A single Form 1040 claiming all four covered tax benefits can expose you to $2,600 in personal penalties if the IRS decides you skipped your due diligence homework. Multiply that by the 300 clients you served last filing season, and a sloppy intake process could cost more than your annual practice insurance premium.
Welcome to Internal Revenue Code Section 6695(g), the rule that turns Form 8867 from a "click-through checkbox" into the most expensive form on your desk. For returns filed in 2026, the IRS bumped the per-failure penalty to $650 each for the Earned Income Credit (EIC), the Child Tax Credit / Additional Child Tax Credit / Credit for Other Dependents (CTC/ACTC/ODC), the American Opportunity Tax Credit (AOTC), and Head of Household (HOH) filing status. That number is indexed to inflation and rises every year.
This guide walks paid preparers — CPAs, Enrolled Agents, Annual Filing Season Program participants, attorneys, and unenrolled preparers alike — through exactly what the IRS expects, how to bulletproof your files for a due diligence visit, and where most practitioners get burned.
What Form 8867 Is (and Why It's Not Optional)
Form 8867, Paid Preparer's Due Diligence Checklist, must be completed and submitted with every Form 1040, 1040-NR, 1040-SR, 1040-SS, or 1040-PR that claims:
- The Earned Income Credit (EIC)
- The Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), or Credit for Other Dependents (ODC)
- The American Opportunity Tax Credit (AOTC)
- Head of Household (HOH) filing status
The form is not a substitute for due diligence — it is evidence that you performed it. The actual obligations live in Treasury Regulation §1.6695-2, and they apply whether or not your software auto-fills the form for you.
A useful mental model: Form 8867 is the receipt. The due diligence is the meal you actually had to cook.
Who counts as a "paid preparer"
If you sign a return for compensation, you are a paid preparer. So is the "non-signing preparer" in your firm who substantively prepares the return, and the firm itself can also be jointly assessed for any employee's failures. There is no exemption for low-fee preparers, volunteer-adjacent practitioners, or seasonal staff. The duty attaches the moment money changes hands.
The Four Due Diligence Requirements
Treasury Regulation §1.6695-2 lays out four distinct duties. Failing any one of them is a separate penalty event.
1. The Knowledge Requirement (the one preparers most often blow)
You must "interview the taxpayer, ask adequate questions, contemporaneously document the questions and responses, review information to determine if it is correct and complete, and apply the appropriate tax law." Three rules sit inside this:
- You cannot ignore implications. If a client tells you they earned $9,500 from house cleaning with zero business expenses and three qualifying children, the optimization-for-EITC math is obvious — and so is your duty to dig further.
- You must make reasonable inquiries whenever information appears incorrect, inconsistent, or incomplete. "Reasonable" is judged against what a well-informed preparer in your shoes would do, not what your client wants you to do.
- You must contemporaneously document the questions you asked and the answers you got. "Contemporaneous" means at the time, not reconstructed six months later when a Letter 5364 arrives.
This is the requirement IRS examiners hammer on, because it is the hardest to fake retroactively.
2. The Form 8867 Itself
The checklist must be completed truthfully and accurately, signed (electronically counts), and submitted with the return. The November 2025 revision is the current version for the 2025 tax year and 2026 filing season — make sure your software is updated.
3. The Computation Worksheet
You must complete the relevant IRS worksheet — the EIC Worksheet, the Credit Limit Worksheet in the Schedule 8812 instructions, the AOTC worksheet in Form 8863 instructions — or your own worksheet that captures the same information. "I ran it through the software" is not, by itself, sufficient. Print or save the computation as part of the client file.
