Due diligence is your best friend in the tax office

Think of due diligence as your personal insurance policy in tax prep. It protects your clients, your reputation, and your bottom line.

If you’ve been in the tax business for more than five minutes, you’ve probably heard the term due diligence thrown around a lot. But here’s the truth. 

It’s not just an IRS requirement. It’s the ethical backbone of a trustworthy practice. When done correctly, due diligence keeps you compliant, confident, and credible in the eyes of your clients and the IRS.

The rulebook

Circular 230 outlines our responsibilities when practicing before the IRS. IRC §6695(g) adds teeth to those rules, imposing a $600 penalty per credit, per return, for due diligence failures involving the earned income credit (EIC), child tax credit (CTC), additional child tax credit (ACTC) or head of household (HOH) filing status.

We must:

• Ask reasonable questions when something doesn’t add up
• Document client answers and verification steps
• Keep those records for at least three years

That means if you make due diligence errors on a single return that includes all four items, the penalty could be $2,400 just for that one return.

The real-world test

Say a client claims HOH but can’t clearly explain their qualifying child’s residency. If you file without digging deeper, you’ve failed due diligence, even if they “promise” it’s correct. Take a few extra minutes to ask for identification, school records, or other information to ensure you have verified your client’s dependents. 

Let’s say a client claims head of household filing status but can’t clearly explain where their qualifying child lived during the year. If you simply take their word for it and file the return, you’ve failed due diligence, even if the client “promises” they meet the rules.

Pro Tip: When in doubt, document the question, the answer, and why it made sense to you at the time. The IRS wants to see your thought process. Use worksheets and keep your records in a safe place. Use IRS Form 8867, Paid Preparer’s Due Diligence Checklist, not just as a compliance form but as a guide for your questions. 

Common due diligence pitfalls

Even experienced preparers can fall into traps:

Overreliance on client memory – Clients may honestly misremember dates, amounts, or details. Without documentation, you can’t confirm accuracy.

Assuming prior-year accuracy – Just because a filing status or credit appeared on last year’s return doesn’t mean it’s correct this year.

Incomplete recordkeeping – Failing to keep copies of supporting documents or detailed notes can be as risky as not asking the questions in the first place.

How due diligence protects you

When an IRS auditor reviews your work, strong due diligence can:

• Prevent penalties by showing you followed the rules.
• Reduce stress because you have everything you need at your fingertips.
• Build trust with clients who see that you’re thorough and professional.

Think of it this way: if the IRS asked you, “Why did you prepare this return this way?” your due diligence file should answer that question without hesitation.

Bottom line

Due diligence isn’t about mistrusting your clients; it’s about protecting them and you. Do it right, every time, and you’ll build the kind of reputation that lasts and the foundation of a reputable tax practice. 

By asking the right questions, documenting answers, and keeping thorough records, you’ll not only meet IRS requirements but also build a reputation for accuracy and integrity. In the tax world, that reputation is worth more than gold.