1.7 Preparer Due Diligence Requirements

Enrolled Agent EA

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1 Part 1, Chapter 1: Tax Return Basics & Filing Requirements

1.1 Form 1040 Overview & Structure 1.2 Form 1040-SR for Seniors 1.3 Who Must File (Income Thresholds) 1.4 Filing Deadlines & Extensions (Form 4868) 1.5 Penalties: Failure to File vs. Failure to Pay 1.6 Sources of Tax Information (W-2s, 1099s, K-1s) 1.7 Preparer Due Diligence Requirements 1.8 Amended Returns (Form 1040-X)

2 Part 1, Chapter 2: Filing Status & Dependents

2.1 Single & Married Filing Jointly 2.2 Married Filing Separately 2.3 Head of Household Requirements 2.4 Qualifying Surviving Spouse 2.5 Qualifying Child Test (5 Tests) 2.6 Qualifying Relative Test (4 Tests) 2.7 SSN, ITIN & Residency Status

3 Part 1, Chapter 3: Wages & Employee Compensation

3.1 W-2 Income & Withholding 3.2 Employee vs. Independent Contractor 3.3 1099-NEC, 1099-MISC & 1099-K Reporting 3.4 Fringe Benefits (Taxable vs. Non-Taxable) 3.5 Stock Options (ISO vs. NQSO) 3.6 Special Categories (Clergy, Military, Foreign)

4 Part 1, Chapter 4: Interest, Dividends & Other Income

4.1 Taxable vs. Tax-Exempt Interest 4.2 US Savings Bonds & OID 4.3 Ordinary vs. Qualified Dividends 4.4 Schedule B Requirements 4.5 Rental & Royalty Income Basics 4.6 Alimony, Gambling & Other Income 4.7 Cancelled Debt & Form 1099-C 4.8 Net Operating Loss (NOL)

5 Part 1, Chapter 5: Capital Gains & Property Transactions

5.1 Capital vs. Non-Capital Assets 5.2 Cost Basis Calculation 5.3 Inherited & Gifted Property Basis 5.4 Short-Term vs. Long-Term Gains 5.5 Capital Gains Tax Rates (0%, 15%, 20%) 5.6 Netting & the $3,000 Loss Limit 5.7 Wash Sales & Related Party Rules 5.8 Sale of Primary Residence (Section 121) 5.9 Installment Sales (Form 6252) 5.10 Like-Kind Exchanges (Section 1031)

6 Part 1, Chapter 6: Adjustments to Income

6.1 Educator Expenses & HSA Contributions 6.2 Self-Employment Tax Deduction 6.3 IRA Contributions (Traditional) 6.4 Student Loan Interest Deduction 6.5 Alimony Paid (Pre-2019 Divorces) 6.6 Other Adjustments & New OBBBA Deductions (Tips, Overtime, Auto Loan, Senior Bonus)

7 Part 1, Chapter 7: Deductions (Standard & Itemized)

7.1 Standard Deduction by Filing Status 7.2 Medical & Dental Expenses (7.5% Floor) 7.3 State & Local Taxes (SALT $40K Cap) 7.4 Mortgage Interest Deduction 7.5 Charitable Contributions 7.6 Casualty & Theft Losses 7.7 QBI Deduction (Section 199A)

8 Part 1, Chapter 8: Tax Calculation & Credits

8.1 Tax Tables & Rate Schedules 8.2 Alternative Minimum Tax (AMT) 8.3 Self-Employment Tax Calculation 8.4 Child Tax Credit & Additional CTC 8.5 Earned Income Tax Credit (EITC) 8.6 Education Credits (AOC & LLC) 8.7 Child & Dependent Care Credit 8.8 Other Credits (Saver's, Premium Tax)

9 Part 1, Chapter 9: Retirement Accounts & Social Security

9.1 Traditional vs. Roth IRA 9.2 401(k), 403(b) & TSP Basics 9.3 SEP-IRA & SIMPLE IRA 9.4 Required Minimum Distributions (RMDs) 9.5 Early Withdrawal Penalties & Exceptions 9.6 Social Security Taxation

