Here’s what HIVE AI had to say about “Due diligence requirements for specific tax credits”:
Due Diligence Requirements for Specific Tax Credits
Overview of Due Diligence Requirements
By law, you must meet four specific due diligence requirements if you are paid to prepare a tax return or claim for refund claiming any of these tax benefits. Failing to meet the four due diligence requirements can result in penalties assessed against you under Internal Revenue Code §6695(g). 1 The due diligence requirements represent a comprehensive framework designed to ensure professional competence and accuracy in claiming specific tax credits and filing statuses.
Credits and Filing Status Subject to Due Diligence Requirements
These requirements under Treasury Regulation §1.6695-2 focus on accurately determining your client’s eligibility for each credit and head of household filing status and computing the amount of each credit. 1 The specific tax benefits subject to due diligence requirements include:
Earned income tax credit (EITC), Child tax credit (CTC), Additional child tax credit (ACTC), Credit for other dependents (ODC), American opportunity tax credit (AOTC), Head of household (HOH) filing status 1
A person who is a tax return preparer (as defined in section 7701(a)(36)) of a tax return or claim for refund under the Internal Revenue Code who determines the taxpayer’s eligibility to file as head of household under section 2(b), or who determines the taxpayer’s eligibility for, or the amount of, the child tax credit (CTC)/additional child tax credit (ACTC) under section 24, the American opportunity tax credit (AOTC) under section 25A(i), or the earned income credit (EIC) under section 32, and who fails to satisfy the due diligence requirements of paragraph (b) of this section will be subject to a penalty as prescribed in section 6695(g) (indexed for inflation under section 6695(h)) for each failure. 2
The Four Core Due Diligence Requirements
Requirement 1: Knowledge of Tax Laws
Know the EITC, CTC/ACTC/ODC, AOTC, and HOH tax laws thoroughly, and carefully evaluate each client’s personal situation, information and eligibility. Ask all the right questions to get the relevant facts. 1 This requirement establishes that preparers must have comprehensive understanding of the applicable tax laws and must conduct thorough client interviews to gather all relevant information.
If you have a reason to doubt or question any information provided to you or known to you to determine your client’s eligibility for the credit(s) or HOH filing status or to compute the amount of the credit(s) you must: Ask your client additional questions if a reasonable and well-informed tax return preparer, knowledgeable in the law, would conclude the information furnished seems incorrect, inconsistent, or incomplete. Not know or have a reason to know the information provided is incorrect, inconsistent or incomplete. 1
Requirement 2: Computation of Credits
When computing the amount of a credit or credits described in paragraph (a) of this section to be claimed on a return or claim for refund, the tax return preparer must either— Complete the worksheet in the Form 1040, 1040A, 1040EZ, and/or Form 8863 instructions or such other form including such other information as may be prescribed by the IRS applicable to each credit described in paragraph (a) of this section claimed on the return or claim for refund; or Otherwise record in one or more documents in the tax return preparer’s paper or electronic files the tax return preparer’s computation of the credit or credits claimed on the return or claim for refund, including the method and information used to make the computations. 3
The tax return preparer’s completion of an applicable worksheet described in paragraph (b)(2)(i)(A) of this section (or other record of the tax return preparer’s computation of the credit or credits permitted under paragraph (b)(2)(i)(B) of this section) must be based on information provided by the taxpayer to the tax return preparer or otherwise reasonably obtained or known by the tax return preparer. 3
Requirement 3: Form 8867 Completion and Submission
A preparer must satisfy the following due diligence requirements: Completion and submission of Form 8867 —The tax return preparer must complete Form 8867, “Paid Preparer’s Due Diligence Checklist,” or complete such other form and provide such other information as may be prescribed by the Internal Revenue Service (IRS), and— In the case of a signing tax return preparer electronically filing the tax return or claim for refund, must electronically file the completed Form 8867 (or successor form) with the tax return or claim for refund; In the case of a signing tax return preparer not electronically filing the tax return or claim for refund, must provide the taxpayer with the completed Form 8867 (or successor form) for inclusion with the filed tax return or claim for refund; or In the case of a nonsigning tax return preparer, must provide the signing tax return preparer with the completed Form 8867 (or successor form), in either electronic or non-electronic format, for inclusion with the filed tax return or claim for refund. 3
The tax return preparer’s completion of Form 8867 must be based on information provided by the taxpayer to the tax return preparer or otherwise reasonably obtained or known by the tax return preparer. 3
Requirement 4: Record Retention
Keep Records for Three Years 1 Preparers must maintain comprehensive documentation of their due diligence efforts for a minimum of three years. This includes retaining copies of Form 8867, worksheets used for credit computations, and documentation supporting the preparer’s knowledge and inquiry efforts.
Penalty Structure for Non-Compliance
A separate penalty applies to a tax return preparer with respect to the head of household filing status determination and to each applicable credit claimed on a return or claim for refund for which the due diligence requirements of this section are not satisfied and for which the exception to penalty provided by paragraph (d) of this section does not apply. 2
The penalty structure recognizes that each credit and filing status determination represents a separate compliance obligation, meaning preparers can face multiple penalties on a single return if they fail to meet due diligence requirements for multiple credits.
