In December 2015, the Protecting Americans From Tax Hikes (PATH) Act, P.L. 114-113, permanently extended a number of tax provisions that are popular for individual taxpayers, finally ending the practice of waiting until the end of the year or even until the next year to pass retroactive extensions. Among the provisions that were permanently extended and otherwise modified were the child tax credit, the additional child tax credit, the American opportunity tax credit, and the earned income tax credit (EITC).
At the same time, there were some other, less-publicized changes that affected those individual tax credits that were less favorable for taxpayers (see "Congress Makes Changes to Popular Tax Credits," Tax Insider, Jan. 28, 2016). This article reviews developments in three areas since that article was published: the new due-diligence requirements for tax preparers who submit returns claiming the child tax credit, additional child tax credit, and American opportunity tax credit; the penalties (now indexed for inflation) that are imposed on preparers for failing to follow these due-diligence requirements; and the provision requiring the IRS to delay processing tax refunds of the additional child tax credit and the EITC until Feb. 15 to give it more time to review those refund claims.
Child tax credit/additional child tax credit: Sec. 24 provides a $1,000 tax credit to a taxpayer whose income is below certain thresholds for each of the taxpayer's qualifying children under age 17. The amount of the credit generally cannot exceed the taxpayer's tax liability (i.e., it is nonrefundable); however, Sec. 24(d) makes portions of the credit refundable. This refundable portion of the credit, commonly referred to as the additional child tax credit, is 15% of the excess of taxable earned income over $3,000. The $3,000 threshold was made permanent by the PATH Act; it is not adjusted for inflation.
American opportunity tax credit: The Sec. 25A American opportunity tax credit permits taxpayers to claim a credit of up to $2,500 for qualified educational expenses for each eligible student. The credit phases out when modified adjusted gross income exceeds certain amounts. The credit was originally going to be effective only through 2017, but the PATH Act made it permanent.
Earned income tax credit: The EITC grants a refundable credit to low- or moderate-income taxpayers who have earned income. The amount of the credit is the taxpayer's earned income (up to a statutory maximum amount as adjusted for inflation) multiplied by the credit percentage. The maximum earned income amount and the credit percentage that apply to a taxpayer are based on the taxpayer's number of qualifying children. The credit is phased out for taxpayers with adjusted gross income or, if greater, earned income, over the applicable credit phaseout threshold amount, which is also based on the number of the taxpayer's qualifying children.
The PATH Act amended Sec. 6695, the preparer penalties provision, to apply to tax return preparers who fail to exercise due diligence when preparing a taxpayer's return with a claim for the child tax credit or additional child tax credit under Sec. 24, or the American opportunity tax credit under Sec. 25A. Before these changes, the due-diligence requirements and the penalties for noncompliance applied only to claims for the EITC. These new rules apply for returns or claims for refund prepared on or after Dec. 5, 2016, for tax years beginning after Dec. 31, 2015.
The IRS issued temporary and proposed regulations implementing these requirements in December 2016 (T.D. 9799; REG-102952-16). It also revised Form 8867, Paid Preparer's Due Diligence Checklist, by adding two columns to the checklist: one for the child tax credit/additional child tax credit, and the second for the American opportunity tax credit. The form was previously called the Paid Preparer's Earned Income Credit Checklist.
To comply with the due-diligence requirements, besides submitting Form 8867, the preparer must complete the applicable worksheet in the instructions to Form 1040, 1040A, 1040EZ, or any other form the IRS may prescribe for each credit. For example, Form 8867 mentions completing the American opportunity tax credit worksheet in the Form 8863, Education Credits, instructions. In lieu of the worksheet, the preparer may otherwise record in his or her files his or her computation of the credit or credits claimed, including the method and information used to make the computations.
The preparer must not know or have reason to know that any information the preparer used to determine eligibility for, and the amount of, each credit is incorrect. The preparer also 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 preparer must document those inquiries and responses contemporaneously.
Finally, the preparer must retain for three years the Form 8867, the worksheet (or alternative records), and the record of how and when the information that was used to determine eligibility for, and the amount of, each credit was obtained by the preparer, including the identity of any person furnishing information and a copy of any document the preparer relied on in preparing the form.
The penalty for failure to comply with the due-diligence requirements is $500 for each failure, which is adjusted for inflation (Sec. 6695(g)). Under the due-diligence regulations, the $500 penalty on preparers for each breach of the rules applies separately to each credit, meaning a preparer could conceivably be subject to as many as three penalties for one tax return for failing to exercise due diligence for the child tax credit, the American opportunity tax credit, and the EITC. For 2016 and 2017, the inflation-adjusted penalty is $510.
Under Sec. 6402(m), the IRS is prohibited from making refunds of an overpayment to taxpayers that are allowed the additional child tax credit or the EITC before the 15th day of the second month after the close of the tax year (i.e., Feb. 15). This provision gives the IRS additional time to review these refund claims to cut down on improper or fraudulent payments.
Sally P. Schreiber is a senior editor for The Tax Adviser.