10 Part 1, Chapter 10: Specialized Individual Returns

10.1 Estate Tax (Form 706) 10.2 Gift Tax (Form 709) 10.3 Foreign Income (Form 2555) 10.4 FBAR & FATCA Reporting 10.5 Farm Income (Schedule F) 10.6 Disaster Area Rules

11 Part 2, Chapter 11: Business Entity Types

11.1 Overview of Entity Types 11.2 State Law vs. Tax Classification 11.3 Entity Selection: Reasonable Comp & QBI 11.4 Form 8832 & Rev. Proc. 2009-41 11.5 LLC Deep Dive: Spouses & EINs 11.6 Changing Status: The 60-Month Rule

12 Part 2, Chapter 12: Starting a Business

12.1 Hobby vs. Business (Profit Motive) 12.2 Employer Identification Number (EIN) 12.3 Tax Year Selection 12.4 Recordkeeping Requirements 12.5 Statute of Limitations 12.6 Related Party Transactions 12.7 Start-Up Costs, Entity Choice & OBBBA Business Changes (2025)

13 Part 2, Chapter 13: Worker Classification & Payroll

13.1 Employee vs. Independent Contractor 13.2 Common Law Test (Behavioral, Financial, Relationship) 13.3 Statutory Employees & Non-Employees 13.4 Form 941 & Payroll Deposits 13.5 Trust Fund Recovery Penalty 13.6 FUTA & Unemployment Taxes

14 Part 2, Chapter 14: Accounting Methods & Income

14.1 Cash vs. Accrual Method 14.2 Hybrid Methods & Changes 14.3 Inventory & COGS 14.4 Gross Receipts & Income Recognition 14.5 Constructive Receipt 14.6 Form 1099 Reporting Requirements 14.7 §163(j) Business Interest Expense Limitation 14.8 §174 Research & Experimental Expenditures

15 Part 2, Chapter 15: Depreciation & Asset Treatment

15.1 MACRS Basics & Recovery Periods 15.2 Mid-Month, Mid-Quarter, Half-Year Conventions 15.3 Section 179 Expense Deduction 15.4 Bonus Depreciation 15.5 Listed Property Rules 15.6 Amortization of Intangibles 15.7 Depletion 15.8 Disposition of Business Assets

16 Part 2, Chapter 16: Business Deductions

16.1 Ordinary & Necessary Test 16.2 Business Travel Expenses 16.3 Business Meals (50% Limitation) 16.4 Business Use of Vehicle 16.5 Home Office Deduction 16.6 Business Interest Limitation (163(j)) 16.7 Business Bad Debts

17 Part 2, Chapter 17: Business Credits & Fringe Benefits

17.1 General Business Credit Overview 17.2 R&D Credit & Disabled Access Credit 17.3 Small Employer Health Insurance Credit 17.4 Fringe Benefit Rules 17.5 Cafeteria Plans (Section 125) 17.6 Achievement Awards & Other Benefits

18 Part 2, Chapter 18: Sole Proprietorships

18.1 Schedule C Overview 18.2 Calculating Net Profit/Loss 18.3 Self-Employment Tax (Schedule SE) 18.4 Estimated Tax Payments 18.5 Hobby Loss Rules

19 Part 2, Chapter 19: Partnerships

19.1 Partnership Formation 19.2 Partner's Basis Calculation 19.3 Form 1065 Overview 19.4 Schedule K-1 (Partner's Share) 19.5 Guaranteed Payments 19.6 Partnership Distributions 19.7 At-Risk & Passive Activity Rules 19.8 Partnership Termination & Liquidation

20 Part 2, Chapter 20: C Corporations

20.1 Form 1120 Overview 20.2 Corporate Tax Rate (21%) & CAMT 20.3 Accumulated Earnings Tax 20.4 Dividends Received Deduction 20.5 Earnings & Profits (E&P) 20.6 Corporate Distributions, Dividends & Stock Redemptions 20.7 §351 Transfers, §1032, §1202 QSBS & Other Corporate Provisions 20.8 Corporate Liquidation

