The Office of Chief Counsel (OCC) advised that after the amendments to the regulations in T.D. 9436 in December 2008, the IRS continues to have the authority to assert the penalty against either the employee-preparer of a return or his or her employer for failing to meet the earned income credit (EIC) due diligence requirements. However, the IRS cannot impose a penalty against both an employee-preparer and the employer based on the same factual situation. In addition, the OCC advised that the signing preparer of a tax return is responsible for retaining the records showing that the preparer met the EIC due diligence requirements.
Employer/Employee Liability
The amendments to the regulations made by T.D. 9436 in December 2008 changed the person who is responsible for meeting the due diligence requirements to “a signing tax return preparer of a tax return or claim for refund.” Previously, the person responsible was “an income tax return preparer . . . of an income tax return or claim for refund.” Thus, in determining whether the IRS could hold both an employer and an employee responsible for a due diligence failure, the OCC considered the meaning of the term “signing preparer.”
Under Regs. Sec. 301.7701-15(b)(1), “[a] signing tax return preparer is the individual tax return preparer who has the primary responsibility for the overall substantive accuracy of the preparation of such return or claim for refund.” According to the OCC, if the employee meets the signing preparer criteria, he or she is subject to the due diligence requirements. However, due to the nature of the employer/employee relationship, the employer retains the responsibility for the overall accuracy of the return and thus would also meet the signing preparer criteria, even if the employer did not actually sign the return. Consequently, both the employee and the employer could be responsible for the penalty for failing to meet the due diligence requirements.
Although the OCC advised that the IRS could assert the penalty against either the employer or the employee, it further advised that, due to the amendments to the regulations in T.D. 9436, the penalty should only be asserted against a single person within a firm. In its discussion of the penalty under Sec. 6694 (Understatement of a Taxpayer’s Liability by Tax Return Preparer), the preamble to T.D. 9436 states that where evidence would support a finding that either a signing preparer or a nonsigning preparer within a firm was primarily responsible for a position giving rise to an understatement, the penalty could be applied against either of the individuals but not both. The OCC explained that while the background information associated with the regulation implementing the penalty did not specifically state that the IRS intended the penalty to be limited to a single person, the single person limitation could be inferred by the incorporation of the definition of signing tax return preparer into Regs. Sec. 1.6695-2(a).
Record Retention Requirement
The OCC also considered whether an employer is required to retain the EIC due diligence documents (eligibility checklist, computation worksheet, and record of how and when the necessary information was obtained) that are required by Sec. 6695(g). It advised that while employers that are individuals could be subject to the requirement, employers that are corporations, partnerships, or other entities could not.
Regs. Sec. 1.6695-2(g) requires a signing tax return preparer to retain the due diligence documents. However, the OCC noted that the regulatory language of amended Regs. Sec. 1.6695-2(b)(4) does not support the imposition of the due diligence requirement of record retention against a corporation, partnership, or other entity employing a signing tax return preparer, because “signing tax return preparer” means an individual tax return preparer with primary responsibility for the overall substantive accuracy of the tax return. Thus, under Regs. Sec. 1.6695-2(b)(4) business entities that employ signing tax return preparers are not covered by the regulation’s requirement. Regardless, the IRS had argued that employers were required to retain the due diligence documents under the general return retention requirements in Sec. 6107 and Regs. Sec. 1.6107-1(b).
While agreeing with the IRS that under Sec. 6107 all employers are required to retain a copy of a return prepared by a signing preparer they employed, the OCC advised that Sec. 6107 does not apply to EIC due diligence documents because these documents are not part of a return. Under Regs. Sec. 1.6011-1(a), a return includes the information required by the applicable regulations or forms; returns that do not include the information required will not be accepted as meeting the requirements of the Code. The OCC pointed out that the regulations and the instructions to Form 1040, U.S. Individual Income Tax Return, Form 1040X, Amended U.S. Individual Income Tax Return, or Form 843, Claim for Refund and Request for Abatement, did not require the EIC due diligence documents to be included as attachments to the return. Therefore, employers who are not individuals are not required under Sec. 6107 to retain the EIC due diligence documents.
PMTA 2009-157
