83 FR 33875 - Tax Return Preparer Due Diligence Penalty Under Section 6695(g)

DEPARTMENT OF THE TREASURY
Internal Revenue Service

Federal Register Volume 83, Issue 138 (July 18, 2018)

This document contains proposed regulations that amend portions of previously proposed regulations related to the tax return preparer penalty under section 6695(g) of the Internal Revenue Code (Code). These amendments to the previously proposed regulations are necessary to implement a recent law change that expands the scope of the tax return preparer due diligence penalty under section 6695(g) so that it applies with respect to eligibility to file a return or claim for refund as head of household. The proposed regulations affect tax return preparers.

[Federal Register Volume 83, Number 138 (Wednesday, July 18, 2018)]
[Proposed Rules]
[Pages 33875-33879]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2018-15351]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-103474-18]
RIN 1545-BO63


Tax Return Preparer Due Diligence Penalty Under Section 6695(g)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking, partial withdrawal of notice of 
proposed rulemaking.

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SUMMARY: This document contains proposed regulations that amend 
portions of previously proposed regulations related to the tax return 
preparer penalty under section 6695(g) of the Internal Revenue Code 
(Code). These amendments to the previously proposed regulations are 
necessary to implement a recent law change that expands the scope of 
the tax return preparer due diligence penalty under section 6695(g) so 
that it applies with respect to eligibility to file a return or claim 
for refund as head of household. The proposed regulations affect tax 
return preparers.

DATES: Written or electronic comments and requests for a public hearing 
must be received by August 17, 2018.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-103474-18), Room 
5207, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through

[[Page 33876]]

Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
103474-18), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC 20224, or sent electronically, via the 
Federal eRulemaking Portal at www.regulations.gov (IRS REG-103474-18).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Marshall French, 202-317-6845; concerning submissions of comments and 
requests for a public hearing, Regina Johnson, 202-317-6901 (not toll-
free numbers).

Paperwork Reduction Act

    The collection of information in current Sec.  1.6695-2 was 
previously reviewed and approved under control number 1545-1570. 
Control number 1545-1570 was discontinued in 2014, as the burden for 
the collection of information contained in Sec.  1.6695-2 is reflected 
in the burden for Form 8867, ``Paid Preparer's Due Diligence 
Checklist,'' under control number 1545-1629.

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 6695(g) of the Code regarding 
the tax return preparer due diligence requirements.
    Prior to 2016, section 6695(g) imposed a penalty on tax return 
preparers who fail to comply with due diligence requirements set forth 
in regulations prescribed by the Secretary with respect to determining 
eligibility for, or the amount of, the earned income credit (EIC). For 
tax years beginning after December 31, 2015, the scope of section 
6695(g) was expanded to apply the penalty to tax return preparers who 
fail to comply with due diligence requirements with respect to 
determining eligibility for, or the amount of, the child tax credit 
(CTC)/additional child tax credit (ACTC) and the American opportunity 
tax credit (AOTC). See section 207 of the Protecting Americans from Tax 
Hikes Act of 2015, Div. Q of Public Law 114-113 (129 Stat. 2242, 3082 
(2015)) (PATH Act). On December 5, 2016, final and temporary 
regulations (TD 9799, 81 FR 87444) with cross-referencing proposed 
regulations (REG-102952-16, 81 FR 87502) (2016 proposed regulations) 
were published in the Federal Register to reflect these changes.
    Effective for tax years beginning after December 31, 2017, section 
6695(g) was amended to further expand the scope of the penalty to tax 
return preparers who fail to comply with due diligence requirements 
with respect to determining eligibility to file as head of household 
(as defined in section 2(b)). See section 11001(b) of ``An Act to 
provide for reconciliation pursuant to titles II and V of the 
concurrent resolution on the budget for fiscal year 2018,'' Public Law 
115-97 (131 Stat. 2054, 2058 (2017)) (Act). This document contains 
proposed regulations to reflect this change.