21 Part 2, Chapter 21: S Corporations

21.1 S Election Requirements (Form 2553) 21.2 Form 1120-S Overview 21.3 Shareholder Basis Calculation 21.4 Reasonable Compensation 21.5 S Corporation Distributions 21.6 Built-In Gains Tax & Termination

22 Part 2, Chapter 22: Specialized Business Returns

22.1 Trusts & Estates (Form 1041) 22.2 Simple vs. Complex Trusts 22.3 Distributable Net Income (DNI) 22.4 Tax-Exempt Organizations (Form 990) 22.5 Retirement Plans (Form 5500) 22.6 Qualified Retirement Plans Overview 22.7 Farm Taxation 22.8 Rental Real Estate Activities

23 Part 3, Chapter 23: Practice Before the IRS

23.1 What is Practice Before the IRS? 23.2 Who Can Practice (Full Rights) 23.3 Limited Practice Rights (AFSP, Unenrolled) 23.4 Special Relationships (Family, Employees) 23.5 PTIN Requirements 23.6 Circular 230 Overview 23.7 Office of Professional Responsibility (OPR)

24 Part 3, Chapter 24: Becoming & Maintaining EA Status

24.1 Two Paths to EA (Exam vs. IRS Experience) 24.2 Application Process (Form 23) 24.3 Background & Compliance Checks 24.4 Renewal Requirements (Form 8554) 24.5 Continuing Education Requirements 24.6 Inactive Status & Termination

25 Part 3, Chapter 25: Practitioner Duties (Circular 230)

25.1 Due Diligence Requirements 25.2 Knowledge of Client's Omission 25.3 Conflict of Interest Rules 25.4 Fee Requirements (Contingent, Unconscionable) 25.5 Advertising & Solicitation Rules 25.6 Tax Return Position Standards 25.7 Written Advice Standards 25.8 Sanctions & Penalties for Violations

26 Part 3, Chapter 26: Power of Attorney & Authorization

26.1 Form 2848 (Power of Attorney) 26.2 CAF (Centralized Authorization File) 26.3 Form 8821 (Tax Information Authorization) 26.4 Third-Party Designee 26.5 Signing Returns for Taxpayers 26.6 Client Confidentiality & Privilege 26.7 Representing Clients in Audits (Examination) 26.8 Appealing IRS Decisions 26.9 Collection Representation

27 Part 3, Chapter 27: Legal Authority & Research

27.1 Hierarchy of Tax Authority 27.2 Internal Revenue Code 27.3 Treasury Regulations 27.4 Revenue Rulings & Procedures 27.5 Court Cases & Precedent 27.6 Statutes of Limitations

28 Part 3, Chapter 28: Specific Representation Issues

28.1 Trust Fund Recovery Penalty (TFRP) 28.2 Innocent Spouse Relief (Form 8857) 28.3 Injured Spouse Allocation (Form 8379) 28.4 Penalty Abatement (FTA & Reasonable Cause) 28.5 Taxpayer Advocate Service (TAS) 28.6 Freedom of Information Act (FOIA)

29 Part 3, Chapter 29: Final Review & Exam Strategy

29.1 Exam Structure & Logistics (2026-2027) 29.2 The "Clock" of Representation (Master Deadlines) 29.3 Ethics vs. Law (Sanctions & Penalties) 29.4 Final Mock Review & Exam Strategy

30 Part 3, Chapter 30: Filing Process & E-File

30.1 E-File Requirements (The "More Than 10 Returns" Rule) 30.2 ERO Responsibilities 30.3 EFIN & Application Process 30.4 Form 8879 (Signature Authorization) 30.5 Record Retention & Data Security (WISP) 30.6 Preparer Penalties (Filing Specific)

1.7 Preparer Due Diligence Requirements

Key Takeaways Explain This Topic AI

Form 8867 due diligence applies to four tax benefits: EITC, CTC/ACTC/ODC, AOTC, and Head of Household filing status

The IRC 6695(g) penalty for 2025 returns filed in 2026 is $650 per failure, meaning a single return could trigger up to $2,600 in penalties if all four benefits are claimed improperly

The four due diligence requirements are: Knowledge, Document, Compute, and Retain records (KDCR)

Preparers must retain due diligence records for 3 years from the latest applicable date

IRC 6694(a) unreasonable position penalty is the greater of $1,000 or 50% of income; IRC 6694(b) willful conduct penalty is the greater of $5,000 or 75% of income

Last updated: October 2026

Tax preparers face significant responsibilities beyond simply completing tax returns. The IRS requires paid preparers to exercise due diligence when claiming certain tax benefits on behalf of their clients. Understanding these requirements is essential for the EA exam and everyday tax practice.