4. The Record Retention Requirement (3 Years)
For each return claiming a covered benefit, you must keep the following for three years from the latest of the return due date, filing date, presentation date to the taxpayer, or submission date to the signing preparer:
- A copy of the completed Form 8867
- A copy of every applicable worksheet (or your equivalent)
- Copies of any documents the taxpayer provided that you relied on
- A record of how, when, and from whom you obtained the information used to prepare the return
- A record of any additional inquiries you made and the client's answers
The three-year clock does not start when the credit is paid. It starts when the return is filed (or due, if later). For an extended 2025 return filed in October 2026, retention runs through October 2029.
The 2026 Penalty Math: Why This Adds Up Fast
For returns filed in calendar year 2026, the per-failure penalty under IRC §6695(g) is $650, indexed annually. Each covered benefit is a separate failure, so the structure looks like this:
| Benefit Claimed | Max Penalty Per Return |
|---|---|
| EIC | $650 |
| CTC / ACTC / ODC | $650 |
| AOTC | $650 |
| HOH filing status | $650 |
| Combined | $2,600 |
Now scale that. A storefront preparer who files 800 EIC returns and gets hit with a 25-return sample audit — the IRS standard sample size — could see penalties grow if the IRS expands to a second 25-return sample after finding failures in the first. And the IRS does expand.
But the dollar penalties are only the first layer. A failed due diligence visit can also trigger:
- Suspension or permanent revocation of your EFIN (Electronic Filing Identification Number) — career-ending for e-file practices
- Loss of your PTIN (Preparer Tax Identification Number)
- Referral to the Office of Professional Responsibility (OPR), which can suspend or disbar CPAs, EAs, and attorneys from federal practice under Circular 230
- Civil injunction suits to bar you from preparing returns
- Criminal prosecution for the most serious patterns of fraud
The dollar penalty is meant to sting. The collateral consequences are meant to end the practice.
What's New for the 2025 Tax Year / 2026 Filing Season
Two notable changes preparers need to operationalize:
-
CTC/ACTC SSN requirement for the taxpayer. Beginning with tax year 2025 returns, the taxpayer claiming the CTC or ACTC must have a valid Social Security Number (not an ITIN). This is on top of the long-standing rule that the qualifying child must have a valid SSN issued before the return's due date. Your knowledge requirement now includes verifying — and documenting — the taxpayer's SSN status, not just the child's.
-
Form 8867 revision dated November 2025. Update your software. If you are still pulling a 2024 revision, your e-file may reject or your file will show stale documentation.
Red Flags That Demand Reasonable Inquiry
The IRS publishes a non-exhaustive list of fact patterns it considers "incorrect, inconsistent, or incomplete." When you encounter any of these, the regulation requires you to ask more questions, not fewer — and to document both.
Schedule C and EITC
Self-employed Schedule C income is the single largest source of EITC errors. Patterns that demand follow-up:
- Cash-heavy businesses (house cleaning, lawn care, child care) reporting income with no offsetting expenses. A real cleaner buys cleaning supplies; a real lawn-care operator buys gas.
- Schedule C net profit that lands precisely in the EITC sweet spot ($15,000–$25,000 for a family with two kids). Real businesses do not optimize their gross to a tax credit phase-out.
- Schedule C losses that conveniently bring AGI below the EITC investment income limit.
- No business name, no separate bank account, no records, but a confidently round number ("$18,000").
Qualifying child claims
- A 22-year-old client claiming three qualifying children, none of whom share the client's last name, and no documentation of the relationship.
- Multiple unrelated taxpayers at the same address claiming the same children.
- A child living "with the taxpayer" for "12 months" when the taxpayer just moved states in July.
Head of Household
- A married client claiming HOH because the spouse "doesn't live here anymore" — without confirming the spouse was absent for the last six months of the year and that the home was the qualifying person's main home for more than half the year.
AOTC
- Tuition claimed without a Form 1098-T, or with a Form 1098-T showing only Box 5 (scholarships) and an empty Box 1.
- "Course materials" claimed at amounts no plausible textbook bill would justify.
- A claim that the student is in the first four years of post-secondary education when the taxpayer has been claiming AOTC for that student for five years running.
