The IRS Hit You With a Due Diligence Penalty. NOW WHAT?

Tax Pros, let's talk about something nobody wants to experience.

You open a letter from the IRS, and they're proposing thousands of dollars in due diligence penalties.

Now what?

Do you panic? Do you immediately pay? Do you ignore the letter and hope it goes away?

Absolutely not!

First, understand something important: Just because the IRS proposes a due diligence penalty doesn't automatically mean the penalty is final or that you have no options.

But what you do next matters.

1. Understand What the IRS Is Penalizing You For

Under Internal Revenue Code §6695(g), paid tax return preparers can face penalties for failing to meet due diligence requirements involving certain tax benefits.

These include:

• Earned Income Tax Credit (EITC)

• Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), and Credit for Other Dependents (ODC)

• American Opportunity Tax Credit (AOTC)

• Head of Household (HOH) filing status

The IRS may identify failures involving Form 8867, required computations, reasonable inquiries, or record retention.

Here's what I want you to understand:

A due diligence penalty is not necessarily a determination that your client was ineligible for the credit or filing status.

The IRS may be questioning whether YOU, as the paid preparer, satisfied your legal responsibilities.

Those are two different issues.

2. Read Your IRS Letter Carefully

Before you do anything else, read the entire notice.

You need to identify:

What is the IRS alleging?

Which tax returns or clients are involved?

How many violations are being proposed?

What is the total proposed penalty?

What is your deadline to respond?

And most importantly:

Is this a proposed penalty or an assessed penalty?

That distinction matters because your available response procedures may differ.

Don't assume every IRS letter requires the same response.

3. Review Your Client Files Before Responding

This is where your recordkeeping becomes extremely important.

Go back and review the files associated with the IRS findings.

Look for your completed Forms 8867, applicable credit computation worksheets, client interview notes, supporting records you relied upon, and documentation of any additional questions and answers.

Ask yourself:

Did I satisfy the required due diligence procedures?

Did I recognize information that appeared incomplete, inconsistent, or incorrect?

Did I make reasonable inquiries when necessary?

Can I demonstrate what I knew and what I did when I prepared the return?

Remember, tax professionals are not automatically required to obtain every possible supporting document from every client.

However, you must meet the applicable knowledge and inquiry requirements and maintain the records required by law.

Your response should be based on the facts, the law, and your actual records—not assumptions.

And never create or alter records to make it appear that work was performed when it wasn't.

4. Understand That You May Have the Right to Disagree

One thing I teach tax professionals is that you must understand your rights during the IRS examination and penalty process.

If you disagree with the IRS findings, you may have an opportunity to provide additional information, request reconsideration, or pursue an administrative appeal, depending on the stage of your case.

But here's the key:

You need to understand WHY you disagree.

Simply saying, "I've been preparing taxes for 20 years," is not a defense.

Saying, "My software completed Form 8867," doesn't establish that you met every due diligence requirement.

You need to identify the specific findings you dispute and explain how your records and the applicable law support your position.

5. Don't Ignore the Response Deadline

Tax Pros, please don't put that IRS letter in a drawer because you're afraid to deal with it.

Ignoring the notice can limit your opportunities to challenge the findings before the IRS takes further action.

The appropriate response depends on the specific notice and the procedural stage of your case.

If you need assistance, seek help from a qualified tax professional experienced in preparer penalties and IRS examination procedures.

Don't wait until the deadline has passed to start asking questions.

6. Understand That Penalty Relief Is Not Automatic

Let me be clear.

Not every proposed due diligence penalty will be removed.

And not every preparer will qualify for relief.

Under the applicable rules, a preparer may have defenses or grounds to contest a penalty, including demonstrating that the due diligence requirements were satisfied or that a failure falls within the regulatory reasonable-cause exception.

But those arguments must be supported by the facts and applicable law.

You cannot simply request that the IRS remove the penalty because you didn't know the rules.

Education, documentation, and preparation matter.

7. Learn From the Examination

Whether your penalty is removed, reduced, or upheld, use the experience to evaluate your business practices.

Review your client interview process.

Review your due diligence procedures.

Review how your office documents reasonable inquiries.

Review how your records are maintained.

And if you have employees or other preparers working under your business, make sure they understand their individual responsibilities.

A due diligence examination should never be the first time you're learning what the IRS expects.

I've Been Through the Process

I've personally dealt with IRS due diligence examinations involving my tax preparation business.

I've also handled appeals involving proposed penalties of approximately $47,000 and $6,000, both of which were ultimately reduced to zero.

Those experiences reinforced something I've taught tax professionals for years:

You must understand the tax law, the due diligence regulations, and the IRS examination process.

A penalty notice is serious. But you should understand the findings and your available options before deciding how to proceed.

Every case is different, and no particular outcome is guaranteed.

Final Thoughts: Don't Panic. Get Informed.

If the IRS hits you with a due diligence penalty, don't ignore it.

Don't automatically assume the IRS is wrong.

And don't automatically assume the IRS is right.

Understand the allegations. Review your records. Know your deadlines. Evaluate your options.

Most importantly, don't wait until you're facing thousands of dollars in proposed penalties to start taking due diligence seriously.

Tax Pros, protecting your business starts long before an IRS examination letter arrives.

Dr. Gwennetta WrightXpert Business Solutions

Educational Disclaimer: This article provides general information and is not individualized legal or tax advice. IRS penalty procedures and available remedies depend on the notice, facts, and stage of the case.