Historical Development and Expansion
At the end of 2015, Congress added three addition tax credits to section 6695(g), the child tax credit (CTC) under section 24, the additional child tax credit (ACTC) under section 24, and the American opportunity tax credit (AOTC) under section 25A(i). In response to these statutory changes, the Treasury Department and the IRS issued proposed and temporary regulations under section 6695(g) that incorporated the CTC, ACTC, and the AOTC in the due diligence requirements already established for the EIC. The Form 8867 was also updated to incorporate the additional credits. 4
New Due Diligence Requirements Under the One Big Beautiful Bill
COVID-Related Employee Retention Credit Due Diligence
Any COVID–ERTC promoter which provides aid, assistance, or advice with respect to any COVID–ERTC document and which fails to comply with due diligence requirements imposed by the Secretary with respect to determining eligibility for, or the amount of, any credit or advance payment of a credit under section 3134 of the Internal Revenue Code of 1986, shall pay a penalty of $1,000 for each such failure. The due diligence requirements referred to in paragraph (1) shall be similar to the due diligence requirements imposed under section 6695(g) of the Internal Revenue Code of 1986. 5
Enhanced Social Security Number Requirements
No credit shall be allowed under subsection (a) to an individual unless the individual includes on the return of tax for the taxable year— such individual’s social security number, and in the case of a credit with respect to the qualified tuition and related expenses of an individual other than the taxpayer or the taxpayer’s spouse, the name and social security number of such individual. No American Opportunity Tax Credit shall be allowed under this section unless the taxpayer includes the employer identification number of any institution to which the taxpayer paid qualified tuition and related expenses taken into account under this section on the return of tax for the taxable year. 6
Specific Credit Requirements and Documentation
American Opportunity Tax Credit Requirements
Except as otherwise provided by the Secretary, no credit shall be allowed under this section unless the taxpayer receives a statement furnished under section 6050S(d) which contains all of the information required by paragraph (2) thereof. 7 This establishes that proper documentation from educational institutions is essential for claiming the AOTC.
Information Reporting and Mathematical Error Authority
an omission of information required by section 25A(b)(4)(B) or an entry on the return claiming the American Opportunity Tax Credit for a taxable year for which such credit is disallowed under section 25A(b)(4)(A) 8 demonstrates that the IRS has mathematical error authority to summarily adjust returns where required information is omitted or credits are improperly claimed.
Professional Standards and Best Practices
Client Communication Requirements
Infórmele al contribuyente que, como parte de sus requisitos de diligencia debida, usted le hará preguntas personales para asegurarse de que la declaración de impuestos sea correcta. Comuníquele las posibles consecuencias de declaraciones incorrectas y falta de investigación: Al contribuyente: Si la declaración es seleccionada para auditoría y se rechaza el estado civil de cabeza de familia (HOH, por sus siglas en inglés), el Crédito tributario por ingreso del trabajo (EITC, por sus siglas en inglés), el Crédito tributario por hijos (CTC, por sus siglas en inglés)/Crédito tributario adicional por hijos (ACTC, por sus siglas en inglés), el Crédito por otros dependientes (ODC, por sus siglas en inglés) o el Crédito tributario de oportunidad para los estadounidenses (AOTC, por sus siglas en inglés), el cliente tiene que devolver cualquier cantidad reembolsada por error, más cualquier cantidad adicional tasada, con intereses 9
Documentation Standards for Complex Credits
For more complex credits requiring substantial documentation, preparers must maintain detailed records. regulations, however, require taxpayers claiming research credits to “retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit.” But a taxpayer’s records, however kept, must be “in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit”. 10 10
Elective Pay and Transfer Credit Requirements
Pre-Filing Registration Requirements
Complete pre-filing registration with the IRS: This will include providing information about yourself, which applicable credits you intend to earn, and each eligible project/property that will contribute to the applicable credit and other information required. Upon completing this process, the IRS will provide you with a registration number for each applicable credit property. You will need to provide that registration number on your tax return as part of making the elective pay election. Complete pre-filing registration in sufficient time to have a valid registration number at the time you file your tax return. 11
Substantiation Requirements
You will need the documentation necessary to properly substantiate any underlying tax credit, including if bonus amounts increased the credit. 11 This requirement extends beyond basic eligibility documentation to include comprehensive substantiation of all credit components and enhancements.
Detailed Information Requirements for Transfer Credits
Unless modified in future guidance, an eligible taxpayer is required to provide the following information to the IRS to complete the pre-filing registration process: The eligible taxpayer’s general information, including its name, address, taxpayer identification number, and type of legal entity; Any additional information required by the IRS electronic portal, such as information establishing that the entity is an eligible taxpayer; The taxpayer’s taxable year, as determined under section 441; The type of annual tax return(s) normally filed by the eligible taxpayer, or that the eligible taxpayer does not normally file an annual tax return with the IRS; The type of eligible credit(s) for which the eligible taxpayer intends to make a transfer election 12
Enforcement and Compliance Considerations
Burden of Proof Standards
Tax deductions and credits are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction or credit claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). 13 This fundamental principle underscores the importance of thorough documentation and substantiation in due diligence procedures.
