Due Diligence: Your Best Defense as a Tax Preparer

NOTE: Due diligence and self-protection are important for everyone. Even blogs. This content is for educational purposes only and should not be considered tax or legal advice. Always consult and defer to IRS guidance as well as your own experience when applying due diligence standards. Now, let's get to it!

When tax professionals hear “due diligence,” they often think of extra paperwork, additional questions, and the constant pressure to get everything right. But IRS Due Diligence Requirements were not created to make life hard. They exist to ensure refundable tax credits and certain filing statuses are only granted to taxpayers who truly qualify.

Due Diligence Protects Tax Preparers:

Due diligence doesn’t just protect the tax system. It protects YOU.

Refundable credits such as the Earned Income Tax Credit (EITC), Child Tax Credit (CTC)/Additional Child Tax Credit (ACTC), American Opportunity Tax Credit (AOTC), and Head of Household (HOH) filing status are frequent audit targets because they are particularly vulnerable to fraud and error. When something looks questionable on a return, the IRS does not only look at the taxpayer — they look at the preparer’s role as well.

That is why the IRS requires "reasonable inquiry." This means you cannot simply accept a client’s statements when information appears inconsistent, incomplete, or incorrect.

Key Takeaway: Due diligence is about asking the right follow-up questions, documenting the responses, and making sure your records show why the return was prepared the way it was.

Why Refundable Credits Require Strong Due Diligence

Refundable credits allow taxpayers to receive money back even if they owe no tax. That makes them powerful tools for helping low- and moderate-income families. But it also makes them attractive targets for abuse. Your best defense as a tax preparer when it comes to refundable credits is to be prepared and document everything.

Common due diligence risks include:

• Incorrect claims for qualifying children

• Fabricated or inflated income to maximize EITC

• Misuse of Head of Household filing status

• False dependency claims

• Education credits claimed without eligible enrollment

• Clients “forgetting” to mention other household members or income

Because of these tax preparer due diligence risks, Congress and the IRS expect paid tax preparers to act as a gatekeeper. You are expected to:

• Ask questions when something does not add up

• Verify information when needed

• Keep detailed records supporting your conclusions

  
  

Key Takeaway: Failing to meet due diligence requirements can result in penalties per credit, per return, per year, plus potential referral to the Return Preparer Office (RPO).

What “Reasonable Inquiry” Really Means

Many tax professionals ask: “Do I really have to verify everything my client says?” No. But you do have to use professional judgment.

Reasonable inquiry means:

• If something appears normal and consistent, you may rely on the client’s statements.

• If something appears incomplete, inconsistent, or incorrect, you must ask follow-up questions and document the answers.

Examples of when follow-up is required:

• A client claims Head of Household but reports no dependents

• Income patterns change drastically year-to-year without explanation

• A child moved mid-year and multiple people may claim them

• Education credits are claimed but there is no enrollment record

• Self-employment income appears fabricated or unusually round

Key Takeaway:

In each case, you should:

1. Ask clarifying questions

2. Record your client’s answers

3. Keep copies of any supporting documentation

This protects you if the IRS questions the return later.

How Due Diligence Protects Tax Professionals

It may feel like due diligence rules exist to penalize you. But in reality, your due diligence is your best legal defense.

When the IRS audits you as a preparer, they are not only evaluating the return — they are evaluating your process.

Strong due diligence protects you because it shows:

✔ You acted in good faith

✔ You followed IRS requirements

✔ You asked reasonable questions

✔ You documented your work

✔ You had a basis for your position

Key Takeaway: When you keep detailed records, you are not relying on your memory months or years later. You have evidence, and evidence matters.

Practical Ways to Strengthen Your Due Diligence Process

To reduce risk and improve compliance:

• Use standardized due diligence intake forms

• Document conversations in real time

• Keep copies of any proof provided

• Avoid “yes/no only” questioning when clarity is needed

• Train staff on reasonable inquiry standards

• Review returns with high-risk credits more carefully

Key Takeaway: Consistency builds protection. Train everyone on a great process and your process will protect you.

Final Takeaway

Your documentation is your defense. If it is not written down, it did not happen.

Good due diligence is not just a requirement, it is one of the most important tools you have to protect your business, your professional credentials, and your reputation.

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At Profit Edge Tax we are dedicated to helping tax businesses operate more efficiently and profitably. Make sure to check out our free Client Intake Due Diligence Form.