Tax Preparer Due Diligence: Why the IRS Can Penalize a Correct Return

The credits check out. The filing status is right.

The IRS can still assess a penalty.

Under tax preparer due diligence rules, the IRS looks at what a paid preparer asked, recorded, and kept, not only at the numbers on the return.

A missing note can cost $650 per failure on returns filed in 2026.

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What Tax Preparer Due Diligence Requires

Due diligence rules kick in when a paid preparer files a return that claims any of four tax benefits: the earned income tax credit (EITC), the child tax credit group (CTC, ACTC, and the credit for other dependents), the American opportunity tax credit (AOTC), or head of household (HOH) filing status.

For each of those returns, the preparer must complete Form 8867, Paid Preparer’s Due Diligence Checklist, and file it with the return. The form is only the visible part. What sits behind it matters more.

One detail surprises many preparers. The IRS says the rules generally do not require you to request specific documents from clients. But if you rely on a document, you have to keep a copy.

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Why the IRS Can Penalize You When the Return Is Correct

The due diligence penalty under Internal Revenue Code section 6695(g) is not a penalty for a wrong answer. It is a penalty for a missing process. If the IRS reviews your file and cannot see the questions you asked, the answers you got, and the records you kept, the credit being valid does not fix that.

And the penalty stacks.

For returns filed in 2026, the IRS can assess $650 for each due diligence failure. A single return claiming the EITC, CTC, AOTC, and HOH status can carry up to $2,600.

Benefit Claimed on the Return	Possible Penalty per Failure (Returns Filed in 2026)
Earned income tax credit (EITC)	$650
Child tax credit, additional child tax credit, or credit for other dependents	$650
American opportunity tax credit (AOTC)	$650
Head of household filing status	$650
All four on one return	Up to $2,600

Now multiply that across a season. If a review covers a sample of your returns and finds the same documentation gap on each one, the numbers grow quickly.

How the IRS finds preparers to review

Reviews are usually driven by data. The IRS compares filing patterns across returns, and combinations like a large refundable credit with very little income can stand out. So can a preparer whose clients are repeatedly examined for the same issue.

The first contact is often an educational letter. The IRS may also call the preparer to review the rules and the possible consequences, then keep monitoring returns to see whether accuracy improves. If it doesn’t, the next step can be a compliance review by mail or in person.

The firm can be on the hook too

The IRS can assess due diligence penalties against an employer when an employee preparer fails to comply. Credentialed practitioners such as enrolled agents, CPAs, and attorneys also answer to Circular 230, the Treasury rules governing practice before the IRS, and can be referred to the IRS Office of Professional Responsibility.

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How to Build a Due Diligence File That Holds Up

On Tax Resolution: The Badran Way, a former IRS employee with 40 years at the agency, who later worked with tax preparers, made a point every preparer should hear. A preparer review looks at the actions and records behind the return. The return alone doesn’t answer those questions.

Write it down while the client is in front of you

You may remember the conversation perfectly two years from now. That won’t help. Memory is not a record, and the rules expect answers documented when you received them.

Use the five-question discipline

Who, what, when, where, and why. For a residency-based claim, that means recording who lived in the home, for how long, and how you learned it. Short notes are fine if they answer the questions that decided eligibility.

Keep what you relied on

If a school record, lease, or medical bill shaped your decision, scan it the day you get it. Form 8867 asks whether you kept copies of documents you relied on. Answering yes without the document in the file creates a problem of its own.

One client, one file

Two families can look alike on paper. Copying notes from a similar return does not show due diligence for a different client, and a reviewer will notice identical language.

• Ask: who, what, when, where, and why for each claimed benefit
• Record: client answers at the time of the interview
• Scan: any document you relied on to decide eligibility
• Separate: each client’s facts into that client’s own file
• Check: the file against Form 8867 before you submit

None of this replaces the Form 8867 instructions or your firm’s own procedures. It makes your fact-gathering visible to someone who wasn’t in the room.

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Treat Inconsistencies as Questions, Not Shortcuts

The IRS expects preparers to make reasonable inquiries when information appears incorrect, inconsistent, or incomplete. You cannot ignore the implications of what a client tells you just because they want the credit or the line is out the door.

Look at the whole household picture

Low wages alongside the cost of raising several children raises a fair question. How is the household getting by? Rent arrangements, other income, public benefits, and help from family can all explain it. Ask, then write down the answer.

Give Schedule C the same attention

A Schedule C, the form used to report self-employment income, can be a red flag when gross receipts land just where the credit peaks and expenses are thin or missing. That is not proof of anything. It is a reason to ask how the business runs and what records the client keeps.

