The following are questions preparers frequently ask us about fulfilling their due diligence requirements and our answers. We updated the answers to include new requirements for returns and claims for refund filed after 2019.
How did the Tax Cuts and Jobs Act (TCJA) of 2017 change my due diligence requirements for returns filed after 2018?
- The TCJA expanded the application of Internal Revenue Code (IRC) § 6695(g) to determining eligibility to file as head of household.
- For tax years 2018-2025, TCJA modified the child tax credit to provide a $500 nonrefundable credit for other dependents (ODC). Because the ODC is part of the child tax credit, the ODC is subject to the same due diligence requirements as the child tax credit.
All paid tax return preparers who determine a client’s eligibility to claim head of household filing status or the ODC, or who determine the amount of ODC, for tax year 2018 or later are subject to due diligence requirements and to the penalties for failure to comply with these requirements. The penalties apply to preparers who sign the return, preparers who prepare the filing status or the applicable credit portion of a return but do not sign the return, and employers of these preparers.
The PATH Act extended the application of IRC § 6695(g) from returns or claims for refund claiming the earned income tax credit (EITC) to also cover returns and claims for refund claiming the child tax credit (CTC)/additional child tax credit (ACTC) and the American opportunity tax credit (AOTC).
All paid tax return preparers who determine eligibility for, or the amount of, the EITC, CTC/ACTC or the AOTC for tax year 2016 or later are subject to due diligence requirements and to the penalties for failure to comply with these requirements. The penalties apply to preparers who sign the return, preparers who prepare the applicable credit portion of a return but do not sign the return, and employers of these preparers.
I use good return preparation software. Why can't I rely on my software to meet my due diligence requirements?
You can’t depend on your software exclusively. Tax software is a tool to assist you and is not a substitute for your knowledge of the tax law, professional judgment, and responsibility. You are the person who can best evaluate the information your client gives you and apply your knowledge of the law to that information. Software cannot be designed to address every possible due diligence issue you may encounter.
Keep the following:
- A copy of the Form 8867PDF, Paid Preparer's Due Diligence Checklist
- A copy of worksheets or equivalent documents for the EITC, CTC/ACTC/ODC or AOTC claimed
- A copy of any document your client gives you on which you relied to determine eligibility for head of household filing status or the EITC, CTC/ACTC/ODC or AOTC or to compute the amount of the EITC, CTC/ACTC/ODC or AOTC
- A record of how, when, and from whom you obtained the information used to complete the return and the applicable worksheets
- A record of any additional questions you may have asked to determine eligibility for the EITC, CTC/ACTC/ODC or AOTC and/or HOH filing status, and the amount of the EITC, CTC/ACTC/ODC or AOTC, and the client’s answers
These documents must be kept for three years from the latest of the following:
- The due date of the return
- The date you electronically filed the tax return
- The date you presented the paper return or claim for refund to your client for signature
- The date you submitted to the signing tax return preparer the part of the return for which you were responsible, if you are a nonsigning tax return preparer
Keep these records in either a paper or electronic format in a secure place to protect your client’s personal information.
Is it true that if I employ other preparers and they don't meet their due diligence requirements; my firm can be penalized?
Yes, it's true. The IRS can assess penalties against a firm that employs others to prepare tax returns if an employee does not meet due diligence requirements for returns or claims for refund claiming head of household filing status or the EITC, CTC/ACTC/ODC, or AOTC if one or more of the following applies:
- A member of the principal management participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements; or
- The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements; or
- The firm disregarded its reasonable and appropriate compliance procedures in the preparation of the tax return or claim for refund through willfulness, recklessness, or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate.
How can I as an employer protect myself from penalties caused by my employees not meeting due diligence requirements?
If you employ tax return preparers, here are some examples of how you can protect yourself from due diligence penalties:
- Review your current office procedures to make sure they address all appropriate due diligence requirements.
- Review your procedures with your employees to make sure they clearly understand their responsibilities and your expectations of them.
- Conduct annual due diligence training or instruct your staff to complete the online training module that we offer in both English and Spanish.
- Test your employees’ knowledge of due diligence requirements and your procedures.
- Perform recurring quality review checks on your employees’ work, including credit computations, questions asked clients, documents reviewed, and the records kept.
- Ensure all records are properly maintained.
Yes, you must complete, submit, and keep a copy of Form 8867, Paid Preparer's Due Diligence Checklist, for every return or claim for refund reporting head of household filing status, the EITC, CTC/ACTC/ODC or AOTC. You must submit the form as part of an electronic return or attach it to a paper return.
To document my compliance with due diligence requirements for head of household filing status, the EITC, CTC/ACTC/ODC and AOTC, is it sufficient to keep a copy of Form 8867 that is signed and dated by my client?
Keeping a copy of the completed Form 8867PDF, Paid Preparer's Due Diligence Checklist, is one of your due diligence requirements. Having your client sign and date the form for your records may be sufficient to document when and from whom you got the return information. But you must also keep the computation worksheets and document any additional questions you ask your client and your client's responses to those questions at the time you are interviewing your client.
