I enjoy blogging as it gives me a forum to discuss some of the issues that I see come into my office in the course of my practice. I particularly enjoy blogging about taxes because being both a tax preparer and an attorney, people come to see me about problems that were caused by other tax preparers who are not attorneys, and they need to have fixed. I have been seeing a number of people who have been having problems with the Internal Revenue Service, as opposed to the Department of Revenue, involving the Earned Income Tax Credit (EITC). I mentioned the Internal Revenue Service, as opposed to the Department of Revenue, because the Department of Revenue does a random desk audit of tax returns, with a heavy weighting towards people who have requested the Earned Income Credit, and an especially heavy weighting for self-employed people taking the Earned Income Tax Credit. Those, are relatively simply matters, and can be handled fairly routinely. When the Internal Revenue Service shows up challenging an Earned Income Credit, that is a more serious matter.
What I have observed of the people who have come to see me is that either they did their tax returns themselves, or their professional tax preparer did not review the appropriate documentation in preparing the return. This result is unsurprising. To understand it requires a little background and history.
The Earned Income Credit is more stringent than many of the other credits and exemptions in the tax code, because it does have a specific requirement that the child actually live with the person claiming the credit. This issue comes up quite commonly in the area of divorce. It may well be that the divorce decree allows the non-custodial parent to claim the child at tax time. However, the non-custodial parent cannot claim the Earned Income Credit. As such, even though the custodial parent might not be claiming the child as a dependent, the custodial parent, nevertheless, would claim the Earned Income Credit, notwithstanding the divorce decree. There are a number of other areas where a child might not live with the parent who nevertheless is supporting that child. In my immigration practice, I have a number of people who are supporting their children who have not yet come to the United States. They may be allowed to claim their child under the right circumstances, but they may not claim the Earned Income Credit. The improper claiming of the Earned Income Tax Credit has become a major issue. Just this past week, the Treasurer Department’s Inspector General reported that in 2012 the Internal Revenue Service paid out $14.5 billion of inappropriate payments for the Earned Income Tax Credit. This is almost one quarter of all Earned Income Credit Payments. It is not surprising, therefore, that the Internal Revenue Service has become zealous in its enforcement of the Earned Income Tax Credit.
In order to crack down on false claims, the Internal Revenue Service started a program three years ago of requiring professional tax preparers to review documents to verify that the child actually lived with the person claiming the Earned Income Credit and to report to the Internal Revenue Service what documents they reviewed. Two years ago, they actually required that the professional tax preparer keep a copy of the documents that they reviewed. The Internal Revenue Service specifically reserved the right to visit the offices of the professional tax preparers, and review the documents that the tax preparers had relied upon. The Internal Revenue Service has the right to fine the professional tax preparer $500.00 for every return for which there is not proper documentation. As such, the Internal Revenue Service can feel pretty comfortable that when a professional tax preparer says that they have reviewed a letter from a landlord, a school record or a medical bill that says that the child lives at the parent’s address, and has kept a copy of that, that that preparer really has reviewed such a document and really does have a copy of it. Otherwise that preparer is just an idiot.
As such, that enables the Internal Revenue Service to focus its enforcement effort in places that are more likely to be productive. One place, obviously, would be the self prepared return. Somebody who is filing their own tax return is not required to review documents. Their signature on their return is the only certification that the child lives with them. As such, that is a relatively productive area of inquiry for the Internal Revenue Service. However, there is one even more productive area of inquiry, and that is for professional tax preparers that have not certified that they have reviewed the proper documents. For example, I recently had a client come to me who had his taxes prepared by a tax preparer whose office is currently closed. Like so many tax preparers, this one is not open year round. This individual had claimed a niece on his tax return. The tax preparer certified that he looked at the child’s birth certificate and social security card. I have no doubt that the tax preparer has, in his files, a copy of this child’s birth certificate and a copy of this child’s social security card. Unfortunately, that does not document that this child lives with her uncle. For a tax examiner at the Internal Revenue Service, this raises a question. If the tax preparer knew to get documents, and the Internal Revenue Service has actually provided a list of appropriate documents, why did the professional tax preparer not get an appropriate document. It is not unreasonable to assume that such a document does not exist, and thus this is a red flag for an inappropriate Earned Income Tax Credit claim.
