7 Due Diligence Mistakes You’re Making (and How to Fix Them Before an Audit)

IRS “due diligence” is not a general best practice. It is a defined set of rules for paid preparers related to credits and filing statuses that are audited often: especially:

• Earned Income Tax Credit (EITC)
• Child Tax Credit (CTC) / Additional Child Tax Credit (ACTC) / Credit for Other Dependents (ODC)
• Head of Household (HOH)
• American Opportunity Tax Credit (AOTC) (also subject to due diligence rules)

If you prepare returns that include these items, you are expected to meet IRS due diligence requirements, complete and keep Form 8867, ask the right questions, document the answers, and keep support that shows you did not ignore red flags.

Below are seven common tax due diligence mistakes that trigger problems during an IRS tax preparer audit: and how to fix them with a repeatable process.

1) Taking the client’s word without verifying eligibility

What goes wrong

A client says:

• “My kid lived with me all year.”
• “I’m separated, so I’m Head of Household.”
• “I paid for most of the household.”
• “That’s my niece; I can claim her.”

If you accept those statements without follow-up and documentation, you risk:

• Incorrect EITC/CTC/HOH claims
• Form 8867 penalties for failure to meet due diligence
• Expanded scrutiny of your entire practice if patterns show up

How to fix it

Use a standard verification set for each area:

For qualifying child/relative (EITC/CTC/ODC):

• Proof of relationship (birth certificate, school/medical record listing parent/guardian, court papers)
• Proof of residency (school record, daycare record, medical record, letter from shelter/agency; avoid “handwritten letters” unless supported by third-party records)
• Proof of support where needed (benefit statements, child care receipts, lease, utilities)

For HOH:

• Proof the home was maintained (lease/mortgage, property tax, utilities, insurance)
• Proof a qualifying person lived with the taxpayer (residency documents)

Operational rule: if an answer changes the outcome, document it and keep support.

2) Treating Form 8867 as a “form to file” instead of a process to complete

What goes wrong

Form 8867 is not a box-check exercise. It is a summary of your due diligence steps. Problems usually show up as:

• Missing fields
• Inconsistent answers vs. the return
• No notes explaining unusual facts
• No retained worksheets or backup

During an IRS tax preparer audit, the IRS often wants to see you followed the process behind Form 8867, not just that you transmitted it.

How to fix it

Build your workflow so Form 8867 is “completed” only after the file is complete.

Minimum process controls:

• Do not e-file a return with EITC/CTC/HOH until Form 8867 is fully answered
• Require a short note for any unusual situation (shared custody, informal separation, temporary absences, multi-family households)
• Save the final Form 8867 PDF to the same folder as the return and supporting documents
• Run a pre-submission review that compares Form 8867 answers to:
  • filing status
  • dependents section
  • EITC/CTC computations
  • residency entries
  • education credit entries (if applicable)

Tip: If your software auto-populates Form 8867, still review each field. Auto-populated does not mean accurate.

3) Not documenting the interview (or documenting it in a way that can’t be defended)

What goes wrong

Many offices rely on memory or short notes like “client said child lived with them.” That is weak support. The IRS expects you to:

• Ask appropriate questions
• Not ignore contradictory facts
• Record how conflicts were resolved

How to fix it

Use a structured interview that produces standardized documentation.

Better documentation methods:

• A due diligence questionnaire signed by the taxpayer
• A consistent “facts” section in your preparer notes:
  • Who lived in the home, and when
  • Who paid which household costs
  • Where the child slept and attended school
  • Custody arrangements
  • Any months the child lived elsewhere and why

Key standard: notes must be detailed enough that another preparer could understand why the credit/status was allowed.

4) Poor recordkeeping (can’t produce documents quickly, or at all)

What goes wrong

Even if the return is correct, you can lose an audit if you cannot produce:

• Form 8867
• EITC/CTC/HOH worksheets (from software or manual)
• Copies of documents you relied on
• Your interview notes and questionnaires

The IRS can assess due diligence penalties per return even when the credit itself is later proven correct, if the preparer failed process requirements.

How to fix it

Set a simple retention and folder standard.

