A new preparer's penalty.

The Taxpayer Relief Act of 1997 created a $100 penalty for return preparers who fall to comply with due-diligence requirements for determining a taxpayer's eligibility for the earned income credit (EIC). The penalty is effective for tax years beginning after 1996.

Notice 97-65 sets forth the requirements paid preparers must meet or be liable for under IRC section 6695(g) for each 1997 return or refund claim involving the EIC.

In order to avoid the penalty, preparers must

1. Complete a checklist (see sidebar) or keep a paper or electronic file containing the information needed to complete the checklist (the alternate eligibility record). This information must be obtained from the taxpayer or be reasonably obtained by the preparer.

2. Either complete the EIC worksheet (included in the 1997 form 1040 instructions) or keep a detailed record of how they computed the EIC.

3. Not know, or have any reason to know, that any information they use in determining the taxpayer's eligibility for, or in computing, the EIC is incorrect. If the information appears to be incorrect, inconsistent or incomplete, preparers must make reasonable inquiries.

4. Retain the above, information for approximately three years after the date the return was presented to the taxpayer for signature. Preparers may keep these documents on magnetic media or in an electronic storage media system.

Observation. If preparers do not meet these requirements, they may still avoid the penalty if they demonstrate to the satisfaction of the IRS that their normal office procedures are reasonably designed and routinely followed to ensure compliance with the 1997 due-diligence requirements and that any failure to meet the requirements is an isolated and inadvertent case.

--Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.