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Due Diligence Checklist for Tax Preparers

Due Diligence Checklist for Tax Preparers

As tax professionals, we understand that it can be a meandering process to go from documents to declarations, fraught with potential pitfalls. Because of this, a robust due diligence strategy isn't just a matter of regulatory compliance—it's an embodiment of the commitment to your clients' financial well-being and professional integrity as a tax preparer. In this article, we'll walk hand in hand through many of the elements included in a successful due diligence checklist, imparting not just procedural knowledge but also the underlying principles that shape a tax preparer into a trusted advisor.  

The Fundamentals 

In tax preparation, due diligence refers to the thoroughness and care with which tax professionals gather, verify, and analyze information from clients to accurately calculate their tax liabilities. It's a deliberate and meticulous approach that ensures no details are missed, with each piece of financial information scrutinized to create a complete and accurate representation of a client's tax situation. 

The due diligence process isn't just a good practice—it's a legal and ethical imperative. As tax preparers, you are entrusted with sensitive financial information and are obligated to handle it with the highest level of integrity. Failing to conduct due diligence can have serious consequences, both for clients and tax professionals. Mistakes or inaccuracies in tax returns can lead to financial penalties, legal actions, and the erosion of your professional reputation. By ensuring accurate and compliant tax filings, tax preparers not only fulfill their obligations but also build trust and rapport with clients, positioning themselves as reliable advisors in their financial journey. 

You can read more about Preparer Due Diligence on the IRS website, as well as find Form 8867 (Paid Preparer’s Due Diligence Checklist) here. Additionally, there are four due diligence requirements that paid tax preparers must meet when preparing returns for clients that claim certain tax benefits, which you can read more about on the IRS website. 

Preparation for Due Diligence  

We’ve outlined some preparatory measures below that will serve as an excellent foundation for your due diligence efforts as a tax preparer.  

  • Document Collection 

The due diligence process begins with the collection of essential documents from clients, which will inform the curation of accurate tax returns. You’ll want to assemble a comprehensive list of required documents, including sources of income, deductions, credits, and any unique financial situations.  

Communicate this list clearly to clients and stress the importance of accuracy and completeness. A well-prepared client will not only streamline the due diligence process but also contribute to the accuracy of the final tax return. In case you need assistance in getting started, check out our blog on Tax Preparer Questions for Clients. 

  • Regulatory Changes 

Given the dynamic nature of the tax industry, regulations, deductions, and credits evolve with each passing year. Staying informed about these changes is a fundamental aspect of due diligence, as with any other area of tax preparation. Leverage reliable resources, such as official government websites, tax publications, and industry forums, ensuring that you dedicate time to pursue continuous education. This proactive approach ensures that your due diligence process is always aligned with the most current requirements, reducing the likelihood of errors due to outdated information. You can find news and updates regarding due diligence on the IRS website. 

  • Client Engagement  

Effective communication with clients is the cornerstone of a successful due diligence process. From the offset, clearly outline your due diligence procedures, explaining the significance of the information you require and how it contributes to their return. By proactively setting expectations and establishing a dialogue, you not only gather accurate information but also build a sense of trust and collaboration with your clients. 

Due Diligence Checklist 

Ideally, this checklist serves as a foundation for supporting your adherence to IRS due diligence guidelines. It's our goal at Drake to help you navigate the intricate processes of due diligence, and support your commitment to accuracy, compliance, and ethical practice every step of the way. You can read more about the consequences of not meeting due diligence requirements here. 

  • Personal Information Verification 

The first checkpoint on our due diligence checklist for tax preparers involves meticulous verification of clients’ personal information. Double-check names, Social Security numbers, addresses, and other identification details; while seemingly a basic measure, even a small error at this stage can lead to future complications or penalties. 

  • Income Sources and Reporting 

Carefully review and cross-reference all forms of income, including wages, self-employment earnings, investments, and rental income. Ensuring accurate income reporting is pivotal in generating an accurate tax return. We recommend staying vigilant for missing information, as well as communicating with your clients to promptly address any discrepancies promptly. 

  • Deductions and Credits Eligibility 

From mortgage interest to educational expenses, uncover all potential deductions and credits applicable to your client's situation, remembering that thoroughness is key. To ensure eligibility for these benefits, gather relevant receipts, statements, and proofs. Navigating deductions and credits accurately can reduce your client's tax burden and showcase your expertise in maximizing their financial well-being. 

  • Foreign Assets and Income 

For clients with international connections, meticulous due diligence includes identifying foreign financial accounts and understanding reporting obligations such as FBAR (Report of Foreign Bank and Financial Accounts). Keep abreast of evolving international tax agreements to ensure that your clients remain compliant across borders. 

  • Business and Self-Employment Compliance 

For clients involved in businesses or self-employment, due diligence requires you to scrutinize business income, expenses, and deductions with meticulous care. You will also want to ensure proper classification of expenses and adherence to regulations, as errors in these areas can raise red flags during audits. In the world of self-employment, due diligence extends to quarterly tax estimates and potential deductions that might not be immediately obvious. 

  • Itemized Deductions Scrutiny 

In terms of itemized deductions, carefully examine each potential deduction, ensuring that your client meets the eligibility criteria and possesses the necessary supporting documentation. From medical expenses to charitable contributions, delve into the details to avoid overstatements or inconsistencies that could trigger audits.  

  • Tax Credits Review 

Tax credits can significantly impact a client's tax liability; we suggest identifying relevant tax credits based on your client's situation, such as the Child Tax Credit, Earned Income Tax Credit, or education-related credits. Verify eligibility criteria and gather documentation to substantiate the claims.  

  • State and Local Tax Considerations 

Tax preparation extends beyond federal regulations, so depending on your client's location, state and local tax considerations become relevant. You will want to familiarize yourself with the intricacies of state tax laws and stay updated on any changes, ensuring a holistic and accurate tax return that aligns with your clients’ complete financial situation. 

Due diligence for tax preparers isn't just an obligation, but a commitment to accuracy, compliance, and professionalism. It’s our goal at Drake to aid and support you with resources you need as a tax preparer to comply and honor the due diligence requirements set forth by the IRS. As we've explored many facets of due diligence, from understanding the fundamentals to providing a comprehensive checklist, we hope you have discovered that the checklist is more than a set of tasks—it's a philosophy that embodies your dedication to your clients' financial well-being. As you implement due diligence best practices into your own firm, you are positioning yourself as a reliable and knowledgeable tax professional. 

Drake Software Blog Team

The Drake Software Blog Team is proud to cover the latest in tax-industry-related news, from tax law and IRS updates to technology and business strategies. If you have questions about an article or just want to reach out to our staff, email comments@taxingsubjects.com.