There is one tax preparer in my neighborhood who, rather than inconveniencing the taxpayer by requesting documents, actually checks a box on the paid preparer’s Earned Income Credit checklist saying that they “did not rely on any documents”. I cannot think of any justification for that. It really is easy to document the residency of a child. We have a form that we give to clients to take to their landlord to sign saying that the child lives in the house. Most children go to school, and would have something from their school indicating where they live, and if not, such a document can easily be obtained. Similarly, most children have doctors who have a record of the child’s address. Now that this requirement is a couple of years old, many pediatrician’s offices have their own form that they will give upon request. If any social service or government agency is involved with the child, they would have generated a record of the child’s address. Frankly, any medical bill gets the job done. I am allowed to accept a statement from the family’s place of worship or even the taxpayer’s, or the child’s, employer as to where the child lives. In fact, I have had a number of cases where the child had a summer job and I used the child’s W-2 Form to document that the child had the same address as the claiming taxpayer. Because it really is so easy to document that a child lives with a person, for a professional tax preparer to check the “did not rely on any documents” box is basically an open invitation to the Internal Revenue Service to do an audit. If a tax preparer is doing this routinely, I would expect them to get a compliance review from the Internal Revenue Service. They have painted a bulls eye on their clients’ backs. We are starting to see these people now coming into the office having two or three years of taxes under scrutiny. This creates a number of problems. Although it is easy to document where a child lives currently, it is not so easy to document where a child lived two years ago. What is more, some of these people are telling me that they were not aware that there was an actual residency requirement for the Earned Income Credit. They simply told the tax preparer that they wanted to claim the child and were simply thrilled when they found out that they were getting a very large refund. The problem there is that all taxpayers are expected to review their tax return. This is why, in my office, I like for the client to sit beside me while I am preparing their return and actually look at the computer monitor as I am entering data. As I fill out the Paid Preparer’s Earned Income Credit Check List, I discuss every question on the check list with my client and always require an Internal Revenue Service compliant document to show residency. Since I tell the Internal Revenue Service exactly what I have looked at and exactly what I have, my clients are not getting caught up in these audits. They are not being required to pay back their refunds, and they are not being penalized for owing the Internal Revenue Service. It is really sad when somebody unexpectedly gets a $4,000.00 refund when they were only entitled to a $1,000.00 refund and now that the money is spent, they find themselves $3,000.00 in debt to the Internal Revenue Service plus interest and penalties. What is more, the Internal Revenue Service may call in to question whether or not other aspects of the tax return are true. For example, if a taxpayer has claimed that a child who does not live with them, lives with them, then why should they believe that same taxpayer’s claim that he provides more than fifty percent of that child’s support. Exemptions, tax filing statuses, child tax credits that the taxpayer may have been legitimately entitled to are now subject to challenge, without there being any benefit of the doubt.
It is certainly true that being required to document that your own child, or another child living in your house, lives with you can be a bit annoying and inconvenient. It is especially true, if for whatever reason, you were not expecting that to happen when you went to see the tax preparer and thus have to make a second trip to the preparer’s office. However, it may be comforting to know that you are not merely doing this because it is a requirement that the Internal Revenue Service has thrust upon tax preparers. You are doing this because it moves you from the pool of taxpayers which are likely to be highly targeted by the Internal Revenue Service into a pool of taxpayers that is less likely to be targeted by the Internal Revenue Service. I have dealt with various Internal Revenue Service officials at various levels over various issues over the years. I will say that in general they have been very reasonable, and usually we are able to work things out and come to an accommodation. However, I will also acknowledge that, in many cases, the process is the punishment. It is not fun having to respond to an Internal Revenue Service letter of inquiry, and it is really not fun to come in for a formal audit. As such, it is better to hire a professional tax preparer, and to provide that tax preparer with the documentation that your child or other minor dependent lives with you. In this way, for the price of a minor inconvenience, you have avoided a major headache.