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Doing your Client’s Taxes the Right Way: IRS Form 8867

September 30, 2023 By Israel Padilla

How to Use Form 8867 for Tax Credits in 2023

Hey there, tax preparers! If you’re looking for a handy guide on how to use Form 8867 for tax credits in 2023, you’ve come to the right place. In this article, I’ll explain what Form 8867 is, why it’s important, who should use it, and how to fill it out correctly. I’ll also cover the due diligence requirements, the consequences of not meeting them, and the recent changes and developments in tax law and regulations regarding these credits. By the end of this article, you’ll be ready to help your clients claim the earned income credit, child tax credit, and American opportunity tax credit using Form 8867.

Table of Contents

I. Introduction

Form 8867 is a document that paid preparers of federal income tax returns or claims must file with the IRS if they are involved in preparing returns or claims that include the earned income credit (EIC), child tax credit (CTC)/additional child tax credit (ACTC), credit for other dependents (ODC), American opportunity tax credit (AOTC), and/or head of household (HOH) filing status. The form is also known as the Paid Preparer’s Due Diligence Checklist.

The purpose of Form 8867 is to ensure that paid preparers meet the due diligence requirements in determining the taxpayer’s eligibility for, and the amount of, the credit and filing status. These requirements are mandated by law and are intended to prevent errors, fraud, and abuse of these tax benefits.

Form 8867 is not only a legal obligation, but also a professional responsibility for tax preparers. By following the due diligence requirements, you can help your clients claim the credits and filing status they are entitled to, avoid penalties and audits, and maintain your reputation as a trustworthy and competent tax professional.

II. Understanding Form 8867

Form 8867 is a two-page form that consists of six parts:

  • Part I: Due Diligence Requirements. This part lists the general requirements that the preparers must follow to meet the due diligence standards for the credits and filing status. The preparers must check the appropriate boxes for the benefits claimed and answer yes or no to the questions in this part.
  • Part II: Due Diligence Questions for Returns Claiming EIC. This part asks specific questions about the eligibility and amount of the earned income credit (EIC) for the taxpayer and any qualifying children. The preparers must answer yes, no, or not applicable to the questions in this part.
  • Part III: Due Diligence Questions for Returns Claiming CTC/ACTC/ODC. This part asks specific questions about the eligibility and amount of the child tax credit (CTC), the additional child tax credit (ACTC), and the credit for other dependents (ODC) for the taxpayer and any qualifying persons. The preparers must answer yes, no, or not applicable to the questions in this part.
  • Part IV: Due Diligence Questions for Returns Claiming AOTC. This part asks specific questions about the eligibility and amount of the American opportunity tax credit (AOTC) for the taxpayer and any eligible students. The preparers must answer yes or no to the questions in this part.
  • Part V: Due Diligence Questions for Claiming HOH. This part asks specific questions about the eligibility for the head of household (HOH) filing status for the taxpayer and any qualifying persons. The preparers must answer yes or no to the questions in this part.
  • Part VI: Eligibility Certification. This part summarizes the due diligence requirements and asks the preparers to certify that they have complied with them by answering yes or no to the question in this part.

You must file Form 8867 with every return or claim that includes any of the credits or filing statuses mentioned above. You must also keep copies of Form 8867 and all the worksheets, records, and documents that support your answers for three years from the latest of the following dates:

  • The date the return or claim was presented to the taxpayer for signature.
  • The date you filed or furnished the return or claim to the IRS.
  • The date you received an IRS request to provide this information.

III. Due Diligence Requirements

The due diligence requirements for tax preparers are specified in section 6695(g) of the Internal Revenue Code and section 1.6695-2 of the Income Tax Regulations. These requirements consist of four elements:

  • Completion and submission of Form 8867.
  • Computation of credits and filing status.
  • Knowledge.
  • Recordkeeping.

Let’s take a closer look at each element and what it entails.

Completion and submission of Form 8867

This element requires you to complete Form 8867 based on the information you obtained from the taxpayer or reasonably obtained from other sources. You must answer all the questions in the form honestly and accurately, and provide any additional information or explanation if necessary. You must also file Form 8867 with the IRS along with the return or claim that includes the credits or filing status.

Computation of credits and filing status

This element requires you to correctly compute the amount of the credits and the eligibility for the filing status using the information and documentation you obtained from the taxpayer or reasonably obtained from other sources. You must also use the appropriate forms, worksheets, and instructions to perform the computation, such as Schedule EIC, Form 1040, Form 8863, etc.

