Due diligence law, regulations and requirements

Paid preparers must follow requirements when claiming certain credits or head of household filing status. Under the Internal Revenue Code, a penalty can be assessed against a paid tax return preparer for not meeting due diligence requirements when preparing a return or claim for refund claiming the:

Earned Income Tax Credit (EITC),
Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), Credit for Other Dependents (ODC),
American Opportunity Tax Credit (AOTC), or
Head of household (HOH) filing status.

Law

Section 6695(g) of the Internal Revenue Code states:

Any person who is a tax return preparer with respect to any return or claim for refund who fails to comply with due diligence requirements imposed by the Secretary by regulations with respect to determining (1) eligibility to file as head of household (as defined in section 2(b)) on the return, or (2) eligibility for, or the amount of, the credit allowable by section 24 [CTC/ACTC/ODC], 25A(a)(1) [AOTC] or 32 [EITC] shall pay a penalty of $500 for each such failure.

Treasury regulation

Section 1.6695-2 of the regulations describes the four due diligence requirements a paid tax return preparer must meet when preparing a return or claim for refund claiming the EITC, CTC/ACTC/ODC, AOTC or HOH filing status.

Firms employing preparers: A firm that employs a tax return preparer can be subject to a due diligence penalty for a return or claim prepared by its employee. (Treas. Reg. section 1.6695-2(c))

The four due diligence requirements

The following are your requirements and your responsibilities

Complete and Submit Form 8867 (Treas. Reg. section 1.6695-2(b)(1))

Based on information obtained from your client or information you otherwise reasonably obtain or know, you must:

complete Form 8867, Paid Preparer's Due Diligence Checklist and electronically submit the completed Form 8867 to the IRS with the e-filed return or claim, or
for a return not e-filed, provide a copy of the completed Form 8867 to your client for inclusion with the filed return or claim, or
if you are the nonsigning preparer, provide a completed electronic or paper copy of Form 8867 to the signing preparer for inclusion with the filed return or claim

Compute the credits (Treas. Reg. section 1.6695-2(b)(2))

Based on information obtained from your client or information you otherwise reasonably obtain or know, you must:

complete the appropriate worksheets to compute each applicable credit, such as those found in the instructions for Form 1040 or Form 8863, or
complete the computations using your own similar worksheets and make sure to keep records showing what information you used and how you made the computations.

Knowledge (Treas. Reg. section 1.6695-2(b)(3))

You must not know or have reason to know that any information you used to claim the credits or HOH filing status is incorrect.

You cannot ignore the implications of any information given to you or known to you.

You must make additional reasonable inquiries, if a reasonable and well-informed tax return preparer, knowledgeable in the law, would conclude the information furnished appears incorrect, inconsistent or incomplete.

At the time you interview your client, make and keep a record of these inquiries and your client's answers.

Know the law and use that knowledge of the law to ensure you are asking your client the right questions to get all relevant information.

The Treasury regulation gives eight examples of meeting the knowledge requirement.

Keep records for three years (Treas. Reg. section 1.6695-2(b)(4))

the completed Form 8867,
the completed worksheets used to determine the amount of each credit,
a record of how, when and from whom you received the information used to complete Form 8867 and the worksheets, and
any documents your client showed you that you relied on to complete Form 8867 or the worksheets.
any additional information you relied on.
the due date of the tax return (not including any extension of time for filing), or
the date the tax return or claim for refund was electronically filed, or
if not electronically filed, the date you presented the tax return or claim for refund to your client for signature, or
if you prepare it and another preparer completes and signs the return or claim for refund, the date you submitted it to the signing tax return preparer.

Note: Keep these records secure in either a paper or electronic format.

Tax preparer due diligence rules

Preparer compliance - Focused and tiered

Knock and talk

Letters or phone calls about due diligence and filing errors

Barring non-compliant EITC return preparers from filing tax returns

Due diligence requirements for knowledge and recordkeeping

Paid preparer due diligence videos

Tax preparer toolkit