Due Diligence Requirements for Knowledge and Record-Keeping

A paid tax return preparer must meet four specific due diligence requirements under Treasury Regulation section 1.6695-2 when preparing returns or claims for refund for clients claiming any of these tax benefits:

• Earned income tax credit (EITC)
• Child tax credit (CTC), additional child tax credit (ACTC), credit for other dependents (ODC)
• American opportunity tax credit (AOTC)
• Head of household (HOH) filing status

Two of the due diligence requirements are knowledge and record-keeping. As part of meeting these two requirements, for each of the above tax benefits claimed a preparer must:

• Not know, or have reason to know, that any information used by the tax return preparer in determining the taxpayer's eligibility to file as head of household or in determining the taxpayer's eligibility for, or the amount of, the credits and claimed on the return or claim for refund is incorrect.
• Not ignore the implications of information furnished to, or known by, the preparer.

• Make reasonable inquiries if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information furnished to the preparer appears to be incorrect, inconsistent, or incomplete.

• At the time of the client interview, make a record of the inquiries made and the client’s answers.

• Keep a copy of the completed Form 8867, Paid Preparer's Due Diligence Checklist. 

• Keep a copy of the worksheets or computations used to compute the amount of the claimed credit(s)

• Keep a record of how and when the information used to complete Form 8867 and the worksheets or computations was obtained by the preparer, including the identity of any person furnishing the information, as well as a copy of any document that was provided by the taxpayer and on which the preparer relied to complete Form 8867 and/or the worksheets or computations.

In general, due diligence rules do not require paid preparers to request specific documentation from their clients. See the complete knowledge and record-keeping requirements here. 

The following client interview examples provide guidance on how to meet the knowledge and record-keeping requirements.

 

Example 1: Client A, a new client, goes to Preparer X to prepare their return. Client A wants to claim a daughter and nephew as qualifying children for the EITC and CTC.

Here are some of the actions Preparer X must take to satisfy the knowledge and record-keeping requirements of the due diligence Treasury Regulation.

1. Interview the client to gather the facts. At the time of the interview, document in their records the questions they asked and the client’s responses.
2. Obtain background information about the family’s living circumstances to address why the nephew may be in Client A’s care.
3. Ask where the daughter’s other parent is residing and whether the daughter lived with her other parent for over half of the year. Ask where the nephew's parents are residing and whether the nephew lived with a parent for over half of the year.
4. Make a clear recordation of whether and what supporting client documentation was provided and keep a copy of any client document the preparer relied on, including the identity of any person furnishing the information.
5. Keep a copy of the completed Form 8867.

The preparer can inquire about possible documents the client may have or can get to support claiming the children for the credits (such as documents to show relationship, age, residency, etc.) in case the IRS audits the client. 

Our page, Forms 886 Can Assist You, includes forms IRS uses to educate taxpayers on the types of documents that can help show eligibility for the above tax benefits.

 

Example 2: Client B goes to Preparer Y to prepare their return. Client B has been the preparer’s returning client for 13 years. Client B wants to claim two grandchildren as qualifying children for the EITC and CTC as they have done in previous years.

Here are some of the actions Preparer Y must take to satisfy the knowledge and record-keeping requirements of the due diligence Treasury Regulation. 

1. If established in a prior year, Prepare Y would not need to inquire about the children’s dates of birth each year. 
2. In general, a child’s relationship to a client, if established in a prior year, is not likely to change.  But change is possible as with, for example, foster placement or adoption.  Preparer Y should be alert to these possibilities and inquire appropriately each year. 
3. Since a child’s residency can change, Prepare Y must inquire about it and record the client’s answers each year. 
4. Review background information about the family’s living circumstances to address any changes to the grandchildren being in Client B’s care.
5. Review where the grandchildren’s parents are residing and whether the grandchildren lived with a parent for over half of the year.
6. Make a clear recordation of whether and what supporting client documentation was provided and keep a copy of any client document the preparer relied on, including the identity of any person furnishing the information.
7. Keep a copy of the completed Form 8867.

 

Example 3: Client C goes to Preparer Z for return preparation and the preparer believes the client may be eligible to claim the EITC without a qualifying child. Client C has income from wages of $30,000 and wishes to report a $15,000 net loss from self-employment. Client C says their business is cash-based and they do not have any records to support business income or expenses.

Here are some of the actions Preparer Z must take to satisfy the knowledge and record-keeping requirements of the due diligence Treasury Regulation.

1. Ask relevant questions and record Client C’s responses to address whether the client is actually carrying on a business.
2. If Preparer Z is satisfied that Client C is carrying on a trade or business, since the client does not have records to support income and expenses, Preparer Z can assist the client in a reasonable reconstruction of business income and expenses to complete Schedule C, Profit or Loss from Business (Sole Proprietorship).

 

Consider reviewing the Schedule C income and expense reconstruction training on IRS.gov. It provides guidance and tools to help tax practitioners assist clients when the client’s business records are missing or incomplete.

A preparer must understand how records of business income and expenses should be maintained and should educate the client on how to do so for the future.

For more information and examples of meeting due diligence requirements, see Publication 4687, Paid Preparer Due DiligencePDF.