Practices and Procedures · Rules and penalties

Preparer due diligence and penalties (e.g., refundable credits, head of household status)

Q: A return claims head of household status, the EIC and the CTC, with due diligence failed on all three. The number of IRC 6695(g) penalties is:

B. Three, one per determination — Reg. § 1.6695-2(a)(1).

Q: A nonsigning tax return preparer satisfies the Form 8867 requirement by:

B. Providing the completed form to the signing preparer for inclusion with the filed return — Reg. § 1.6695-2(b)(1)(i)(C).

Q: A preparer telephones a client to resolve an apparent inconsistency, is satisfied, and files. No note is made. The knowledge requirement is:

B. Not satisfied, because inquiries and responses must be contemporaneously documented

Q: The exception in Reg. 1.6695-2(d) requires the preparer to show:

B. Both that normal office procedures are reasonably designed and routinely followed, and that the failure was isolated and inadvertent — , and it is unavailable to a firm penalised under the firm rule.

Q: A firm employing a penalised preparer is itself liable:

B. Only if management participated or knew, the firm failed to establish reasonable procedures, or it disregarded its own procedures through willfulness, recklessness or gross indifference — Reg. § 1.6695-2(c).

Verification 2026 Verified
tax year · reviewed 2026-08-18 · I. Ohu

The due diligence penalty is the one that scales fastest, because it applies per benefit and not per return. A single return claiming head of household status alongside three credits can carry four penalties, and none of them is capped annually. What the regulation asks for is not judgement but process: four requirements, all documentary, all provable from the file or not at all.

The rule

What it covers. The penalty reaches a preparer who determines eligibility for, or the amount of, head of household filing status; the child tax credit, additional child tax credit and credit for other dependents under section 24; the American opportunity tax credit; and the earned income credit^TY2026 and fails to satisfy the due diligence requirements (IRC § 6695(g); Reg. § 1.6695-2(a)(1)). The statute names §§ 2(b), 24, 25A(a)(1) and 32; because the credit for other dependents sits inside § 24, at § 24(h)(4), it is covered too, though neither the statute nor the regulation names it separately.

It is per benefit. A separate penalty applies with respect to the head of household filing status determination and to each applicable credit claimed on a return for which the requirements are not met (Reg. § 1.6695-2(a)(1)). The regulation’s own examples make the arithmetic plain: a return claiming the CTC and the AOTC with due diligence failed on both draws two penalties; failed on one, one.

The amount. $665 per failure, no cap^TY2026, indexed under § 6695(h) — and, unlike § 6695(a) to (e), not subject to any annual maximum.

The four requirements (Reg. § 1.6695-2(b)):

Complete and submit Form 8867. A signing preparer who e-files must file the completed Form 8867 with the return; a signing preparer not e-filing must give it to the taxpayer for inclusion with the filed return; a nonsigning preparer must give it to the signing preparer for inclusion. Completion must be based on information the taxpayer provided or that the preparer otherwise reasonably obtained or knew.
Compute the credit. Either complete the applicable worksheet in the instructions, or record the computation in the preparer’s files — including the method and the information used. Again based on information provided, reasonably obtained, or known.
Knowledge. The preparer must not know, or have reason to know, that any information used is incorrect. The preparer may not ignore the implications of information furnished or known, and must make reasonable inquiries where a reasonable, well-informed preparer knowledgeable in the law would conclude the information appears incorrect, inconsistent or incomplete — and must contemporaneously document the inquiries made and the responses.
Retain records. Keep the completed Form 8867, each worksheet or computation record, and a record of how and when the information was obtained, including who furnished it, plus copies of any documents the taxpayer provided and the preparer relied on. Retention is 3 years from the latest of the unextended due date, the e-filing date, the date presented to the taxpayer for signature, or a nonsigning preparer's submission date^TY2026.

The exception is narrow. The penalty is not applied to a particular return if the preparer demonstrates, on all the facts and circumstances, that the normal office procedures are reasonably designed and routinely followed to ensure compliance, and the failure on that return was isolated and inadvertent (Reg. § 1.6695-2(d)). Both limbs are required, and the exception does not apply to a firm penalised under the firm rule.

Firms are liable only on fault. A firm employing a penalised preparer is itself liable if, and only if, principal management or a branch office participated in or knew of the failure before filing; or the firm failed to establish reasonable and appropriate procedures; or the firm disregarded its own procedures through willfulness, recklessness or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate (Reg. § 1.6695-2(c)).

Current figures

Item	Value
Penalty per failure	$665 per failure, no cap^TY2026
Benefits covered	head of household filing status; the child tax credit, additional child tax credit and credit for other dependents under section 24; the American opportunity tax credit; and the earned income credit^TY2026
Record retention	3 years from the latest of the unextended due date, the e-filing date, the date presented to the taxpayer for signature, or a nonsigning preparer's submission date^TY2026

How it works in practice

Requirement three is the only one that asks for judgement, and it is where every real case is decided. The standard is not whether the client lied but whether a reasonable and well-informed preparer would have found the information incorrect, inconsistent or incomplete — and if so, whether an inquiry was made and documented at the time. A file recording that the preparer asked and what the client said is the difference between diligence and its absence. A memory of having asked is not evidence, because the regulation says contemporaneously.

The retention rule is measured from the latest of four dates, which for most e-filed returns is the filing date, but for an extended paper return may be the date presented for signature, and for a nonsigning preparer runs from their own submission to the signer. Firms applying a single three-year rule from the due date will be short on some files.

