was the taxpayer or the taxpayer’s spouse if filing jointly at least age 25 but under age 65 at the end of the year? (if the answer to this question is “No”, the taxpayer cannot take the EITC)

Is the taxpayer or the taxpayer’s spouse if filing jointly, eligible to be claimed as a dependant on anyone else’s federal tax return? (if answered “Yes”, the taxpayer cannot take the EITC)

Are the taxpayer’s earned income and adjusted gross income less than the limit that applies to the taxpayer for the tax year? (these limits are listed in Publication 596) (if this question is answered “No”, then the taxpayer is not eligible to apply for EITC)

Tax Preparer Questions

Lastly, the tax preparer has to answer a few questions to round out the due diligence:

• Was the form based on information provided by the taxpayer or reasonably obtained by you (the tax preparer)?
• Did you complete the EIC worksheet found in Form 1040, 1040A or 1040EZ instructions? (this worksheet is for line 1a, Schedule M)
• Did you comply with the knowledge requirements? (To comply with the knowledge requirements, you must not know or have reason to know that any information used to determine the taxpayer’s eligibility for, and the amount of, the EIC is incorrect.  You may not ignore the implications of information furnished to or known by you, and you must make reasonable inquiries if the information furnished appears to be incorrect, inconsistent, or incomplete.  At the time you make these inquiries, you must document in your files the inquiries you made and the responses you received.)
• Did you keep the following records?
  • Form 8867 (the questions above)
  • The EIC worksheet(s) (the one referred to above from Schedule M)
  • A record of how, when, and from whom the information used to prepare the form and worksheet(s) was obtained

If the answer to any of the four questions above is “No”, then as the tax preparer, you have not complied with all the due diligence requirements and may have to pay a $100 penalty for each failure to comply.