Explanation of Provisions

    The proposed regulations contained in this document withdraw 
paragraphs (a), (b)(3), and (e) of Sec.  1.6695-2 of the 2016 proposed 
regulations and propose in their place new paragraphs (a), (b)(3), and 
(e) of Sec.  1.6695-2 (amended paragraphs). The amended paragraphs 
update the 2016 proposed regulations to reflect the recent change in 
the law that expands the tax return preparer due diligence requirements 
under section 6695(g) to apply to determining eligibility to file as 
head of household. Accordingly, the proposed regulations contained in 
this document amend paragraphs (a) and (b)(3) of Sec.  1.6695-2 of the 
2016 proposed regulations by adding a reference to determining 
eligibility to file as head of household where reference is made to 
determining eligibility for, or the amount of, the EIC, the CTC/ACTC 
and/or the AOTC. In addition, Example 5 in paragraph (b)(3)(ii) of 
Sec.  1.6695-2 of the 2016 proposed regulations is revised to 
demonstrate how head of household due diligence requirements are 
intertwined with the rules for determining a taxpayer's eligibility for 
the CTC.
    A new example is also added to Sec.  1.6695-2(a)(2) to illustrate 
how the penalty applies if there is a failure to satisfy the due 
diligence requirements with respect to determining eligibility to file 
as head of household in addition to a failure to satisfy the due 
diligence requirements with respect to one of the applicable credits. 
As explained in the preamble of the 2016 temporary regulations, the 
preparation of one return or claim for refund may result in the 
imposition of more than one penalty under section 6695(g). That is 
because under section 6695(g), each failure to comply with the due 
diligence requirements set forth in regulations prescribed by the 
Secretary results in a separate penalty. To illustrate this point, a 
new example, Example 3, is added to proposed Sec.  1.6695-2(a)(2) 
contained in this document.
    The applicability date in Sec.  1.6695-2(e) is also updated to 
reflect the effective date of the addition of determining eligibility 
to file as head of household to the due diligence requirements. 
Accordingly, proposed Sec.  1.6695-2(e) contained in this document 
provides that Sec.  1.6695-2 applies to tax returns and claims for 
refund for taxable years beginning after December 31, 2015, that are 
prepared on or after the date of publication of the Treasury decision 
adopting the proposed rules as final regulations in the Federal 
Register. However, the rules relating to the determination of a 
taxpayer's eligibility to file as head of household under section 2(b) 
apply to tax returns and claims for refund for taxable years beginning 
after December 31, 2017, that are prepared on or after the date of 
publication of the Treasury decision adopting the proposed rules as 
final regulations in the Federal Register.
    As part of satisfying the due diligence requirements, the 
regulations under Sec.  1.6695-2 require tax return preparers to 
complete the Form 8867, ``Paid Preparer's Due Diligence Checklist,'' 
and, in most cases, attach it to the relevant return or claim for 
refund as part of satisfying the section 6695(g) due diligence 
requirements. The Form 8867 underwent significant revisions for the 
2016 tax year and is currently a single checklist to be used for all 
applicable credits (namely, the EIC, the CTC/ACTC, and the AOTC) on the 
return or claim for refund subject to the section 6695(g) due diligence 
requirements. It is anticipated that the IRS will revise the Form 8867 
to include the head of household filing status in time for the 2019 
filing season.

Proposed Applicability Dates

    Proposed Sec.  1.6695-2(e) provides that the rules in this notice 
of proposed rulemaking with respect to determining eligibility to file 
as head of household under section 2(b) will apply to tax returns and 
claims for refund for taxable years beginning after December 31, 2017, 
that are prepared on or after the date the final regulations are 
published in the Federal Register.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations. Under the 
Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it is hereby 
certified that these proposed rules, if adopted, would not