What Is Due Diligence?

Due diligence means the preparer must make reasonable inquiries to determine if a taxpayer is eligible for certain tax benefits and must properly compute the amounts claimed. This goes beyond accepting a client's word at face value. The preparer must ask questions, verify information, and document the process.

Due diligence requirements apply under IRC Section 6695(g) and are documented on Form 8867, Paid Preparer's Due Diligence Checklist .

Which Tax Benefits Require Due Diligence?

Form 8867 due diligence applies to four specific tax benefits :

Tax Benefit Abbreviation Purpose
Earned Income Tax Credit EITC or EIC Refundable credit for low-to-moderate income workers

Child Tax Credit/Additional Child Tax Credit/Credit for Other Dependents CTC/ACTC/ODC Credits for qualifying children and dependents

American Opportunity Tax Credit AOTC Education credit for first four years of college
Head of Household Filing Status HOH Filing status for unmarried taxpayers with dependents

Key Point: These are the only benefits covered by Form 8867 due diligence. Other credits and deductions have their own verification requirements but do not trigger Form 8867 penalties.

The Four Due Diligence Requirements (KDCR)

The regulations under Treas. Reg. Section 1.6695-2 describe four requirements preparers must meet. An easy way to remember them is the acronym KDCR :

1. Knowledge Requirement

The preparer must know the tax law and apply that knowledge to the client's specific facts. This means:

Understanding eligibility rules for each credit
Asking appropriate questions to determine eligibility
Not ignoring the implications of information received
Making reasonable inquiries if information seems incorrect, inconsistent, or incomplete

Example: If a client claims three qualifying children for EITC but only provides documentation for two children's Social Security numbers, the preparer cannot ignore this inconsistency. They must ask about the third child and obtain proper documentation.

The preparer may not rely on client statements alone if a reasonable preparer would question the information based on what they know.

2. Document Requirement

The preparer must document the eligibility determination by completing Form 8867 for each return claiming the covered benefits. This includes:

Completing all applicable sections of Form 8867
Recording specific questions asked and the taxpayer's responses
Maintaining notes about the interview process
Documenting how eligibility was determined

The form must be completed based on information provided by the taxpayer or information the preparer reasonably obtains or knows.

3. Compute Requirement

The preparer must properly calculate the credit or verify the HOH filing status. This means:

Using IRS-provided worksheets or software that performs the calculations
Verifying that income, dependents, and other factors produce the claimed credit amount
Ensuring the taxpayer meets all dollar thresholds and phase-out limits
Confirming the computed amount matches what appears on the return
4. Retain Records Requirement

The preparer must retain five categories of records for 3 years from the latest applicable date:

Record Type Description
1. Form 8867 Completed due diligence checklist
2. Worksheets Any computations used to determine credit amounts
3. Taxpayer documents Copies of documents provided by the taxpayer
4. Information sources Records of how information was obtained
5. Interview notes Questions asked and taxpayer responses

Retention Period: Records must be kept for 3 years from the latest of:

The return due date (without extensions)
The date the return was e-filed
The date the return was presented to the taxpayer for signature
The date the return was submitted to the signing preparer (for nonsigning preparers)
Due Diligence Penalties Under IRC 6695(g)

Failure to meet due diligence requirements triggers penalties under IRC Section 6695(g):

Tax Year Penalty Per Failure Maximum Per Return
2025 returns (filed in 2026) $650 $2,600 (4 failures)

How Penalties Accumulate: If a return claims multiple covered benefits and the preparer fails due diligence on each one, separate penalties apply for each failure .

