Why the IRS Can Penalise You, Even When the Tax Return Is Correct

A tax return can appear complete while still leaving serious questions unanswered. For paid preparers, refundable credits, filing status, and dependent claims can require careful follow-up rather than a quick entry based only on a client’s first response.

Pressure to finish returns quickly can make documentation seem secondary. Missing notes or supporting records can create problems even when the information reported on a return is ultimately correct.

Tax Resolution: The Badran Way features insight from a former IRS employee with 40 years of agency experience who later worked with tax preparers. That perspective highlights how preparer reviews can focus on the actions and records behind a return.

The sections below break down the warning signs, documentation habits, and taxpayer safeguards that support sound tax preparer due diligence before a return is filed.

Why Refundable-Credit Returns Draw Due Diligence Attention

The IRS uses systems to review returns involving refundable credits, the earned income credit, child tax credit, other dependent credit, and head-of-household status. Returns with information that appears out of line may receive additional attention.

Patterns can prompt a closer look

Reviews can compare information across returns and identify unusual combinations, such as a large credit with little or no income. A preparer whose clients have repeated examinations for the same issue may also draw scrutiny.

An initial letter should change the response

A preparer may first receive a letter raising concerns about due diligence, including record retention and knowledge requirements. If practices do not improve, the review may continue through correspondence or an on-site visit.

A correct result does not replace a complete file

A return’s credits or filing status can be correct while the preparer’s process remains deficient. The review can focus on whether the preparer asked required follow-up questions and retained support for the answers.

• Refundable credits paired with very low reported income
• Dependent or filing-status claims lacking supporting details
• Multiple client returns examined for a similar credit issue
• Records referenced on a form but absent from the case file

These patterns are not proof that a return is wrong. They are reasons to slow down, verify the facts, and preserve a clear record of how the preparer reached the reported result.

Strong due diligence starts before submission. A file that shows the questions asked, answers received, and documents reviewed provides a clearer foundation if the IRS requests information later.

Build Tax Preparer Due Diligence Into Every File

Documentation is most useful when it is created while the return is being prepared. A preparer who remembers the facts later may still have trouble showing what was known, asked, reviewed, and retained at the time of filing.

Record the facts while they are available

Details held only in a preparer’s memory do not resolve a file-documentation problem. Notes should capture information supporting a credit, filing status, or dependent claim when the client provides it.

Use the five-question discipline

A practical inquiry covers who was involved, what happened, when it happened, where it occurred, and why it occurred. For residency-based claims, that can mean documenting who lived in the home and how long they lived there.

Keep documents that support the answer

Form 8867 requires particular care. Stating that a document was reviewed without retaining it in the file can result in a penalty that may not be reduced, so scanning support as it is received helps connect the record to the return.

• Ask who, what, when, where, and why
• Write down relevant client answers promptly
• Scan or retain documents used to support the claim
• Keep each client’s facts in that client’s own file
• Review the file before submitting the return

This checklist is not a substitute for professional requirements or firm procedures. It is a practical way to make fact-gathering visible and accessible when a file is later reviewed.

Tax preparer due diligence is not simply a form completed at the end of the process. It is a file-building habit that links questions, answers, and evidence to the specific taxpayer’s return.

Treat Inconsistencies as Questions, Not Shortcuts

Due diligence requires more than collecting documents. When a statement, document, or reported figure conflicts with other information, the preparer needs to ask follow-up questions and document the response.

Apply the three I’s

Information that is inconsistent, inaccurate, or incorrect calls for follow-up. A preparer should not ignore a mismatch simply because the client wants to claim a credit or finish the return quickly.

Explore gaps in the household picture

Low reported wages alongside the costs of supporting several children can reasonably lead to further questions. Rent, other income, public benefits, and loans are examples of information that may help clarify a household’s circumstances.

Give Schedule C information the same scrutiny

A Schedule C showing just enough gross receipts to trigger a credit with little or no expense information is a red flag. It does not establish wrongdoing, but it does call for a careful, file-specific inquiry.

• Compare the client’s statements with the documents provided
• Ask focused follow-up questions about the mismatch
• Request supporting records when they are available
• Scan new documents received during follow-up
• Document the explanation in the correct client file

The goal is not to interrogate taxpayers or make assumptions about their circumstances. It is to resolve a relevant inconsistency through respectful questions and a record that explains the preparer’s work.

Careful follow-up protects both accuracy and process. It also reduces the temptation to reuse notes from a similar return, which does not establish due diligence for a different client.

IRS Problems, Tax Debt, and the Cost of an Unsigned Return

Taxpayers and business owners can face consequences when a return was prepared carelessly or by someone who cannot be identified. A disciplined filing process and prompt review of concerns can keep uncertainty from becoming a larger tax-resolution problem.

Do not rely on a ghost preparer

Ghost preparers are paid preparers who do not appear on the return. If a paid preparer will not sign the return, it should not be submitted because the taxpayer may be left without the preparer’s records or accountability.

Understand the exposure for paid preparers

Circular 230 was described as rules governing paid tax preparers, including enrolled agents and others with a PTIN who prepare returns for compensation. A company also may face penalties if it does not address a preparer’s due-diligence issues.

Address problems through an orderly review

When an IRS notice, missing records, or a suspected preparer error creates concern, the first task is to identify what was filed and what documentation exists. Tax resolution should be approached through facts, records, and informed representation, not panic or avoidance.

• Choose a reputable paid preparer
• Confirm that the preparer signs the return
• Keep copies of returns and supporting records
• Answer relevant questions honestly and completely
• Question any pitch that treats a refund as a choice instead of a supported calculation

These steps help taxpayers retain information needed to understand their filing position. They also make it easier to seek assistance if a notice or collection issue develops later.

Due-diligence penalties can be substantial and may apply per return selected for review. The financial stakes make careful preparation and early problem diagnosis essential for preparers, taxpayers, and firms.

Conclusion

Reliable tax preparation depends on more than entering figures into a return. It requires a process that tests questionable information, records the answers, and preserves documents supporting important claims.

First, refundable credits and filing-status claims can receive additional review when the facts do not fit together. Preparers should treat unusual patterns as a reason for thoughtful follow-up, not a reason to rush.

Second, records created after the fact may not solve a due-diligence issue. Notes and scanned support are strongest when collected as the preparer works through the client’s information.

Third, taxpayers should avoid unsigned returns and maintain their own copies of filing records. A reputable preparer’s questions may be personal, but they can be necessary to support the return properly.

For anyone facing an IRS notice, tax debt, or uncertainty about a prior filing, tax preparer due diligence offers a useful starting point: gather the records, define the issue, and seek qualified tax-resolution guidance before making the next decision.

FAQs

What is tax preparer due diligence?

It is the process of asking relevant questions, checking information that appears inconsistent, and retaining records that support claims made on a return.

Why should a preparer document client answers?

Documentation shows what the preparer knew and did at the time of filing. Information remembered later may not be enough during a preparer review.

What should a taxpayer do if a paid preparer will not sign the return?

A return prepared for pay should not be submitted if the preparer will not sign it. Taxpayers should seek a reputable preparer and retain copies of their records.

Can a return be correct but still create a due-diligence problem?

Yes. A preparer may face scrutiny if required questions were not asked or supporting documents were not kept, even if the reported claims are correct.

Amro Badran, EA, is the Managing Partner of Badran Tax,

With over 40 years of experience and accreditation as a Federal Enrolled Agent,
Amro Badran and his team of tax professionals specialize in helping individuals and businesses resolve complex IRS & state tax issues and controversies.

Experienced and Trusted Tax Resolution Firm based in New Brunswick, NJ.

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