When any of these surface, your file must show three things: that you noticed, that you asked, and what the client said. A single contemporaneous note ("Client confirmed eldest daughter lived with her the full year; school records and pediatrician statement on file") is worth a thousand retroactive justifications.
Documentation That Survives an IRS Visit
A clean due diligence file is boring, which is the point. For each return with a covered credit or filing status, your folder should include:
- The signed Form 8867 (e-signature is fine)
- The EIC / Schedule 8812 / AOTC computation worksheets
- Copies of documents the client provided (driver's license, Social Security cards, Form 1098-T, school records, doctor statements, lease, custody decree, Schedule C books-and-records summaries)
- An intake interview note listing the questions you asked, the answers received, and the date
- Any inconsistency you noticed, what you asked about it, and what the client said
- The source of every piece of information ("Client provided W-2 by email 2026-02-14; verified employer name against prior-year return")
Two practical tips for partners and firm owners:
- Use a templated intake checklist that mirrors Form 8867 line by line. Train staff that "client said yes" without a follow-up question is not a complete answer.
- Time-stamp everything. A practice management system that logs the date and time a note was entered makes "contemporaneous" indisputable. A handwritten note dated "January" does not.
How an IRS Due Diligence Visit Actually Works
The IRS doesn't audit preparers at random. It uses return-level data to identify preparers whose filings show high error rates on the four covered benefits, then schedules pre-filing-season "due diligence visits." Knowing the playbook helps:
- The examiner contacts you to schedule a visit and requests a list of returns you prepared in the prior season.
- They typically pull a sample of 25 client files and review the returns plus your due diligence records.
- They look for the four requirements above — knowledge, Form 8867, worksheets, and retention — and they spot-check for the inconsistencies your file should have caught.
- If failures are found in the first 25, they may expand to another 25.
- Findings are assessed at $650 per credit per failure. Severe patterns are referred to OPR, EFIN suspension processes, or criminal investigation.
There is no "good faith" defense in the regulation. Either the documentation exists or it does not. The discipline is procedural, and the cure is procedural.
A Workflow That Scales
Practitioners who never get penalized share a few habits worth copying:
- Front-load due diligence at intake. Build the four-requirements logic into the engagement letter and intake form, before the return is even started. A junior staffer collecting documents in February is cheaper than a partner reconstructing them in November.
- Track exceptions, not just compliance. Every return where the preparer made an additional inquiry should be flagged with a note explaining what triggered the inquiry and how it was resolved. That trail is what the IRS examiner reads first.
- Reconcile bank deposits against Schedule C income. For self-employed EITC claims, asking the client for three months of bank statements is the single highest-yield exercise in the field. If deposits don't match the reported gross, you have a documentation problem and possibly a fraud problem.
- Run an internal mock visit every summer. Pull 25 of your own returns blind and grade them against the four requirements. Anything you can't reconstruct is a gap your real examiner will find.
Keep Your Practice's Own Records Just as Clean
Form 8867 enforces a discipline that good preparers already apply to themselves: every number on every return should be traceable to a source, dated, and stored where you can find it three years later. The same logic applies to your firm's own books. If your billing, payroll, and trust accounts can't survive the same scrutiny you bring to a client's Schedule C, you are setting up the next bad surprise — only this time it's yours.
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Bottom Line
Form 8867 looks like a checkbox and bills like a class-action lawsuit. The IRS has invested heavily in identifying preparers whose due diligence files don't match their return volume, and the 2026 penalty schedule — $650 per failure, $2,600 per worst-case return, plus EFIN and OPR consequences — is set up to make a single bad season existential for a small practice.
The escape hatch is not heroic. It is paperwork. Document the question. Document the answer. Keep the worksheet. Keep the documents. For three years. Every time. That habit, built into the intake workflow and enforced as a firm policy, is what separates the practitioners who quietly survive due diligence visits from the ones who quietly close their doors after them.