IRS Examination Strategies
Is there a potential of inflated income in order to claim credits. (e.g. EITC)? 14 This indicates that IRS examination procedures specifically focus on potential manipulation of income to qualify for refundable credits, making thorough due diligence essential for preparer protection.
Practical Implementation Guidelines
Integration with Return Preparation Process
The due diligence requirements must be integrated throughout the return preparation process, from initial client interview through final review. Preparers should establish systematic procedures to ensure all four requirements are consistently met for each applicable credit and filing status determination.
Quality Control Procedures
Effective due diligence requires robust quality control procedures that verify compliance with all four requirements before returns are filed. This includes supervisory review of Form 8867 completion, verification of computation worksheets, and confirmation that adequate records are maintained.
Technology and Documentation Systems
Modern tax preparation software can facilitate due diligence compliance through automated prompts and integrated documentation systems. However, preparers must ensure that technology supplements rather than replaces professional judgment in evaluating client eligibility and conducting appropriate inquiries.
The due diligence requirements for specific tax credits represent a comprehensive framework designed to ensure accuracy and prevent improper claims. These requirements have evolved significantly over time and continue to expand as new credits are introduced and existing credits are modified. Preparers must maintain current knowledge of these requirements and implement systematic procedures to ensure consistent compliance across all applicable credits and filing status determinations.
Sources
1 IRC § 38(c)
2 IRC § 6213(g)
3 IRC § 6417(d)
4 IRC § 853A(a)
5 IRC § 25A(g)
6 IRS – Publication 4687 Paid Preparer Due Diligence
7 IRS – Publication 5713 (sp) Due Diligence Interviews — Steps to Success (Spanish Version)
8 IRS – Publication 5817-D Elective Pay for Tax-Exempt Organizations
9 IRS – Instruction 4255 Instructions for Form 4255, Certain Credit Recapture, Excessive Payments, and Penalties
10 IRS – Publication 5792 Small Businesses & Tax-Exempt Organizations Beware of Tax Credit Scams!
11 Treasury Regulation 1.6695-2
12 Treasury Regulation 1.6662-4
13 Treasury Regulation 1.6418-4T
14 Treasury Regulation 1.905-2
15 Treasury Regulation 1.6664-4
16 T.D. 9842
17 IRS IRM 32.1.2 Procedural Requirements for Regulation Projects
18 IRS IRM 4.1.5 Case Building, Classification, Storage and Delivery
19 IRS IRM 21.6.3 Credits
20 IRS IRM 4.19.14 Refundable Credits Strategy
21 Dawson U.S. Tax Court Opinions Donald R. Golan & Sheila E. Golan
22 Dawson U.S. Tax Court Opinions Diran Li
23 Dawson U.S. Tax Court Opinions Little Sandy Coal Company, Inc.
24 Dawson U.S. Tax Court Opinions Little Sandy Coal Company, Inc.
25 Dawson U.S. Tax Court Opinions Xing F. Wang & Kathleen P. Lee
26 One Big Beautiful Bill Act Sec. 70605. Enforcement provisions with respect to COVID-related employee retention credits
27 One Big Beautiful Bill Act Sec. 70606. Social security number requirement for American Opportunity and Lifetime Learning credits
28 One Big Beautiful Bill Act Sec. 70421. Permanent renewal and enhancement of opportunity zones
29 One Big Beautiful Bill Act Sec. 70411. Tax credit for contributions of individuals to scholarship granting organizations
30 One Big Beautiful Bill Act Sec. 70422. Permanent enhancement of low-income housing tax credit
Sources
1 IRS – Publication 4687 Paid Preparer Due Diligence
2 T.D. 9842
3 Treasury Regulation 1.6695-2
4 IRS IRM 32.1.2 Procedural Requirements for Regulation Projects
5 One Big Beautiful Bill Act Sec. 70605. Enforcement provisions with respect to COVID-related employee retention credits
6 One Big Beautiful Bill Act Sec. 70606. Social security number requirement for American Opportunity and Lifetime Learning credits
7 IRC § 25A(g)
8 IRC § 6213(g)
9 IRS – Publication 5713 (sp) Due Diligence Interviews — Steps to Success (Spanish Version)
10 Dawson U.S. Tax Court Opinions Little Sandy Coal Company, Inc.
11 IRS – Publication 5817-D Elective Pay for Tax-Exempt Organizations
12 Treasury Regulation 1.6418-4T
13 Dawson U.S. Tax Court Opinions Diran Li
14 IRS IRM 4.1.5 Case Building, Classification, Storage and Delivery
Try Your AI Tax Assistant for Free!
Ready to transform your practice with agentic AI in tax? See firsthand how our cutting-edge AI tax tools can revolutionize your approach to tax research and planning.