The exception is regularly overestimated. It is not a reasonable cause defence and does not turn on the preparer’s good faith. It requires procedures that are both well designed and routinely followed, and a failure that was isolated — so the second or third failure of the same kind in a season defeats it by its own terms, and no amount of good intention rescues a firm whose process is sound on paper but not in use.

The firm rule cuts the other way and is generous by design. A firm is liable only on one of three fault findings, so a well-run firm whose individual preparer fails on one return is not automatically exposed. But the second limb — failing to establish reasonable and appropriate procedures — is a standing obligation rather than a per-return one, and a firm with no due diligence process is liable across every return its preparers get wrong.

Four benefits, four penalties

A preparer files a return using head of household filing status and claiming the earned income credit, the child tax credit and the American opportunity credit. No Form 8867 is completed and no worksheets or computation records exist for any of them.

Analysis. Four separate penalties. Reg. § 1.6695-2(a)(1) applies the penalty to the head of household determination and to each applicable credit, and the regulation's own examples confirm the count. There is no annual maximum on § 6695(g), so this arithmetic does not stop at a cap. On the current amount, one return's exposure exceeds most engagement fees several times over.

The question that was asked but not written down

A client's intake sheet shows two nephews living with her all year and no income of her own beyond a small Schedule C. The preparer, suspicious, telephones and satisfies himself that the arrangement is genuine, then files claiming the EIC. He makes no note of the call.

Analysis. The inquiry was the right one and it fails anyway. Reg. § 1.6695-2(b)(3)(i) requires the preparer to contemporaneously document in the files any inquiries made and the responses to those inquiries. An undocumented inquiry cannot be distinguished from no inquiry, and the knowledge requirement is not satisfied. The substantive answer being correct does not save the file.

Isolated, or the third this season

A firm has a written due diligence checklist, trains on it annually, and reviews a sample of files each week. On one return in March the Form 8867 was completed but the supporting documents were never scanned. The IRS proposes a penalty.

Analysis. This is what Reg. § 1.6695-2(d) is for: procedures reasonably designed and routinely followed, and a failure that is isolated and inadvertent. The weekly sampling is evidence of "routinely followed", which is the limb firms most often cannot prove. Had the same omission occurred on three returns, "isolated" would fail on its face and the exception would be unavailable however good the checklist.

Traps

Per benefit, not per return. Head of household plus three credits is four determinations.

No annual cap. Section 6695(g) is outside the caps that limit § 6695(a) to (e).

Inquiries must be documented contemporaneously. Asking is not enough.

A nonsigning preparer has the duty too, discharged by giving the completed Form 8867 to the signer.

The exception has two limbs and needs both. Good procedures plus an isolated, inadvertent failure — and it is unavailable to a firm penalised under the firm rule.

Retention runs from the latest of four dates, not from the return's due date.

The credit for other dependents counts. It lives in § 24(h)(4), and § 6695(g)(2) names § 24 as a whole — but it is easy to miss because no source spells it out.

How this has changed

The regulation began as an EIC-only rule in T.D. 8905 (65 FR 61269, 17 October 2000) and has widened in stages. T.D. 9799 (81 FR 87446, 5 December 2016) extended it beyond the EIC to the child tax credit, the additional child tax credit and the American opportunity credit, effective for tax years beginning after 31 December 2015 and returns prepared on or after 5 December 2016. T.D. 9842 (83 FR 55635, 7 November 2018) added head of household filing status, effective for tax years beginning after 31 December 2017 and returns prepared on or after 7 November 2018 — the only one of the four with a later start date, which matters on any older file. Section 6695(h) has indexed the amount for returns filed in calendar years beginning after 2014, so the figure moves every year.

Exam focus

The four benefits and the four requirements, in both cases as lists you can recite. That the penalty is per benefit and that § 6695(g) has no annual maximum. The three delivery rules for Form 8867 — e-filing signer, paper signer, nonsigning preparer. The knowledge standard and the contemporaneous documentation it demands. The two limbs of the exception, and the three alternative grounds of firm liability. Expect a computation question counting penalties on one return.

Check yourself

1. A return claims head of household status, the EIC and the CTC, with due diligence failed on all three. The number of IRC 6695(g) penalties is: (A) One, because it is one return (B) Three, one per determination (C) One, capped annually (D) Two, filing status not counting Answer: B. Reg. § 1.6695-2(a)(1).

2. A nonsigning tax return preparer satisfies the Form 8867 requirement by: (A) Filing it with the IRS directly (B) Providing the completed form to the signing preparer for inclusion with the filed return (C) Retaining it in the file (D) Nothing; the duty falls on the signer alone Answer: B. Reg. § 1.6695-2(b)(1)(i)(C).

3. A preparer telephones a client to resolve an apparent inconsistency, is satisfied, and files. No note is made. The knowledge requirement is: (A) Satisfied, the inquiry having been made (B) Not satisfied, because inquiries and responses must be contemporaneously documented (C) Satisfied if the answer was correct (D) Inapplicable to telephone inquiries Answer: B.

4. The exception in Reg. 1.6695-2(d) requires the preparer to show: (A) Reasonable cause (B) Both that normal office procedures are reasonably designed and routinely followed, and that the failure was isolated and inadvertent (C) That the client misled the preparer (D) That the credit was ultimately allowable Answer: B, and it is unavailable to a firm penalised under the firm rule.

5. A firm employing a penalised preparer is itself liable: (A) Automatically (B) Only if management participated or knew, the firm failed to establish reasonable procedures, or it disregarded its own procedures through willfulness, recklessness or gross indifference (C) Only if it is a partnership (D) Never Answer: B. Reg. § 1.6695-2(c).

Change log

2026-08-18Initial publication from IRC § 6695(g), (h) and Reg. § 1.6695-2.