Knowledge

This element requires you to have sufficient knowledge of the tax law and regulations regarding the credits and filing status, and to apply them correctly to the taxpayer’s situation. You must also make reasonable inquiries if you encounter information that is inconsistent, incomplete, incorrect, or insufficient. You must not ignore the implications of the information you have or rely on improbable or unrealistic information.

Let’s consider a scenario where a tax preparer, John, is working with a taxpayer, Mary. Mary is a single, childless individual who earned $20,000 in the last tax year and wants to claim the Earned Income Credit (EIC).

John knows that to qualify for the EIC, a taxpayer must meet certain requirements. Here are some questions John might ask to determine Mary’s eligibility:

  1. Income: “What was your total earned income for the last tax year?” This is important because the EIC is only available to low- to moderate-income individuals and families.
  2. Filing Status: “What is your filing status?” Certain filing statuses are not eligible for the EIC.
  3. Investment Income: “Did you have more than $3,650 in investment income last year?” If Mary had more than this amount, she would not be eligible for the EIC.
  4. Dependents: “Do you have any qualifying children or dependents?” The EIC amount varies depending on the number of qualifying children.
  5. Social Security Number: “Do you have a valid Social Security number?” This is required for the EIC.
  6. Residency: “Did you live in the United States for more than half of the year?” This is another requirement for the EIC.
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After asking these questions, John determines that Mary does not qualify for the EIC because her income is too high. He explains this to Mary and advises her not to claim the credit to avoid potential issues with the IRS.

By asking these questions and using Form 8867 as a checklist, John has fulfilled his due diligence requirements as a tax preparer. John would not need to complete and file the form if Mary does not qualify for the Earned Income Credit (EIC).

Recordkeeping

This element requires you to keep copies of Form 8867 and all the worksheets, records, and documents that support your answers for three years from the latest of the dates mentioned above. These include:

  • The taxpayer’s completed return or claim.
  • The worksheets you used to compute the credits and filing status.
  • The documents that prove the taxpayer’s identity, income, expenses, residency, relationship, age, enrollment, etc., such as Social Security cards, birth certificates, school records, bank statements, etc.
  • The records of how and when you obtained the information and documentation from the taxpayer or other sources, such as notes of your conversations, dates of your meetings, copies of emails or letters, etc.
  • The records of any additional inquiries you made and the responses you received, such as verification of income or expenses from employers or providers, clarification of discrepancies or inconsistencies from the taxpayer or other sources, etc.

If you fail to meet any of these due diligence requirements, you may be subject to a penalty of $550 for each failure concerning each credit or filing status. The penalty may be waived if you can show that there was reasonable cause for your failure and that you acted in good faith.

IV. Step-by-step Guide to Completing Form 8867

Before completing Form 8867, the tax preparer must fulfill their due diligence and ensure the taxpayer qualifies to the specific tax credit that they want to claim.

Let’s consider a scenario where a tax preparer, Susan, is working with a taxpayer, Bob. Bob is a single father with one child who is in his first year of college. Bob earned $40,000 in the last tax year and wants to claim the American Opportunity Tax Credit (AOTC).

Susan knows that to qualify for the AOTC, a taxpayer must meet certain requirements. Here are some questions Susan might ask to determine Bob’s eligibility:

  1. Student Status: “Is your child enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential for at least one academic period beginning in the tax year?” This is important because the AOTC is only available for students who are enrolled at least half-time at an eligible educational institution.
  2. Course of Study: “Is your child pursuing a degree or other recognized education credential?” The AOTC is not available for students who are not pursuing a degree or other recognized education credential.
  3. Number of Years of Post-Secondary Education: “Is this your child’s first four years of post-secondary education?” The AOTC is only available for the first four years of post-secondary education.
  4. Felony Drug Conviction: “Does your child have a felony drug conviction?” Students with a felony drug conviction are not eligible for the AOTC.
  5. Income: “What was your adjusted gross income (AGI) for the last tax year?” The amount of the AOTC gradually reduces for taxpayers who have an AGI above $80,000 and is completely phased out for taxpayers who have an AGI above $90,000.

After asking these questions, Susan determines that Bob does qualify for the AOTC because his child is in his first year of college, enrolled at least half-time in a degree program, has no felony drug convictions, and Bob’s AGI does not exceed the limit. She advises Bob to claim the credit and completes Form 8867 to demonstrate her due diligence in determining Bob’s eligibility.

The next step is to fill out the form.