[[Page 33877]]

have a significant economic impact on a substantial number of small 
entities. When an agency issues a notice of proposed rulemaking, the 
RFA requires the agency to ``prepare and make available for public 
comment an initial regulatory flexibility analysis'' that will 
``describe the impact of the proposed rule on small entities.'' (5 
U.S.C. 603(a)). Section 605 of the RFA provides an exception to this 
requirement if the agency certifies that the proposed rulemaking will 
not have a significant economic impact on a substantial number of small 
entities.
    The proposed rules affect paid tax return preparers who determine a 
taxpayer is eligible to file as head of household, in addition to those 
tax return preparers who determine eligibility for, or the amount of, 
the EIC, the CTC/ACTC, and/or the AOTC. The North American Industry 
Classification System (NAICS) code that relates to tax return 
preparation services (NAICS code 541213) is the appropriate code for 
tax return preparers subject to this notice of proposed rulemaking. 
Entities identified as tax return preparation services are considered 
small under the Small Business Administration size standards (13 CFR 
121.201) if their annual revenue is less than $20.5 million. The IRS 
estimates that approximately 75 to 85 percent of the 505,000 persons 
who work at firms or are self-employed tax return preparers are 
operating as or employed by small entities. The IRS has therefore 
determined that these proposed rules will have an impact on a 
substantial number of small entities.
    The IRS has further determined, however, that the economic impact 
on entities affected by the proposed rules will not be significant. The 
current final and temporary regulations under section 6695(g) already 
require tax return preparers to complete the Form 8867 when a return or 
claim for refund includes a claim of the EIC, the CTC/ACTC, and/or the 
AOTC. Tax return preparers also must currently maintain records of the 
checklists and computations, as well as a record of how and when the 
information used to compute the credits was obtained by the tax return 
preparer. The information needed to document a taxpayer's eligibility 
to file as head of household is information the preparer must gather to 
file the return. Even if certain preparers are required to maintain the 
checklists and complete Form 8867 for the first time, the IRS estimates 
that the total time required should be minimal for these tax return 
preparers. Further, the IRS does not expect that the requirements in 
these proposed regulations would necessitate the purchase of additional 
software or equipment in order to meet the additional information 
retention requirements.
    Based on these facts, the IRS hereby certifies that the collection 
of information contained in this notice of proposed rulemaking will not 
have a significant economic impact on a substantial number of small 
entities. Accordingly, a Regulatory Flexibility Analysis is not 
required.
    Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking has been submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on the 
impact on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written and electronic comments that 
are timely submitted to the IRS as prescribed in this preamble under 
the ADDRESSES heading. The Treasury Department and the IRS request 
comments on all aspects of the proposed rules. All comments will be 
available at www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these regulations is Rachel Gregory of the 
Office of the Associate Chief Counsel (Procedure and Administration).

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Partial Withdrawal of a Notice of Proposed Rulemaking

    Accordingly, under the authority of 26 U.S.C. 7805, Sec.  1.6695-
2(a), (b)(3), and (e) of the notice of proposed rulemaking (REG-102952-
16) published in the Federal Register on December 5, 2016 (81 FR 87502) 
are withdrawn.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.6695-2 is amended by revising the section heading and 
paragraphs (a), (b)(3), and (e) to read as follows:


Sec.  1.6695-2  Tax return preparer due diligence requirements for 
certain returns and claims.

    (a) Penalty for failure to meet due diligence requirements--(1) In 
general. A person who is a tax return preparer (as defined in section 
7701(a)(36)) of a tax return or claim for refund under the Internal 
Revenue Code who determines the taxpayer's eligibility to file as head 
of household under section 2(b), or who determines the taxpayer's 
eligibility for, or the amount of, the child tax credit (CTC)/
additional child tax credit (ACTC) under section 24, the American 
opportunity tax credit (AOTC) under section 25A(i), or 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 as prescribed in section 6695(g) (indexed for inflation 
under section 6695(h)) for each failure. A separate penalty applies to 
a tax return preparer with respect to the head of household filing 
status determination and to each applicable credit claimed on a return 
or claim for refund for which the due diligence requirements of this 
section are not satisfied and for which the exception to penalty 
provided by paragraph (d) of this section does not apply.
    (2) Examples. The provisions of paragraph (a)(1) of this section 
are illustrated by the following examples:


    Example 1. Preparer A prepares a federal income tax return for a 
taxpayer claiming the CTC and the AOTC. Preparer A did not meet the 
due diligence requirements under this section with respect to the 
CTC or the AOTC claimed on the taxpayer's return. Unless the 
exception to penalty provided by paragraph (d) of this section 
applies, Preparer A is subject to two penalties under section 
6695(g): One for failure to meet the due diligence requirements for 
the CTC and a second penalty for failure to meet the due diligence 
requirements for the AOTC.

    Example 2. Preparer B prepares a federal income tax return for a 
taxpayer claiming the CTC and the AOTC. Preparer B did not meet the 
due diligence requirements under this section with respect to the 
CTC claimed on the taxpayer's return, but Preparer B did meet the 
due diligence requirements under this section with respect to the 
AOTC claimed on the taxpayer's return. Unless the exception to 
penalty provided by paragraph (d) of this section applies, Preparer 
B is subject to one penalty under section 6695(g) for the failure to 
meet the due diligence requirements for the CTC. Preparer B is not

[[Page 33878]]

subject to a penalty under section 6695(g) for failure to meet the 
due diligence requirements for the AOTC.

    Example 3. Preparer C prepares a federal income tax return for a 
taxpayer using the head of household filing status and claiming the 
CTC and the AOTC. Preparer C did not meet the due diligence 
requirements under this section with respect to the head of 
household filing status and the CTC claimed on the taxpayer's 
return. Preparer C did meet the due diligence requirements under 
this section with respect to the AOTC claimed on the taxpayer's 
return. Unless the exception to penalty provided by paragraph (d) of 
this section applies, Preparer C is subject to two penalties under 
section 6695(g) for the failure to meet the due diligence 
requirements: One for the head of household filing status and one 
for the CTC. Preparer C is not subject to a penalty under section 
6695(g) for failure to meet the due diligence requirements for the 
AOTC.

    (b) * * *
    (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 to file as 
head of household or 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 preparer's paper or electronic files 
any inquiries made and the responses to those inquiries.
    (ii) Examples. The provisions of paragraph (b)(3)(i) of this 
section are illustrated by the following examples:


    Example 1. In 2018, Q, a 22 year-old taxpayer, engages Preparer 
C to prepare Q's 2017 federal income tax return. Q completes 
Preparer C's standard intake questionnaire and states that she has 
never been married and has two sons, ages 10 and 11. Based on the 
intake sheet and other information that Q provides, including 
information that shows that the boys lived with Q throughout 2017, 
Preparer C believes that Q may be eligible to claim each boy as a 
qualifying child for purposes of the EIC and the CTC. However, Q 
provides no information to Preparer C, and Preparer C does not have 
any information from other sources, to verify the relationship 
between Q and the boys. To meet the knowledge requirement in 
paragraph (b)(3) of this section, Preparer C must make reasonable 
inquiries to determine whether each boy is a qualifying child of Q 
for purposes of the EIC and the CTC, including reasonable inquiries 
to verify Q's relationship to the boys, and Preparer C must 
contemporaneously document these inquiries and the responses.

    Example 2. Assume the same facts as in Example 1 of this 
paragraph (b)(3)(ii). In addition, as part of preparing Q's 2017 
federal income tax return, Preparer C made sufficient reasonable 
inquiries to verify that the boys were Q's legally adopted children. 
In 2019, Q engages Preparer C to prepare her 2018 federal income tax 
return. When preparing Q's 2018 federal income tax return, Preparer 
C is not required to make additional inquiries to determine the boys 
relationship to Q for purposes of the knowledge requirement in 
paragraph (b)(3) of this section.

