[Federal Register Volume 63, Number 244 (Monday, December 21, 1998)]
[Rules and Regulations]
[Pages 70339-70341]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33343]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8798]
RIN 1545-AW74


Preparer Due Diligence Requirements for Determining Earned Income 
Credit Eligibility

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations relating to the 
due diligence requirements for paid preparers of federal income tax 
returns or claims for refund involving the earned income credit. The 
temporary regulations reflect changes to the law made by the Taxpayer 
Relief Act of 1997. The temporary regulations provide guidance to paid 
preparers who prepare federal income tax returns or claims for refund 
claiming the earned income credit. The text of the temporary 
regulations also serves as the text of the proposed regulations set 
forth in the notice of proposed rulemaking on this subject in the 
Proposed Rules section of this issue of the Federal Register.

DATES: These regulations are effective December 21, 1998.

FOR FURTHER INFORMATION CONTACT: Marc C. Porter (202) 622-4940 (not a 
toll free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These regulations are being issued without prior notice and public 
procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). 
For this reason, the collection of information contained in these 
regulations has been reviewed and pending receipt and evaluation of 
public comments, approved by the Office of Management and Budget under 
control number 1545-1570. Responses to this collection of information 
are mandatory.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    For further information concerning this collection of information, 
and where to submit comments on the collection of information and the 
accuracy of the estimated burden, and suggestions for reducing this 
burden, please refer to the preamble to the cross-referencing notice of 
proposed rulemaking published in the Proposed Rules section of this 
issue of the Federal Register.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR parts 1 and 602) under section 6695(g) relating to the penalty for 
failure of a preparer to be diligent in determining a taxpayer's 
eligibility for the earned income credit (EIC). Section 6695(g) was 
added by section 1085(a)(2) of the Taxpayer Relief Act of 1997, Public 
Law 105-34 (11 Stat. 788, 955 (1997)) (the Act), effective for taxable 
years beginning after December 31, 1996.
    Section 6695(g) imposes a $100 penalty for each failure by an 
income tax return preparer to meet the due diligence requirements set 
forth in this regulation. The IRS may impose the section 6695(g) 
penalty in addition to any other applicable penalty provided by law.
    In Notice 97-65 (1997-51 I.R.B. 14 (December 22, 1997)), the IRS 
set forth the preparer due diligence requirements for 1997 returns and 
claims for refund involving the EIC. To avoid the imposition of the 
section 6695(g) penalty for 1997 returns and claims for refund, Notice 
97-65 requires preparers to meet four requirements: (1) Complete the 
Earned Income Credit Eligibility Checklist attached to Notice 97-65 
(Eligibility Checklist), or otherwise record the information necessary 
to complete the Eligibility Checklist; (2) complete the Earned Income 
Credit Worksheet (Computation Worksheet), as contained in the 1997 Form 
1040 instructions, or otherwise record the computation and information 
necessary to complete the Computation Worksheet; (3) have no knowledge 
that any information used by the preparer in determining eligibility 
for, and amount of, the EIC is incorrect; and (4) retain for three 
years the Eligibility Checklist and Computation Worksheet (or 
alternative records), and a record of how and when the information used 
to determine eligibility for, and amount of, the EIC was obtained by 
the preparer. This information may be retained either as a paper record 
or in magnetic media format consistent with Rev. Proc. 81-46 (1981-2 
C.B. 621).
    Notice 97-65 also requested comments on preparer due diligence 
requirements for tax years after 1997. Two comments were received. The 
commentators did not suggest alternative due diligence requirements. 
One commentator suggested, however, increased education for the public. 
The IRS and Treasury Department adhere to the principle that education 
is an integral part of good tax administration. Therefore, as part of 
its overall EIC strategy, the IRS has established various educational 
tools and outreach programs for taxpayers and preparers. These efforts 
are intended to provide the public with the tools necessary to receive 
the full amount of the EIC allowed by law.
    The second commentator suggested that preparers should be able to 
meet the due diligence requirements by using software reviewed and 
approved by the IRS. The IRS does not approve commercial software. The 
IRS is currently exploring, however, new opportunities for partnership 
with outside stakeholders to reduce burden, enhance customer service, 
and increase compliance. As part of this effort, the IRS will continue 
to review this comment and evaluate options.