Ask respectfully

The goal is not to interrogate anyone. Some questions will feel personal to the client. Explaining that the IRS requires them usually helps, and the documented answer protects both of you.

• Compare what the client says with the documents provided
• Ask focused follow-up questions about any mismatch
• Request supporting records when the client has them
• Scan anything new that comes in during follow-up
• Note the explanation in the correct client file

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What to Do If the IRS Questions Your Due Diligence

A letter from the IRS about your preparer practices deserves a prompt, organized response. Panic and silence both make it worse.

If you’re a preparer or firm owner

• Read the letter closely: identify whether it is educational, a warning, or a proposed penalty, and note any response deadline
• Pull the affected files: check each one for Form 8867, worksheets, interview notes, and client documents
• Don’t backfill records: fix your process for future returns rather than creating notes for past ones
• Review firm procedures: the IRS can hold an employer responsible for an employee’s failures
• Get representation early: an Enrolled Agent or tax attorney can respond on your behalf and may identify defenses

If you’re a taxpayer

Your preparer’s due diligence protects you too. You remain responsible for what’s on your return, even if someone else prepared it.

Watch out for ghost preparers. These are people who charge to prepare a return but refuse to sign it or include their Preparer Tax Identification Number (PTIN). If a paid preparer won’t sign, don’t file that return. You could be left with no records and no one accountable if the IRS has questions later.

• Choose a preparer with a PTIN who signs the return
• Keep your own copies of returns and supporting records
• Answer eligibility questions honestly and completely
• Walk away from anyone who treats a refund amount as something to pick

For improper EITC claims, the stakes are personal. If the IRS finds reckless or intentional disregard of the rules, you can be barred from claiming the credit for two years. Fraud can mean a ten-year ban.

If you’ve received an IRS notice or letter tied to a prior return, start by gathering what was filed and what records exist. The team at Badran Tax helps preparers, firms, and taxpayers work through due diligence reviews and related IRS problems across all 50 states. A free consultation can clarify where you stand before you respond.

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Frequently Asked Questions

What is tax preparer due diligence?

It is the set of IRS requirements paid preparers must meet when a return claims the EITC, CTC/ACTC/ODC, AOTC, or head of household status. It includes completing Form 8867, computing the credits, making reasonable inquiries, and keeping records.

How much is the due diligence penalty in 2026?

For returns filed in 2026, the penalty is $650 per failure. A return claiming all four covered benefits can carry up to $2,600.

Can the IRS penalize me if the credits on the return were correct?

Yes. The penalty targets the preparer’s process. If you didn’t ask required questions or keep supporting records, a correct return does not cure the failure.

How long do I need to keep due diligence records?

Keep Form 8867, worksheets, client documents you relied on, and your notes for 3 years from the latest of the dates listed in the Form 8867 instructions, generally the return due date or the date it was filed.

Do I have to collect documents from every client?

Not always. The IRS says the rules generally don’t require requesting specific documents. You do have to keep copies of any document you relied on, and ask for more when information seems incorrect, inconsistent, or incomplete.

Can a tax firm be penalized for an employee’s due diligence failures?

Yes. The IRS can assess due diligence penalties against an employer when an employee preparer fails to comply.

What should I do if a paid preparer won’t sign my return?

Don’t file it. Paid preparers are required to sign and include their PTIN. Find a reputable preparer and keep your own copies of your records.

Will the IRS contact me before assessing a penalty?

Often, yes. The IRS may send educational letters or call preparers before a compliance review. Treat any contact as a signal to review your files and procedures right away.

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Bottom Line

Tax preparer due diligence is judged on the file, not the refund. A return can be right on every line and still cost the preparer $650 per failure if the questions, answers, and documents aren’t there to show how the result was reached.

Build the record while you work. Question what doesn’t fit. And if the IRS has already reached out, organize your files before you respond.

If you’re facing a due diligence letter, a proposed preparer penalty, or questions about a return someone else prepared, Amro Badran, EA, Managing Partner of Badran Tax, and the firm’s licensed tax professionals are available to help. Badran Tax brings over 40 years of experience resolving IRS and state tax problems, with a team of Enrolled Agents, CPAs, Tax Attorneys, and Former IRS Agents working with taxpayers in all 50 states.

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Sources & Helpful Resources

• IRS: Consequences of Filing EITC Returns Incorrectly
• IRS: Due Diligence Requirements for Knowledge and Recordkeeping
• IRS: Instructions for Form 8867, Paid Preparer’s Due Diligence Checklist
• IRS: News and Updates for Paid Preparers
• IRS: Tax Preparer Penalties
• U.S. Code: 26 U.S.C. § 6695, Other Assessable Penalties

 

 

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