Due Diligence Requirements for Tax Preparers: What You Need to Know to Avoid Penalties
As a tax preparer, one of your most important duties is ensuring that the returns you prepare meet all IRS requirements. This includes fulfilling the due diligence requirements for claims related to specific credits and filing statuses. Failing to meet these requirements can result in costly penalties. By understanding what due diligence involves and how to stay compliant, you can avoid these penalties and help your clients maximize their tax benefits.
What Is Due Diligence?
Due diligence refers to the care and verification that tax preparers must exercise when preparing tax returns, especially those that involve refundable credits or head of household (HOH) filing status. The IRS mandates due diligence to ensure that tax preparers thoroughly review the client’s eligibility for certain credits and ensure that the information provided is accurate.
Key Elements of Due Diligence:
- Verification: You must confirm that the client qualifies for specific credits.
- Calculation: Ensure all credit amounts are calculated accurately.
- Documentation: Maintain thorough records of all the steps you took to verify eligibility.
- Inquiry: Ask relevant questions to ensure the information provided by your client is accurate.
Which Credits and Filing Statuses Are Subject to Due Diligence?
- Earned Income Tax Credit (EITC): For low-to-moderate-income workers with dependents.
- Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), Credit for Other Dependents (ODC): These credits help offset the cost of raising children or other dependents.
- American Opportunity Tax Credit (AOTC): For qualified education expenses.
- Head of Household (HOH) Filing Status: Provides a higher standard deduction for taxpayers who meet the criteria.
The Four Key Due Diligence Requirements
1. Complete and Submit Form 8867: Paid Preparer’s Due Diligence Checklist
As part of due diligence, you are required to complete Form 8867, the Due Diligence Checklist, for returns claiming EITC, CTC/ACTC/ODC, AOTC, or HOH status. This form must be filed electronically along with the return. If the return isn’t filed electronically, the completed form must be provided to your client.
Tip: Make sure all sections of Form 8867 are thoroughly completed to verify eligibility for the claims being made.
2. Accurate Calculation of Credits
Tax preparers must ensure that the credits are calculated correctly. Use the appropriate worksheets and resources to calculate the EITC, CTC, AOTC, and other credits.
Tip: Use IRS forms and worksheets (such as Form 8863 for AOTC) or create your own worksheet to track the calculations. Ensure records of the calculations are maintained for future reference.
3. Knowledge of the Law and the Client’s Information
It’s your responsibility to know the laws surrounding these credits and ensure that the information your client provides is accurate. If something seems off or inconsistent, you must ask for clarification.
Tip: Ask targeted questions based on the law to ensure the client qualifies for the credits. Don’t ignore discrepancies. Inquire further when information seems incomplete.
4. Keep Records for Three Years
You must keep records of all documentation related to due diligence, including:
- Completed Form 8867
- The worksheets used for calculating credits
- Any supporting documents provided by the client
Practice Tip: Secure these records, either in paper or electronic format, for at least three years. This is critical for audit protection and for ensuring that you comply with IRS regulations.
Penalties for Non-Compliance
If you fail to meet due diligence requirements, you could face substantial penalties. The IRS imposes a penalty of $560 for each failure to meet due diligence for each return. This can add up quickly if multiple credits or HOH filing status are involved. For example, if you fail to meet due diligence for a return that claims multiple credits, the penalties could total up to $2,240.
Practice Tip: To avoid penalties, always double-check the accuracy of your client’s information and ensure that all necessary forms are completed and submitted.
How to Avoid Penalties and Stay Compliant
- Stay Updated on Tax Laws: Tax laws are constantly evolving. Make it a habit to stay informed about changes in tax law, especially those related to refundable credits and filing statuses.
- Use Technology: Take advantage of tax software that helps streamline the due diligence process by automatically completing Form 8867 and verifying calculations.
- Maintain Clear Communication with Clients: Have an open and transparent conversation with your clients. Ensure that they understand the importance of providing accurate information.
- Document Everything: Keep detailed records of all interactions with clients, including the questions you asked and their responses.
Conclusion
Due diligence is an essential responsibility for tax preparers, especially when dealing with credits like EITC, CTC, ACTC, AOTC, and filing statuses like HOH. By following the IRS guidelines and taking the necessary steps to verify the accuracy of claims, you can avoid penalties and ensure that your clients receive the tax benefits they deserve.
Useful Resources
Roundtable – Due Diligence Law
Due Diligence Law and EITC RegulationsWhat is Form 8867?
Access Form 8867 – Paid Preparer’s Due Diligence ChecklistDue Diligence Requirements for Knowledge and Record-Keeping
Due Diligence Requirements for Knowledge and Record-KeepingConsequences of Not Meeting the Due Diligence Requirements
Consequences of Failing to Meet Due DiligenceForm 8862 – Due Diligence Requirements for EITC Claims
Form 8862 – Earned Income Tax Credit (EITC)Consequences for Not Meeting Due Diligence Requirements
If we review the returns or claims for refund you prepared and find that you did not meet the due diligence requirements, we may assess a $500 penalty for each failure to meet the due diligence requirements (see section 6695(g) of the Internal Revenue Code).
The penalty amount is indexed for inflation. For returns or claims for refund filed in 2025, the penalty that can be assessed is $635 per failure. Therefore, if due diligence requirements are not met on a return or claim for refund claiming EITC, CTC/ACTC/ODC, AOTC, and HOH filing status, the penalty could be as much as $2,540 per return or claim.
Footnotes:
Treas. Reg. section 1.6695-2(b)(1)
Treas. Reg. section 1.6695-2(b)(2)
Treas. Reg. section 1.6695-2(b)(3)
Treas. Reg. section 1.6695-2(b)(4)
Related Posts
Was this helpful?