File checklist for returns with EITC/CTC/HOH:

• Signed engagement / consent forms (as applicable)
• Photo ID for taxpayer (and spouse if MFJ)
• SSN/ITIN verification
• Form 8867 (final)
• Credit worksheets (EITC/CTC/HOH, and AOTC if used)
• Residency and relationship support for dependents
• Proof of HOH household costs (if HOH)
• Income documents (W-2s, 1099s, Schedule C records)
• Interview questionnaire + preparer notes

Organization rule: one return = one folder = consistent naming:

• YYYY ClientName - 8867
• YYYY ClientName - Residency Docs
• YYYY ClientName - HOH Costs
• YYYY ClientName - Income

5) Missing red flags (or seeing them and filing anyway)

What goes wrong

Due diligence requires you to identify information that seems incorrect, inconsistent, or incomplete. Common red flags:

• Child claimed by multiple taxpayers in prior years
• New dependent appears with no history
• HOH claimed but taxpayer lives with another adult who appears to share costs
• Self-employment income that “lands” at an amount that maximizes EITC
• Address changes that conflict with school/medical records
• A client cannot explain living arrangements clearly

How to fix it

Create a “stop-and-verify” list. If any item hits, pause preparation until resolved.

Stop-and-verify actions:

• Ask additional questions (who, where, when, why)
• Request third-party documents (school/medical/daycare, lease, benefit letters)
• Recompute household support using actual bills
• Document the resolution in notes
• If unresolved, do not claim the credit or status

Internal policy: no “estimated” residency timelines, no “assumed” support percentages, no “it should be fine.”

6) Inconsistent HOH support calculations (or no calculation at all)

What goes wrong

Head of Household is heavily audited. Many preparers claim HOH based on:

• a separation story without confirming marital status rules, or
• vague statements about paying bills without verifying the “more than half the cost” standard

HOH requires that the taxpayer paid more than half the cost of keeping up the home for a qualifying person (with specific exceptions).

How to fix it

Use a simple HOH support worksheet every time.

Include these costs (typical categories):

• Rent or mortgage interest
• Property taxes
• Utilities
• Home insurance
• Food consumed in the home
• Repairs and maintenance

Do not count (common errors):

• Clothing
• Education
• Medical expenses
• Vacations
• Life insurance
• Car payments (unless clearly tied to housing costs, which is uncommon)

Process step: ask for at least two proof points (e.g., lease + utility bills, or mortgage statement + property tax). Keep copies.

7) Weak internal controls (no consistent checklist, limited training, no second review)

What goes wrong

Many due diligence failures are not technical. They are operational:

• Different preparers ask different questions
• Documentation standards vary by location
• New staff are not trained on Form 8867 workflow
• No one checks returns with EITC/CTC/HOH before submission

This is how patterns form, and patterns are what trigger an IRS tax preparer audit.

How to fix it

Implement a basic control stack that is the same for every preparer.

Control stack:

1. Standardized checklists for EITC/CTC/HOH (required documents + required questions)
2. Required questionnaire signed by the taxpayer for returns with due diligence items
3. Pre-file review for all returns with Form 8867:
   • verify identity and SSNs
   • verify residency support present
   • verify HOH costs worksheet completed (if HOH)
   • verify Schedule C support (if self-employment affects EITC)
4. Training refresh before peak season and mid-season
5. File audit sampling (weekly random returns reviewed internally)

At TIG Tax Pros, advanced training and standardized workflow are used to keep files consistent and due diligence-ready across preparers, with special focus on tax compliance and Form 8867 accuracy. For related services and tools, see: https://www.tigtaxpros.com/services

Audit protection and bank products: where due diligence mistakes create extra risk

Audit Protection

If you offer audit-related support to clients, your documentation needs to be cleaner, not looser. A due diligence audit looks at the preparer file first. If your file is incomplete, the client’s audit becomes harder to defend.

Operational requirement: audit support packages should pull directly from the same organized folder system used at filing time. No last-minute document hunts.

Bank Products (refund transfer/advance programs)

Bank products add another layer of scrutiny because:

• identity verification failures become bigger issues
• inconsistencies in personal data (address, dependents, filing status) create delays
• missing documentation can create compliance problems with partners

Process requirement: align bank product intake with your due diligence checklist so the same identity and residency documentation supports both.

Quick reference: due diligence essentials (keep this on your desk)

• Complete Form 8867 accurately for every return that requires it
• Keep Form 8867, worksheets, interview notes, and copies of documents you relied on
• Ask follow-up questions when facts are unclear or inconsistent
• Verify HOH support with an actual worksheet and proof
• Treat self-employment income affecting EITC as high-risk; document how it was determined
• Use a checklist and a second-review step for returns with EITC/CTC/HOH

Professional disclaimer

This content is for general informational purposes only and does not constitute tax, legal, or accounting advice. Due diligence requirements and documentation standards can vary based on facts and IRS guidance. Consult applicable IRS instructions and publications and use professional judgment for specific situations.