The Four Due Diligence Requirements
1. Complete and Submit Form 8867: Form 8867 must be completed for every return claiming EITC, CTC/ACTC, AOTC, or Head of Household status. It must be submitted with the return (e-filed or paper). A separate Form 8867 is not required for each credit — one form covers all applicable credits on the same return.
2. Complete the Applicable Worksheets: The preparer must complete the EITC worksheet (Schedule EIC), the CTC/ACTC worksheet, and/or the AOTC worksheet as applicable. These worksheets must be retained in the preparer's records even if they are not submitted with the return.
3. Apply the Knowledge Standard: The preparer must not know, or have reason to know, that any information used to determine eligibility for or the amount of the credit is incorrect. If a client provides information that seems inconsistent (e.g., a client claims three qualifying children but lives in a one-bedroom apartment), the preparer must ask additional questions and document the inquiry and the client's response.
4. Retain Records for Three Years: The preparer must retain Form 8867, all worksheets, and a record of how and when the information was obtained from the client for three years from the return due date or the date the return was filed, whichever is later.
The Knowledge Standard: What "Reason to Know" Means
The knowledge standard is the most frequently cited basis for §6695(g) penalties. The IRS expects preparers to be alert to inconsistencies and to ask follow-up questions when something doesn't add up. Red flags that trigger additional inquiry: a client claims a child as a qualifying child but the child's other parent also claims the child; a client's reported income is significantly lower than in prior years but their lifestyle appears unchanged; a client claims Head of Household but appears to live with a spouse; a client claims AOTC for a student who has already received the credit for four years.
When a red flag exists, the preparer must document: the question asked, the client's response, and any documentation reviewed. The documentation does not need to be elaborate — a contemporaneous note in the client file is sufficient. But the note must exist. "I asked and they told me" without documentation is not sufficient if the IRS audits the preparer's due diligence records.
Frequently Asked Questions
What is the penalty for failing to file this form on time?
Failure-to-file penalties are generally 5% of unpaid tax per month (up to 25%). Failure-to-pay penalties are 0.5% per month (up to 25%). Interest accrues on unpaid tax at the federal short-term rate plus 3%. Penalties can be waived for reasonable cause (illness, natural disaster, IRS error). First-time penalty abatement is available for taxpayers with a clean compliance history.
What is the statute of limitations for IRS assessment related to this form?
The IRS generally has three years from the later of the return due date or filing date to assess additional tax. If the taxpayer omits more than 25% of gross income, the statute is extended to six years. There is no statute of limitations for fraudulent returns or failure to file. Taxpayers should retain tax records for at least seven years to cover the extended statute of limitations.
Can this form be filed electronically?
Most IRS forms can be filed electronically through IRS e-file or through tax preparation software. Electronic filing is faster, more accurate, and provides confirmation of receipt. Some forms (such as Form 2553 and Form 8832) must be filed on paper. The IRS mandates electronic filing for businesses that file 10 or more information returns (1099s, W-2s) starting in 2024.
What records should be retained to support this form?
Taxpayers should retain all records supporting the information reported on this form for at least seven years (to cover the extended statute of limitations for omission of income). Records include: receipts, invoices, bank statements, brokerage statements, contracts, and correspondence with the IRS. Electronic records are acceptable if they are accurate, complete, and accessible.
What is the first-time penalty abatement (FTA) program?
The IRS First-Time Penalty Abatement (FTA) program waives failure-to-file, failure-to-pay, and failure-to-deposit penalties for taxpayers who have a clean compliance history (no penalties in the three prior years, all required returns filed, and no outstanding tax debt). FTA is available by calling the IRS or submitting a written request. It is one of the easiest ways to get a penalty waived.
How does this form interact with state tax returns?
Federal tax forms often have state counterparts that must be filed separately. State tax laws do not always conform to federal tax law, so the state return may require different calculations or additional schedules. Taxpayers should review their state’s conformity to federal tax law changes and file all required state returns by the applicable deadlines.
What is the difference between a tax deduction and a tax credit?
A tax deduction reduces taxable income, saving taxes at the marginal rate. A tax credit directly reduces tax liability dollar-for-dollar. A $1,000 deduction saves $370 for a taxpayer in the 37% bracket; a $1,000 credit saves $1,000 regardless of the tax bracket. Refundable credits can reduce tax liability below zero, resulting in a refund. Non-refundable credits can only reduce tax liability to zero.
How does the alternative minimum tax (AMT) affect this form?
The AMT is a parallel tax system that disallows certain deductions and adds back preference items. Taxpayers who owe AMT must complete Form 6251 to calculate their AMT liability. Common AMT triggers include: ISO exercises, large state tax deductions, accelerated depreciation, and passive activity losses. Taxpayers should model both regular tax and AMT before making decisions that could trigger AMT.
What is the IRS correspondence audit process for issues related to this form?
An IRS correspondence audit is conducted by mail, without a face-to-face meeting. The IRS sends a notice requesting documentation to support specific items on the return. Taxpayers should respond by the deadline with organized documentation and a clear explanation. If the IRS does not accept the response, they will issue a 30-day letter (proposed adjustment) and then a 90-day letter (Statutory Notice of Deficiency).
Can this form be amended after filing?
Most tax returns and forms can be amended within three years of the original filing date (or two years from the date the tax was paid, whichever is later). Amended returns are filed on Form 1040-X (individual) or the applicable amended business return. Amendments that increase tax liability should be filed promptly to minimize interest. Amendments that decrease tax liability (refund claims) must be filed within the statute of limitations.
What is the IRS Taxpayer Advocate Service and when should it be contacted?
The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that helps taxpayers resolve problems that cannot be resolved through normal IRS channels. TAS can be contacted when: (1) a tax problem is causing financial hardship, (2) the taxpayer has tried to resolve the problem but has not been successful, or (3) the taxpayer believes an IRS system or procedure is not working as it should. TAS can be reached at 1-877-777-4778.
How does this form affect the taxpayer’s overall tax planning strategy?
Every tax form is part of a larger tax planning picture. Taxpayers should review all forms filed during the year to identify opportunities for tax savings, such as: maximizing retirement plan contributions, accelerating deductions, deferring income, and taking advantage of available credits. A comprehensive tax planning review should be conducted annually, not just at tax time.