Explanation of Provisions

    The temporary and proposed regulations impose due diligence 
standards on persons who are income tax return preparers with respect 
to determining eligibility for, or the amount of, the EIC. Consistent 
with existing regulations under section 6695, these temporary 
regulations apply a modified definition of income tax return preparer. 
Section 7701(a)(36) provides that, in general, the term income tax 
return preparer means any person who prepares for compensation, or who 
employs one or more persons to prepare for compensation, any return or 
claim for refund of tax imposed by subtitle A. The preparation of a 
substantial portion of a return or claim for refund is treated as if it 
were the preparation of such return or claim for refund. Persons are 
considered preparers if they give legal advice concerning a return or 
claim for refund or if they prepare another return which affects the 
return or claim for refund (Sec. 301.7701-15(a)(2) and (b) and 
Sec. 301.7701-15(b)(3), respectively). The

[[Page 70340]]

regulations retain this definition of an income tax return preparer, 
except that preparers who merely give advice or prepare another return 
that affects the EIC return or claim for refund are not preparers for 
purposes of the section 6695(g) penalty. Rather, the due diligence 
standards are imposed only on paid preparers who prepare the return 
claiming the EIC.
    The temporary regulations essentially adopt the four due diligence 
requirements in Notice 97-65. Thus, to avoid the penalty under section 
6695(g), a preparer must: (1) Complete the Eligibility Checklist (Form 
8867, Paid Preparer's Earned Income Credit Checklist, or such other 
form as may be prescribed by the IRS), or otherwise record in the 
preparer's files the information necessary to complete the Eligibility 
Checklist; (2) complete the Computation Worksheet (Earned Income Credit 
Worksheet contained in the Form 1040 instructions), or otherwise record 
in the preparer's files the computation and information necessary to 
complete the Computation Worksheet; (3) have no knowledge, and have no 
reason to know, that any information used by the preparer in 
determining eligibility for, and amount of, the EIC is incorrect; and 
(4) retain for three years the Eligibility Checklist and the 
Computation Worksheet (or alternative records), and a record of how and 
when the information used to determine eligibility for, and the amount 
of, the EIC was obtained by the preparer.
    The temporary regulations also provide that the income tax return 
preparer may avoid the section 6695(g) penalty with respect to a 
particular income tax return or claim for refund if the preparer can 
demonstrate to the satisfaction of the IRS that, considering all the 
facts and circumstances, the preparer's normal office procedures are 
reasonably designed and routinely followed to ensure compliance with 
the due diligence requirements of the regulations, and that the 
particular failure was isolated and inadvertent.
    The temporary regulations will be effective for taxable years 
beginning after December 31, 1996. However, the Eligibility Checklist 
contained in Notice 97-65 has been expanded in Form 8867. Therefore, 
for taxable year 1997, the applicable Eligibility Checklist is the 
Eligibility Checklist contained in Notice 97-65. For taxable year 1998, 
a preparer may choose as the applicable Eligibility Checklist either 
the Eligibility Checklist published in Notice 97-65 modified however, 
by replacing, $9,770, $25,760, $29,290, and $2,250 each time these 
figures appear on the 1997 Eligibility Checklist with $10,030, $26,473, 
$30,095, and $2,300, respectively, or Form 8867. For taxable years 
beginning after December 31, 1998, the applicable Eligibility Checklist 
will be the Form 8867.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations. Further, it is hereby certified, 
pursuant to sections 603(a) and 605(b) of the Regulatory Flexibility 
Act, that the collection of information in these regulations will not 
have a significant economic impact on a substantial number of small 
entities. This certification is based upon the fact that the amount of 
time necessary to record and retain the required information will be 
nominal for those income tax return preparers that choose to use the 
Alternative Eligibility Record and Alternative Computation Record. 
Therefore, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to 
section 7805(f) of the Internal Revenue Code, these temporary 
regulations will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on their impact.

Drafting Information

    The principal author of these regulations is Marc C. Porter, Office 
of Assistant Chief Counsel (Income Tax & Accounting). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
adding an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * * Section 1.6695-2T also issued 
under 26 U.S.C. 6695(g). * * *

    Par. 2. Section 1.6695-2T is added to read as follows:


Sec. 1.6695-2T  Preparer due diligence requirements for determining 
earned income credit eligibility (temporary).

