THE TAX ATTIC with Jerry Coon

Follow-up on EITC, Form 8867

Jerry Coon

Here is a follow-up on last week’s article concerning the Earned Income Tax Credit (EITC) and the Form 8867, Paid Preparers Earned Income Due Diligence Checklist. The object of the form is to require tax preparers to go over all of the rules concerning the EITC with their clients (i.e. perform good due diligence).

This is an attempt to cut down on the number of mistakes and outright fraud that occurs in the EITC program. The Internal Revenue Service (IRS) has found that there are a significant number of mistakes being made by paid tax preparers and by all indications there is a significant amount of fraud accompanying those errors. I noted that the IRS requires that Form 8867 be signed by both the preparer and the taxpayers. In addition, the form will have to be submitted with the return as part of the return package. Previously, preparers were required to keep the form in their file. Now, it has to go in with the return and a copy still has to remain in the file.

The penalty for noncompliance was increased. The penalty for not sending the form in, for not having a copy in the file, or simply for not performing good due diligence has been increased from $100 per incident up to $500 per incident. The IRS will be authorized to penalize:

1. the return preparer;

2. the firm that employs the return preparer, or

3. a non-signing preparer who is supervised by a

return preparer.

The IRS reserves the right to penalize any or all three of the parties involved. They are serious about penalizing those who do not comply with the due diligence rules when preparing EITC returns. All of us want to see taxpayers who legitimately qualify for the EITC receive the right amount of credit. However, none of us want to see taxpayers who do not qualify still receive the credit because a preparer doesn’t know the rules or intentionally bends the rules.

Another area where there seems to be a large amount of fraud is in the area of Michigan unemployment. Some of it comes from people drawing unemployment benefits when they aren’t entitled to the benefits and some of it comes from employers circumventing the system. In the end, the Michigan Unemployment Insurance Agency (UIA) estimates that millions of dollars are either paid out annually in fraudulent benefits or results in taxes not being paid by businesses circumventing the rules.

There are a number of ways that fraudulent benefits are paid out to claimants. First, a claimant still collects full benefits while also working and does not report the earnings to the UIA.

Second, a claimant reports false information for leaving a job. Not everyone leaving a job is entitled to unemployment benefits.

Third, the claimant fails to report a refusal of work. He is offered a job but for whatever reason, turns down the job.

Fourth, not supplying correct information concerning pay received after a job separation occurs. An example of this is receiving severance, vacation, holiday or personal-paid-time-off pay after leaving a job and not reporting it to UIA.

Fifth, a claimant fails to report that he is unable and unavailable for work due to an injury, illness, or even a vacation.

The flip side of this deals with businesses fraudulently not paying taxes by circumventing the system.

Allow me to explain how the UIA process works. Each employer is assigned a UIA tax rate. For the first two years of existence, the business pays a 2.7% tax rate on the first $9,000 of each employee’s earnings—$9,000 times 2.7% equals $243. If the employer has six employees, it would pay $243 times 6, or $1,458 in UIA tax. If the employer has 10 employees, the UIA would receive $2,430.

After the second year, the rate is adjusted. If the employer has had no one draw UIA benefits during those two years, the rate would most likely fall below the 2.7% rate. However, if the employer had even one person draw benefits, the rate would likely raise dramatically above the 2.7% rate. The maximum assessed rate can be 11.05% so the $243 of tax paid in the first two years could go up to $994.50 ($9,000 x 11.05%) of tax per employee. If the employer has six employees, it pays $5,967 ($994.50 x 6) of tax. For 10 employees, the tax liability would be $9,945. Those are significant dollars that the employer is paying.

Sometimes the incentive to improperly keep that rate down is more than an employer can stand, so it attempts to bend the rules. First, an employer might lay off all of its workers and hire them back as subcontractors. If this process is completed properly and the workers really do become subcontractors, that is okay. However, many times the workers are still employees. Nothing has changed except the “subcontractors” are now responsible for their own taxes. In reality, they are still employees and should still be getting paid as employees. The UIA tax is still due.

Second, an employer might pay employees some or all of their pay in cash. Paying people under the table is not acceptable in our system and can result in a bad situation for both the employer and the employee.

Finally, the employer might provide incorrect information to the UIA in an attempt to keep an employee from drawing benefits. As the tax increases, employers have the incentive to try to reduce the tax or at least keep it even.

Bending the rules by the employee or the employer is not a legitimate way to keep tax down. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns Action Tax Service in Rockford. Contact Jerry at www.actiontaxservice.com.

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