This is how Susan, from the example, would fill out Form 8867 for Bob:

  • Part I: Due Diligence Requirements. Susan would check the box for AOTC and answer “Yes” to all questions in this part, indicating that she completed the return based on the information provided by Bob, completed the AOTC worksheet, satisfied the knowledge requirement, made reasonable inquiries and documented them, kept records, and asked Bob about his ability to provide documentation and his previous credit history.
  • Part II: Due Diligence Questions for Returns Claiming EIC. Susan would skip this part because Bob is not claiming the EIC.
  • Part III: Due Diligence Questions for Returns Claiming CTC/ACTC/ODC. Susan would skip this part because Bob is not claiming the CTC, ACTC, or ODC.
  • Part IV: Due Diligence Questions for Returns Claiming AOTC. Susan would answer “Yes” to question 13, indicating that Bob provided substantiation for the credit, such as a Form 1098-T and/or receipts for the qualified tuition and related expenses for the claimed AOTC.
  • Part V: Due Diligence Questions for Claiming HOH. Susan would skip this part because Bob is not claiming the HOH filing status.
  • Part VI: Eligibility Certification. Susan would answer “Yes” to question 15, certifying that she complied with all due diligence requirements for claiming the AOTC on Bob’s return.

By filling out Form 8867 in this way, Susan has demonstrated her due diligence as a tax preparer and avoided potential penalties.

It’s worth mentioning that you only need to fill the sections that are relevant to the credits your client wants to claim. If you have further questions about filling the form, you can refer to the instructions for Form 8867 on the IRS website for more details and examples.

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Need Specialized Help with Form 8867?

At Bottomline Tax, we want to give our readers the best information we can compile, however your specific situation as a tax preparer may exceed the contents of this article. We always recommend readers consult a tax professional in case of unresolved questions.

V. Tax Credits Associated with Form 8867

We know that Form 8867 is a tool that helps tax preparers ensure that they meet the due diligence requirements for certain tax credits. Let’s focus on the tax credits now. These credits are the earned income credit (EIC), the child tax credit (CTC), and the American opportunity tax credit (AOTC). Eligible taxpayers can reap substantial advantages from these credits, such as reducing their tax liability or increasing their refund. However, these credits also have specific eligibility rules that must be followed to avoid errors or penalties.

  • The EIC is a refundable credit that helps low- to moderate-income workers and families. The amount of the credit depends on the taxpayer’s income, filing status, and number of qualifying children.
  • The CTC is a partially refundable credit that helps families with children under the age of 17. The amount of the credit depends on the taxpayer’s income and number of qualifying children.
  • The AOTC is a partially refundable credit that helps students and their families pay for higher education expenses. The amount of the credit depends on the taxpayer’s income and the amount of qualified education expenses.

To claim these credits, tax preparers must complete Form 8867 and attach it to the taxpayer’s return.

Here are some of the best resources for understanding the Earned Income Credit (EIC), the Child Tax Credit (CTC), and the American Opportunity Tax Credit (AOTC):

Earned Income Credit (EIC)

Child Tax Credit (CTC)

American Opportunity Tax Credit (AOTC)

VI. Recent Changes and Developments

Tax law and regulations regarding these credits are subject to change from year to year. Tax preparers should be aware of these changes and how they affect the use of Form 8867. Some of the recent changes and developments include:

  • The Consolidated Appropriations Act, 2021, made several temporary changes to the EIC and the CTC for tax year 2020. These changes include allowing taxpayers to use their 2019 earned income instead of their 2020 earned income to calculate the EIC, increasing the CTC for children age 6 or younger, and expanding the CTC to include qualifying children who are 17 years old.
  • The American Rescue Plan Act of 2021, made several temporary changes to the EIC, the CTC, and the AOTC for tax year 2021. These changes include expanding the EIC for workers without qualifying children, increasing the maximum amount and phaseout thresholds of the EIC, increasing the CTC for all qualifying children, making the CTC fully refundable, and allowing taxpayers to claim the AOTC for a fifth year.
  • The IRS has issued guidance and instructions on how to apply these changes and how to complete Form 8867 accordingly. Tax preparers should refer to these sources for more details and examples.

Here are some resources that can help you understand the changes made by the Consolidated Appropriations Act, 2021 and the American Rescue Plan Act of 2021:

Consolidated Appropriations Act, 2021

American Rescue Plan Act of 2021

IRS Guidance on Form 8867 Changes

VII. Conclusion

Form 8867 is an important document that helps tax preparers comply with the due diligence requirements for claiming certain tax credits. These credits can provide valuable benefits to eligible taxpayers, but they also have complex rules that must be followed correctly. Tax preparers should stay updated on the changes in tax law and regulations regarding these credits and use Form 8867 as a guide to ensure accuracy and avoid errors or penalties.