Example: A preparer fails to meet due diligence for EITC, CTC, and HOH on the same 2025 return. The penalty is:

$650 (EITC) + $650 (CTC) + $650 (HOH) = $1,950 total penalty

Important: These penalties are assessed against the preparer , not the taxpayer. They apply even if the taxpayer was actually eligible for the credits. The penalty is for failing to document due diligence, not for incorrectly claiming credits.

Other Preparer Penalties: IRC 6694 and 6695

Beyond due diligence, preparers face additional penalties for various violations. Understanding the complete penalty landscape is essential for the EA exam.

IRC 6694 - Understatement of Taxpayer Liability

IRC 6694 imposes penalties when a preparer's position on a return causes an understatement of the taxpayer's liability.

Penalty Type IRC Section Amount Standard

Unreasonable Positions 6694(a) Greater of $1,000 or 50% of income derived Position must have substantial authority (or reasonable basis if disclosed)

Willful or Reckless Conduct 6694(b) Greater of $5,000 or 75% of income derived Willful attempt to understate liability or reckless disregard of rules

Key Distinctions:

6694(a) applies to negligent or unreasonable positions the preparer should have known about
6694(b) applies to intentional misconduct or deliberate disregard of regulations
The 6694(b) penalty is reduced by any 6694(a) penalty paid on the same return

Reasonable Cause Defense: A preparer may avoid the 6694(a) penalty if they had reasonable cause for the position and acted in good faith. Factors considered include the nature and frequency of errors, normal office practices, and reliance on another preparer's advice.

IRC 6695 - Other Assessable Penalties

IRC 6695 covers various administrative and procedural failures. For 2025 returns filed in 2026:

Violation IRC Section Penalty Per Failure Maximum (filing year 2026)
Failure to furnish copy to taxpayer 6695(a) $65 $32,500
Failure to sign return 6695(b) $65 $32,500
Failure to furnish PTIN 6695(c) $65 $32,500
Failure to retain copy or list 6695(d) $65 $32,500
Failure to file correct information returns 6695(e) $65 $32,500
Negotiating taxpayer's refund check 6695(f) $650 N/A
Due diligence failure 6695(g) $650 N/A

Exam Focus: The EA exam frequently tests the distinction between the 6694 penalties (for incorrect positions) and the 6695 penalties (for procedural failures).

Record Retention Requirements

Tax preparers have multiple record retention obligations:

General Retention (IRC 6107)

Under IRC 6107(b), preparers must retain either:

A copy of each return they prepare, OR
A list containing the name and TIN of each taxpayer for whom they prepared a return
Retention Period: 3 years after the close of the return period (July 1 through June 30 of the following year)
Penalty for Non-Compliance: $65 per failure under IRC 6695(d), maximum $32,500 per return period
Due Diligence Retention (Reg. 1.6695-2)

For Form 8867 due diligence records specifically, the 3-year period begins from the latest of the dates described above (due date, e-file date, signature date, or submission date).

Best Practice: Retain all supporting documentation for at least 3 years, including:

Copies of taxpayer-provided documents (W-2s, 1099s, etc.)
Notes from client interviews
Completed Form 8867
Worksheets and computations
Any correspondence about eligibility questions
Consequences Beyond Penalties

Failing to meet due diligence requirements can result in consequences beyond the monetary penalties:

Referral to Office of Professional Responsibility (OPR) - May result in suspension or disbarment from practice before the IRS

Referral to IRS Criminal Investigation - If failure is willful, criminal prosecution is possible
Injunction - The Department of Justice may seek to permanently bar the preparer from preparing tax returns
Employer liability - Firms employing non-compliant preparers can also be penalized
Practical Due Diligence Checklist

When preparing returns with covered credits, follow this process:

Interview the client - Ask detailed questions about eligibility
Document responses - Record answers contemporaneously
Verify information - Do not ignore red flags or inconsistencies
Complete Form 8867 - Answer all questions based on actual knowledge
Perform calculations - Use worksheets or software to compute amounts
Retain records - Keep copies for at least 3 years
Submit the form - Include Form 8867 with the return (electronic or paper)

Exam Tip: The EA exam tests whether you understand that due diligence is about the process of determining eligibility, not just the outcome. A preparer who claims a legitimate credit but fails to document the determination can still face penalties.