    Example 3. In 2018, R, an 18 year-old taxpayer, engages Preparer 
D to prepare R's 2017 federal income tax return. R completes 
Preparer D's standard intake questionnaire and states that she has 
never been married, has one child, an infant, and that she and her 
infant lived with R's parents during part of the 2017 tax year. R 
also provides Preparer D with a Form W-2 showing that she earned 
$10,000 during 2017. R provides no other documents or information 
showing that R earned any other income during the tax year. Based on 
the intake sheet and other information that R provides, Preparer D 
believes that R may be eligible to claim the infant as a qualifying 
child for the EIC and the CTC. To meet the knowledge requirement in 
paragraph (b)(3) of this section, Preparer D must make reasonable 
inquiries to determine whether R is eligible to claim these credits, 
including reasonable inquiries to verify that R is not a qualifying 
child of her parents (which would make R ineligible to claim the 
EIC) or a dependent of her parents (which would make R ineligible to 
claim the CTC), and Preparer D must contemporaneously document these 
inquiries and the responses.

    Example 4. The facts are the same as the facts in Example 3 of 
this paragraph (b)(3)(ii). In addition, Preparer D previously 
prepared the 2017 joint federal income tax return for R's parents. 
Based on information provided by R's parents, Preparer D has 
determined that R is not eligible to be claimed as a dependent or as 
a qualifying child for purposes of the EIC or CTC on R's parents' 
return. Therefore, for purposes of the knowledge requirement in 
paragraph (b)(3) of this section, Preparer D is not required to make 
additional inquiries to determine that R is not her parents' 
qualifying child or dependent.

    Example 5. 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 EIC and the CTC. To meet the knowledge requirement in 
paragraph (b)(3) of this section, Preparer E must make 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 EIC and the CTC, 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.

    Example 6. W engages Preparer F to prepare her federal income 
tax return. During Preparer F's standard intake interview, W states 
that she is 50 years old, has never been married, and has no 
children. W further states to Preparer F that during the tax year 
she was self-employed, earned $10,000 from her business, and had no 
business expenses or other income. Preparer F believes W may be 
eligible for the EIC. To meet the knowledge requirement in paragraph 
(b)(3) of this section, Preparer F must make reasonable inquiries to 
determine whether W is eligible for the EIC, including reasonable 
inquiries to determine whether W's business income and expenses are 
correct, and Preparer F must contemporaneously document these 
inquiries and the responses.

    Example 7. Y, who is 32 years old, engages Preparer G to prepare 
his federal income tax return. Y completes Preparer G's standard 
intake questionnaire and states that he has never been married. As 
part of Preparer G's client intake process, Y provides Preparer G 
with a copy of the Form 1098-T Y received showing that University M 
billed $4,000 of qualified tuition and related expenses for Y's 
enrollment or attendance at the university and that Y was at least a 
half-time undergraduate student. Preparer G believes that Y may be 
eligible for the AOTC. To meet the knowledge requirements in 
paragraph (b)(3) of this section, Preparer G must make reasonable 
inquiries to determine whether Y is eligible for the AOTC, as Form 
1098-T does not contain all the information needed to determine 
eligibility for the AOTC or to calculate the amount of the credit if 
Y is eligible, and contemporaneously document these inquiries and 
the responses.
* * * * *
    (e) Applicability date. The rules of this section apply to tax 
returns and claims for refund for taxable years beginning after 
December 31, 2015, that are prepared on or after the date of 
publication of the Treasury decision adopting these rules as final 
regulations in the Federal Register. However, the rules relating to the 
determination of a taxpayer's eligibility to file as head of household 
under section 2(b) apply to tax returns and claims for refund for 
taxable years beginning after December 31, 2017, that are prepared on 
or after the date of publication of the Treasury

[[Page 33879]]

decision adopting these rules as final regulations in the Federal 
Register.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-15351 Filed 7-13-18; 4:15 pm]
 BILLING CODE 4830-01-P