    (a) Penalty for failure to meet due diligence requirements.  A 
person who is an income tax return preparer (preparer) of an income tax 
return or claim for refund under subtitle A of the Internal Revenue 
Code (Code) with respect to determining the eligibility for, or the 
amount of, the earned income credit (EIC) under section 32 and who 
fails to satisfy the due diligence requirements of paragraph (b) of 
this section will be subject to a penalty of $100 for each such 
failure. However, no penalty will be imposed under section 6695(g) on a 
person who is an income tax return preparer solely by reason of--
    (1) Section 301.7701-15(a)(2) and (b) of this chapter, on account 
of having given advice on specific issues of law; or
    (2) Section 301.7701-15(b)(3) of this chapter, on account of having 
prepared the return solely because of having prepared another return 
that affects amounts reported on the return.
    (b) Due diligence requirements. A preparer must satisfy the 
following due diligence requirements:
    (1) Completion of eligibility checklist. (i) The preparer must 
either--
    (A) Complete Form 8867, Paid Preparer's Earned Income Credit 
Checklist, or such other form as may be prescribed by the IRS 
(Eligibility Checklist); or
    (B) Otherwise record in the preparer's paper or electronic files 
the information necessary to complete the Eligibility Checklist 
(Alternative Eligibility Record). The Alternative Eligibility Record 
may consist of one or more documents containing the required 
information.
    (ii) The preparer's completion of the Eligibility Checklist or 
Alternative Eligibility Record must be based on information provided by 
the taxpayer to the preparer or otherwise reasonably obtained by the 
preparer.
    (2) Computation of credit. (i) The preparer must either--
    (A) Complete the Earned Income Credit Worksheet in the Form 1040 
instructions or such other form as may be prescribed by the IRS 
(Computation Worksheet); or
    (B) Otherwise record in the preparer's paper or electronic files 
the preparer's EIC computation, including the method and information 
used to make the computation (Alternative Computation Record). The 
Alternative Computation Record may consist of one or more

[[Page 70341]]

documents containing the required information.
    (ii) The preparer's completion of the Computation Worksheet or 
Alternative Computation Record must be based on information provided by 
the taxpayer to the preparer or otherwise reasonably obtained by the 
preparer.
    (3) Knowledge. The preparer must not know, or have reason to know, 
that any information used by the preparer in determining the taxpayer's 
eligibility for, or the amount of, the EIC is incorrect. The preparer 
may not ignore the implications of information furnished to, or known 
by, the preparer, and must make reasonable inquiries if the information 
furnished to, or known by, the preparer appears to be incorrect, 
inconsistent, or incomplete.
    (4) Retention of records. (i) The preparer must retain--
    (A) A copy of the completed Eligibility Checklist or Alternative 
Eligibility Record;
    (B) A copy of the Computation Worksheet or Alternative Computation 
Record; and
    (C) A record of how and when the information used to complete the 
Eligibility Checklist or Alternative Eligibility Record and the 
Computation Worksheet or Alternative Computation Record was obtained by 
the preparer, including the identity of any person furnishing the 
information.
    (ii) These items must be retained for three years after the June 
30th following the date the return or claim for refund was presented to 
the taxpayer for signature, and may be retained on paper or 
electronically in the manner prescribed in applicable regulations, 
revenue rulings, revenue procedures, or other appropriate guidance.
    (c) Exception to penalty. The section 6695(g) penalty will not be 
applied with respect to a particular income tax return or claim for 
refund if the preparer can demonstrate to the satisfaction of the IRS 
that, considering all the facts and circumstances, the 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 return or claim for refund was isolated and inadvertent.
    (d) Effective date--(1) In general. This section applies to income 
tax returns and claims for refund for taxable years beginning after 
December 31, 1996. This section expires on December 21, 2001. For the 
applicable Eligibility Checklist see paragraph (d)(2) of this section.
    (2) Eligibility Checklist--(i) For the 1997 taxable year. For 
taxable year 1997, the applicable Eligibility Checklist is the 
Eligibility Checklist published in Notice 97-65 (1997-51 I.R.B. 14) 
December 22, 1997. (See Sec. 601.601(d)(2)(ii)(b) of this chapter.)
    (ii) For the 1998 taxable year. For taxable year 1998 the 
applicable Checklist is either--
    (A) The Checklist published in Notice 97-65 (1997-51 I.R.B. 14) 
December 22, 1997, modified however, by applying the figures $10,030, 
$26,473, $30,095, and $2,300 in place of $9,770, $25,760, $29,290, and 
$2,250, respectively, each time these figures appear on the 1997 
Checklist; or
    (B) Form 8867, Paid Preparer's Earned Income Credit Checklist.
    (iii) For taxable years after 1998. For taxable years beginning 
after December 31, 1998, the applicable Eligibility Checklist is the 
Eligibility Checklist contained in Form 8867, Paid Preparer's Earned 
Income Credit Checklist, or such other form as may be prescribed by the 
IRS.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 4. In Sec. 602.101, paragraph (c) is amended by adding the 
following entry in numerical order to the table to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *

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                                                             Current OMB
     CFR part or section where identified and described      control No.
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                  *        *        *        *        *
1.6695-2T..................................................    1545-1570
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David S. Mader,
Acting Deputy Commissioner of Internal Revenue.

    Approved: December 9, 1998.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 98-33343 Filed 12-18-98; 8:45 am]
BILLING CODE 4830-01-U