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Unit 7: Due Diligence & Audit Protection

Master IRS Form 8867 due diligence, statutory penalties, audit defense, CP2000 notices, and client representation.

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Shmuel Eagle

Shmuel Eagle

Instructor

Unit 7: Due Diligence & Audit Protection

What Will You Learn

  • Complete Form 8867 with zero errors for all covered credits and HOH status
  • Implement the four statutory due diligence requirements on every return
  • Conduct probing client interviews to detect contradictory tax claims
  • Establish a 3-year record retention workflow compliant with IRC §6695(g)
  • Protect your tax firm against statutory penalties exceeding $600 per failure
  • Interpret IRS CP2000 matching notices and prepare timely written responses
  • Distinguish correspondence, office, and field audits and manage client files
  • Build well-indexed document substantiation binders for IRS examiners
  • Understand Circular 230 representation limits and know when to refer out
  • Request penalty relief using First-Time Abatement and Reasonable Cause

About This Class

Course & Unit Overview: Due Diligence & Audit Protection (Classes 23–24)

Welcome to Unit 7 of BlueLink Academy’s 1040 Income Tax Preparation Course. Due diligence is not merely an administrative checkbox—it is a federal legal standard that shields your professional license and protects your practice from catastrophic statutory penalties under IRC Section 6695(g). This unit covers the 4 statutory due diligence requirements on Form 8867, IRS notice decoding (CP2000), audit examination defense, and penalty abatement strategies.

The Preparer's Mindset

The IRS does not audit returns to catch simple math errors; automated algorithms do that. When an examination notice arrives, the preparer who maintained contemporaneous interview notes, substantiation logs, and completed Form 8867 checklists resolves the audit in a single written response.

Unit Curriculum Architecture

Class 23

IRS Due Diligence Requirements

Form 8867 compliance pillars, EIC/CTC/AOTC/HOH rules, $600+ per failure statutory penalties, and 3-year recordkeeping.

Class 24

IRS Audits & Notices

CP2000 automated notices, correspondence vs office vs field audits, Circular 230 representation limits, and penalty abatement.

Unit Quick Reference Table

Regulatory Standard IRS Code / Form Preparer Compliance Requirement
Covered Tax Benefits Form 8867 Mandatory checklist for EIC, CTC/ACTC/ODC, AOTC, and Head of Household
Due Diligence Penalty IRC §6695(g) $600+ statutory penalty per failure, per credit, per return
Document Retention Treas. Reg. §1.6695-2 Must retain Form 8867, worksheets, and client records for 3 full years
CP2000 Response Window IRS Notice CP2000 Strict 30-day response window to challenge automated underreporter assessments
First-Time Abatement IRM 20.1.1.3.3.2.1 Administrative penalty waiver for clean 3-year prior compliance history
Requirements
  • Completion of Units 1 through 6 of the 1040 Preparation Program
  • Working knowledge of EIC, CTC, AOTC, and Head of Household rules
  • Commitment to professional ethics, Circular 230, and IRS rules
  • Access to tax software, Form 8867, and client intake templates
  • Dedication to retaining complete, contemporary client workpapers

Frequently Asked Questions

What tax credits and filing statuses trigger mandatory Form 8867 due diligence?
Form 8867 must be completed and submitted with any return claiming: (1) The Earned Income Credit (EIC), (2) The Child Tax Credit / Additional Child Tax Credit / Credit for Other Dependents (CTC/ACTC/ODC), (3) The American Opportunity Tax Credit (AOTC), or (4) Head of Household (HOH) filing status.
What are the four core requirements of paid preparer due diligence?
Under Treas. Reg. §1.6695-2, the four requirements are: (1) Complete and submit Form 8867, (2) Compute the credit or deduction using the correct worksheets, (3) Knowledge: make reasonable, contemporaneous inquiries if information appears incorrect or inconsistent, and (4) Retention: keep all records, worksheets, and notes for three years.
What is the penalty for failing to meet due diligence requirements in 2026?
Under IRC §6695(g), the penalty is assessed on a per-failure, per-credit basis and is adjusted annually for inflation (over $600 per failure in 2026). A single return improperly claiming HOH, CTC, and EIC can trigger three separate penalties totaling more than $1,800 for the preparer.
How long must a tax preparer retain due diligence documentation?
Preparers must retain all required due diligence documents for three years from the later of the return's due date or the date the return was actually filed. Records can be stored electronically as long as they are readily accessible upon IRS request.
What should a preparer do when a client's information seems contradictory or incomplete?
The preparer must make reasonable inquiries, ask probing questions, and document the questions asked along with the client's responses contemporaneously in the workpapers. If the client refuses to provide credible explanations or documents, the preparer must refuse to claim the credit or prepare the return.
What is an IRS CP2000 Notice and what does it mean?
A CP2000 is an Automated Underreporter (AUR) notice generated by IRS computer matching when income, deductions, or credits reported on a return do not match third-party data (such as W-2s, 1099s, or 1098s). It is not a formal audit, but a proposed tax adjustment that gives the taxpayer 30 days to agree or disagree with documentation.
What are the three primary types of IRS audits?
(1) Correspondence audits: conducted entirely through the mail for simple documentation issues; (2) Office audits: conducted in-person at a local IRS office for more complex itemized deductions or small business records; and (3) Field audits: conducted on-site at the taxpayer's home, office, or accountant's office for thorough corporate or multi-year examinations.
Who is authorized to represent a taxpayer during an IRS examination?
Under Treasury Circular 230, full representation rights (attending meetings on behalf of the client, signing agreements, negotiating settlements) are limited to licensed attorneys, Certified Public Accountants (CPAs), and Enrolled Agents (EAs). Non-credentialed preparers participating in the Annual Filing Season Program (AFSP) have limited representation rights only for returns they prepared and signed.
What is First-Time Abatement (FTA) and how does it work?
First-Time Abatement is an administrative waiver that allows the IRS to remove failure-to-file, failure-to-pay, or failure-to-deposit penalties for a taxpayer who has a clean compliance history for the preceding three tax years, has filed all currently required returns, and has paid (or arranged to pay) all tax owed.
What constitutes "Reasonable Cause" for penalty abatement?
Reasonable cause relief is granted when a taxpayer demonstrates that they exercised ordinary business care and prudence in determining and fulfilling their tax obligations, but were nevertheless unable to comply due to circumstances beyond their control (e.g., severe illness, death of an immediate family member, natural disaster, or unavoidable destruction of records).

Meet Your Instructors

Shmuel Eagle

Shmuel Eagle

Lead Tax Instructor

Co-founder of BlueLink with 15+ years in tax preparation and office management.

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