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Penalties for due diligence violations by tax preparers

August 2, 2021


Tax preparers have a weighty responsibility to not only understand tax rules but also apply them correctly. That means ensuring you have an adequate basis of information for claiming certain credits and statuses on behalf of a taxpayer. Failing to do so could result in stiff penalties against you in the event of an audit.

The nuts and bolts of due diligence requirements

The IRS sets forth detailed due diligence regulations that professional tax preparers must adhere to when filing returns that claim:

  • Head of household (HOH) status
  • Earned income tax credits (EITC)
  • American opportunity tax credits (AOTC)
  • Child tax credits
  • Credits for other dependents (ODC)
  • Additional child tax credits (ACTC)

There are four components to the due diligence requirement:

  1. Completing and filing the due diligence checklist (Form 8867)
  2. Properly calculating the applicable tax credits
  3. Ensuring that you have an adequate basis of knowledge for the taxpayer’s eligibility for those credits
  4. Maintaining records for a minimum of three years

At its core, due diligence involves inquiry and documentation. You must ask the taxpayer detailed questions to obtain the factual basis for a favorable tax status or credits. You must document their responses and hold onto that information, along with other supporting documents, in case an audit takes place.

The consequences of violating due diligence requirements

If an audit uncovers due diligence violations on the part of a paid tax preparer, you could face a penalty of $500 per failure, adjusted for inflation. That penalty is $545 per failure for 2022 returns. Additional consequences could include suspension from the e-filing system, disciplinary action, and a criminal investigation if fraud is suspected.

Due diligence lapses are also costly for taxpayers, who may have their refunds withheld or be forced to repay the IRS.

Given the high stakes involved, due diligence is a critical issue for professional tax preparers. It’s one of their many responsibilities that should not be taken lightly.

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