You can keep this documentation either electronically or on paper.
When questioning a client who reports income that seems inadequate to support a family, is it sufficient to accept an answer that government benefits are received? Do we need to specify the type and amount?
Asking questions about the source and amount of income used to support a family for due diligence has several purposes. One purpose is to ensure your client is reporting all income to compute the correct adjusted gross income (AGI) for the EITC. Another purpose is to ensure the child is not the qualifying child of another person for the EITC or the CTC/ACTC/ODC. A third purpose is to determine the total cost of maintaining your client’s home to assist in determining whether your client paid more than half of the total cost of maintaining the home.
Due diligence requires you to make additional inquiries if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information you receive from your client appears to be incorrect, inconsistent, or incomplete.
I know taxpayers need to report all income, but what about expenses? What if the client doesn't want to claim business expenses to keep their earned income higher and qualify for more EITC?
Revenue Ruling 56-407PDF, 1956-2 C.B. 564, held that under IRC § 1402(a), every taxpayer (with the exception of certain farm operators) must claim all allowable deductions in computing net earnings from self-employment for self-employment tax purposes. Because earned income for EITC must include net earnings from self-employment under IRC § 1402(a), the ruling applies equally to the EITC.
What should a preparer do if he or she thinks or suspects the taxpayer is not providing all expenses in order to claim a larger credit?
To meet the knowledge requirement, you must follow-up on your suspicion. Ask additional questions, document the answers, and make a judgment about whether the answers make sense. If they don’t, you have the responsibility to ask additional questions and possibly ask for documentation until you have no reason to know that the return you are preparing is not accurate.
You must use your professional judgment regarding the credibility of your client and the answers you receive. If you are not comfortable with the answers or the credibility of the client, then due diligence dictates you do not prepare the return until you receive satisfactory information to resolve your concerns.
You may also want to present your client with the Publication 4717PDF, Help Your Tax Preparer Get You the EITC You Deserve. This publication explains a paid tax preparer's due diligence requirements and the consequences of not filing an accurate return.
No, it's not required. But, if you have reason to question a child's age, you must investigate further, which may mean requesting the birth certificate. If the client provides a birth certificate and you use it to determine eligibility for head of household filing status, or eligibility for or the amount of the EITC, CTC/ACTC/ODC or AOTC, you must keep a copy of it.
How do you handle the situation when you decline to prepare a claim for head of household filing status, the EITC, CTC/ACTC/ODC or AOTC, and the client then refuses to leave his or her information with you?
Any client has the option of deciding not to complete a return with a preparer and, therefore, would have no reason to leave information with that preparer.
If the preparer wants to report a taxpayer whom he or she thinks will erroneously claim a tax benefit with another preparer, use the process described in the Fraud section of the Frequently Asked Questions.
Consider what due diligence requires in the following situation. The household is made up of an unmarried couple, their natural child, and the grandmother of the child. The child is the qualifying child of all three for purposes of the EITC. The grandmother is the client and neither one of the parents is a client. The grandmother says they all agreed she should take the credit and she has the highest income. What responsibility do you have to verify this information?
To meet your due diligence requirements, you must ask the appropriate questions and document the questions you ask and your client's answers. You do not have the responsibility to verify the AGI of the parents.
As a service to your customer, you may want to explain the tiebreaker rules for qualifying child and explain what happens when more than one person claims the same qualifying child - the IRS may reject the return or the IRS may reject the return or disallow the claim.
You may also want to present your client with Publication 4717PDF, Help Your Tax Preparer Get You the EITC You Deserve. This publication explains a paid tax preparer's due diligence requirements and the consequences of not filing an accurate return.
We have a checklist to make sure our clients are eligible for the EITC. We determined they were not and did not claim the EITC on the return. But, the IRS sent a letter saying they might qualify. Why?
If your client appears to qualify for the EITC but doesn’t, you are instructed to enter or write "no" on the EITC line. The IRS checks for the "no" on the EITC line before sending out a notice. We have heard of this problem previously but need more information to determine whether it’s due to an IRS, software or preparer error. Please submit information to EITC.firstname.lastname@example.org if you entered or wrote "no" and we sent your client a letter.
Do due diligence requirements, including the three-year retention of records, apply to VITA prepared returns?
No. The due diligence requirements apply only to paid tax return preparers.
No. There is no requirement to review Social Security cards, but it is a best practice to review them. You are more likely to get the child's name and number correct if you copy them directly from the card. Also, having copies of cards is helpful in resolving e-file rejects. If the client provides a Social Security card and you use it to determine eligibility for head of household filing status or eligibility for or the amount of the EITC, CTC/ACTC/ODC or AOTC, you must keep a copy of the card with your records.
IRS selects preparers for due diligence visits based on the likelihood that the returns they prepare are in error. We determine the likelihood based on a set of standard criteria applied to all returns. See What to Expect during a Due Diligence Audit for additional information.