What Are EITC Due Diligence Penalties?

Paid tax return preparers are subject to specific due diligence rules when handling certain tax credits and filing statuses. These regulations are designed to curb errors and ensure only eligible taxpayers receive these benefits. A failure to follow these mandatory checks can result in monetary penalties from the Internal Revenue Service (IRS). These penalties underscore the responsibility placed on preparers to verify information for specific, high-error-rate claims.

Understanding Due Diligence Requirements

A preparer’s due diligence obligation involves completing and submitting Form 8867, Paid Preparer’s Due Diligence Checklist. This form must be filed with any tax return that claims certain benefits or uses the Head of Household (HOH) filing status. The form documents the questions asked and answers received to determine eligibility. The covered tax benefits are:

• Earned Income Tax Credit (EITC)
• Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), or Credit for Other Dependents (ODC)
• American Opportunity Tax Credit (AOTC)

Beyond the checklist, preparers must satisfy a knowledge requirement. They cannot ignore information from a client if it appears incorrect, inconsistent, or incomplete. If a client’s statements seem questionable, the preparer must make further reasonable inquiries to resolve the discrepancies. For example, if a shared custody agreement raises questions about a child’s residency for the EITC, the preparer must ask clarifying questions to confirm the child met the residency test.

Proper record-keeping is another component of due diligence. Preparers must retain specific documents for three years from the return’s due date. These records include a copy of Form 8867, credit computation worksheets, and detailed notes of any additional inquiries made to the client and their responses. These files provide proof that the preparer fulfilled their obligations if the IRS questions the return.

The Penalty for Non-Compliance

The penalty for failing to meet due diligence requirements is specified in Internal Revenue Code Section 6695. The amount is adjusted for inflation annually, and for returns filed in 2025, the penalty is $635 per failure. A preparer can be penalized for each of the previously mentioned credits or the HOH filing status on a single return where they did not exercise the required care.

The assessment is not a single penalty per return but per individual failure on that return. For instance, if a preparer fails to properly document eligibility for both the EITC and Head of Household status on the same client’s return, the IRS can assess two separate penalties. A single tax return claiming all four categories of benefits could result in a total penalty of $2,540 for the preparer if due diligence failures are found for each one.

The IRS Examination and Assessment Process

The IRS identifies potential due diligence failures through several channels. A preparer’s compliance often comes under scrutiny when a client’s return is selected for an audit. If an audit reveals the taxpayer was ineligible for a credit, the IRS will then investigate the preparer. The agency also uses data analytics to identify patterns of questionable returns from a single preparer, which can trigger a direct examination.

When the IRS initiates a due diligence examination, the preparer receives a formal notice requesting the complete files for specific client returns. The preparer must provide all mandated records, including copies of Form 8867, computation worksheets, and notes from client interviews. An examiner reviews these documents to determine if the preparer took the necessary steps to verify eligibility.

If the examiner concludes that the preparer did not meet the requirements, the IRS will issue a report detailing the proposed penalties. This report explains the specific failures identified for each client’s return. Following this report, the preparer will receive a formal notice and demand for payment for the assessed penalties.

Appealing an Assessed Penalty

A preparer assessed a due diligence penalty has the right to challenge it. The primary basis for having the penalty abated is to demonstrate the failure was due to “reasonable cause” and not willful neglect. Reasonable cause is determined case-by-case, requiring a preparer to show they had robust compliance procedures and the failure was an isolated incident.

To contest the penalty, the preparer must respond to the IRS notice with a written explanation detailing why reasonable cause exists. The preparer must provide supporting documentation, such as office procedure manuals, staff training materials, and evidence of a strong overall compliance record. This evidence aims to prove that the error was an anomaly rather than a result of systemic carelessness.

If the initial request for abatement is denied by the examiner, the preparer can escalate the case. The next step is to file a formal protest and request a conference with the IRS Independent Office of Appeals. This office is separate from the compliance division that proposed the penalty and provides an impartial venue to review the case. The appeals officer will consider the facts and the preparer’s arguments before making a final determination on the penalty.