Protect your practice with due diligence

Every paid tax preparer must meet IRS due diligence requirements when claiming certain tax credits and when filing as head of household. Each year, the IRS reviews preparer compliance and assesses penalties when standards are not met. For tax professionals, understanding how to document eligibility and ask the right questions is essential to protect clients and reduce the risk of penalties for preparers and firms.

Due diligence is required by law

Due diligence requirements under §6695(g) apply to the earned income tax credit (EIC), child tax credit (CTC), additional child tax credit (ACTC), American opportunity tax credit (AOTC) and head of household (HOH) filing status. These rules require more than entering numbers into tax software. You must ask appropriate questions, evaluate responses and document your work to support the position taken on the return.

Form 8867, Paid Preparer’s Due Diligence Checklist, must be completed and submitted with each return that claims the EIC, CTC/ACTC, AOTC or HOH filing status. It must also be retained as part of your required records. The IRS expects preparers to comply with all four due diligence requirements whenever they apply.

The four due diligence requirements

The IRS defines due diligence through four core standards.

First, you must ask all necessary questions and document the client’s responses. If information appears incomplete, inconsistent or incorrect, you are required to make reasonable inquiries.

Second, you must compute the credit or filing status accurately based on the information obtained.

Third, you must complete and file Form 8867 for each applicable return.

Fourth, the record retention period is three years from the latest of the following dates: (1) the due date of the return (not including extensions), (2) the date the return was filed (if filed after the due date), or (3) the date the return was presented to the taxpayer for signature. Required records include Form 8867, worksheets that show how you determined eligibility and calculated the credit, and documentation of your client interview and follow-up questions.

Meeting these standards demonstrates that you exercised reasonable care in preparing the return.

Documentation is critical

The IRS expects you to document how you determined eligibility for credits and head of household status. If you rely on information provided by the client, your records should reflect what was asked, what was answered and why the information was accepted as accurate.

Documentation may include interview notes, worksheets, copies of records provided by the client and supporting calculations. Tax software prompts do not replace your responsibility to evaluate information. If something does not make sense, you must ask additional questions and document the answers.

The IRS provides due diligence training modules that emphasize applying professional judgment and documenting your reasoning when preparing returns that claim refundable credits or head of household status.

Pay attention to high-risk areas

Certain situations require additional scrutiny. Returns that claim the earned income tax credit with self-employment income reported on Schedule C are one example. Preparers must ensure that income and expenses are accurate and complete rather than simply accepting figures provided without question.

Head of household filing status is another area that requires careful review. You must confirm that the taxpayer paid more than half the cost of keeping up a home and that a qualifying person lived with the taxpayer for the required period. When facts are unclear, additional questions are necessary.

Recognizing unusual facts and asking follow-up questions protect both the client and your practice.

Penalties can add up quickly

Penalties for failure to meet due diligence requirements are assessed per failure and per return. Both individual preparers and firms can be subject to penalties. The IRS may also take additional compliance actions if patterns of noncompliance are identified.

A single return with multiple due diligence failures can result in multiple penalties. 

Train staff and strengthen procedures

Due diligence is a firmwide responsibility. Staff should understand which credits and filing statuses trigger additional requirements and when Form 8867 must be completed.

Consider implementing standardized interview checklists, internal review procedures and annual training using IRS due diligence resources. The IRS offers online training modules in English and Spanish that can help preparers understand and apply the rules correctly.

Build confidence in your due diligence process

Due diligence is a critical compliance obligation that protects your clients and your firm. Understanding how the IRS defines due diligence, identifying which credits and filing statuses require additional steps, and maintaining proper documentation are all essential parts of a compliant practice.

NATP’s webinar on due diligence provides practical guidance to help you meet IRS expectations with confidence. You will learn how to ask probing questions professionally, complete Form 8867 accurately, identify situations that require additional documentation and understand how penalties are calculated for failures to comply.

Join NATP’s July 9 or Dec. 8 webinar, Ethics and Due Diligence Requirements of Tax Preparation, to strengthen your compliance process and reduce penalty risk. The webinar is also available on demand after the live event. Register today and ensure your office is prepared for the next IRS review.