Preparing an accurate tax return is not just about entering numbers. It is about making sure every credit, deduction, and filing status is supported, defensible, and compliant with IRS rules.
That is where tax return preparer due diligence comes in.
Due diligence requires tax professionals to ask questions that sometimes feel uncomfortable. These questions protect both the client and the preparer, and they help prevent costly IRS audits, penalties, and disallowed credits.
What Is Tax Preparer Due Diligence?
Tax preparer due diligence is the process of confirming a taxpayer’s eligibility for certain tax benefits by reviewing information, asking follow-up questions, and verifying documentation when needed.
Under Treasury Regulation 1.6695-2, a tax return preparer must make reasonable inquiries when information provided by a client appears incorrect, inconsistent, or incomplete.
In simple terms, if something does not make sense on paper, a professional preparer is required to ask questions until it does.
Why Due Diligence Sometimes Feels Uncomfortable
Many due diligence questions are inherently personal. They are not asked out of suspicion. They are asked because the tax law requires clarity. Clients sometimes feel uneasy when asked detailed questions. A good tax advisor explains that these questions exist to protect everyone involved.
When documentation is gathered upfront and eligibility is confirmed before filing, returns are stronger, audits are smoother, and surprises are avoided.
Example 1: Dependents and Family Relationships
Consider a 24-year-old single mother claiming two children ages 10 and 11.
A well-informed preparer would reasonably ask follow-up questions because the timeline raises questions about biological parentage. In this case, the client adopted the children and provided adoption paperwork. Once verified, the dependents were properly claimed.
The questions were necessary. The documentation made the return defensible.
Example 2: Head of Household and Low Income
Another example is a single father filing as Head of Household with three children and a reported income of $20,000.
A preparer must ask how basic living expenses are being met. The follow-up revealed the client received child support and other nontaxable income. With proper documentation, the filing status and credits were supported in case of an IRS audit.
Credits and Filing Statuses Subject to Due Diligence Rules
These areas are subject to heightened IRS scrutiny and are common audit triggers. Under IRC 6695(g), tax preparers must meet specific due diligence requirements when preparing returns that claim certain benefits, including:
- Earned Income Tax Credit (EITC)
- Child Tax Credit, Additional Child Tax Credit, and Other Dependent Credit
- American Opportunity Tax Credit (AOTC)
- Head of Household filing status
What Happens If Due Diligence Is Ignored?
Impact on Clients
If the IRS audits a return and disallows credits or filing status, the consequences can be serious. These outcomes can create financial strain and long-term tax complications. Clients may be required to:
- Repay refunds received in error, plus interest.
- File Form 8862 to reclaim disallowed credits in future years.
- Lose eligibility to claim certain credits for two years if errors were reckless.
- Lose eligibility for ten years if fraud is determined.
Impact on Tax Preparers
Due diligence is not optional. It is a professional obligation. The penalties for preparers can be just as severe. Potential consequences include:
- Civil penalties ranging from $1,000 to $5,000 per violation.
- Suspension or removal from IRS e-file participation.
- Disciplinary action from the IRS Office of Professional Responsibility.
- Court injunctions prohibiting return preparation.
- Criminal penalties in cases involving fraudulent returns.
FAQs
What is tax preparer due diligence?
Tax preparer due diligence is the requirement for tax professionals to verify eligibility for certain credits and filing statuses by asking reasonable questions and reviewing documentation.
Why does due diligence matter?
It protects clients from audits and penalties and protects preparers from fines, sanctions, and loss of practice rights.
Which credits require due diligence?
EITC, Child Tax Credit and related credits, American Opportunity Tax Credit, and Head of Household filing status.
Protect Your Return, Refund, and Future
Due diligence is not about making assumptions or creating discomfort. It is about protecting your return, your refund, and your future. When a tax preparer takes the time to ask the right questions and verify eligibility, it helps reduce audit risk, prevent costly repayments, and ensure your filing stands up to IRS review.
Working with an experienced tax professional who follows due diligence standards gives you confidence that your return is prepared accurately, responsibly, and with your best interests in mind.
At Steel Ledger Advisors, compliance and client advocacy go hand in hand. Asking the right questions today can prevent serious problems tomorrow.