Key Takeaways
- Practitioners must exercise due diligence in preparing, approving, and filing documents.
- Due diligence applies to all communications with the IRS and representations to clients.
- May rely on client-provided information in good faith, but must make reasonable inquiries.
- Cannot ignore obvious red flags or inconsistencies.
- Failure to exercise due diligence can lead to OPR disciplinary action.
- Technological competency is part of due diligence.
Due Diligence (Section 10.22): The Foundation of Practice
Why This Matters for the Exam
Due diligence is the foundational standard for all practitioner conduct under Circular 230. It applies to everything you do before the IRS—not just return preparation. The exam tests whether you understand when due diligence applies, what it requires, and when you can rely on client information.
Exam Note: For the May 2025 - February 2026 testing window, you are tested on Circular 230 as in effect through December 31, 2024 (Tax Year 2024).
Expect at least 3-4 questions on due diligence requirements.
What Is Due Diligence?
Due diligence means exercising reasonable care and competence in all professional activities. Under Circular 230 Section 10.22, practitioners must exercise due diligence in:
| Activity | Description |
|---|---|
| Preparing documents | Tax returns, claims, submissions to IRS |
| Approving documents | Reviewing and signing off on filings |
| Filing documents | Submitting to the IRS |
| Determining correctness | Verifying accuracy of information |
| Oral representations | Verbal statements to IRS or clients |
| Written representations | Letters, memos, advice to clients |
The Standard of Care
Due diligence does not require perfection. The standard is:
- Reasonable care: Take steps a competent practitioner would take.
- Reasonable inquiry: Ask questions when something appears incomplete or incorrect.
- Good faith: Act honestly and without intent to deceive.
Key Point: You need not be ultimately correct—but you must have exercised reasonable care in reaching your conclusions.
Reliance on Client Information
Practitioners may rely on information provided by clients, but with limits:
| When You Can Rely | When You Cannot Rely |
|---|---|
| Information appears complete and correct | Information is obviously incomplete |
| Client has no history of providing false info | Red flags suggest information is false |
| No reason to doubt the information | Inconsistencies with other known facts |
| You made reasonable inquiries | You failed to ask obvious questions |
The "Red Flag" Test: If something doesn't look right, you have a duty to inquire further. Ignoring obvious problems is a due diligence failure.
Examples of Due Diligence Failures
| Scenario | Due Diligence Failure? |
|---|---|
| Claiming deduction without any documentation | ✅ Yes |
| Accepting client's verbal estimate without verification | ✅ Yes (for material items) |
| Filing return with obvious math errors | ✅ Yes |
| Not asking about foreign accounts despite large wire transfers | ✅ Yes |
| Accepting documented expenses at face value | ❌ No (reasonable reliance) |
Technological Competency
Modern practice requires technological competency as part of due diligence. Practitioners must:
- Understand technology used in tax practice (software, e-file, portals).
- Protect client data from cybersecurity threats.
- Stay current with IRS electronic systems and requirements.
Consequences of Due Diligence Failure
| Consequence | Description |
|---|---|
| OPR Referral | Office of Professional Responsibility investigation |
| Censure | Public reprimand |
| Suspension | Temporary loss of practice rights |
| Disbarment | Permanent loss of practice rights |
| IRC §6694 Penalties | Civil preparer penalties |
Real-World Scenario
Scenario: A client provides you with a list of business expenses totaling $50,000. The list has no receipts or documentation. The client says, "Just trust me."
- Due Diligence Failure? Yes, if you claim the deduction without any verification.
- What Should You Do? Request documentation. Explain that you cannot claim deductions without support. If the client refuses, consider declining the engagement.
On the Exam
Expect 3-4 questions on due diligence, typically:
- Scope Questions: "When must practitioners exercise due diligence?"
- Reliance Questions: "When can a practitioner rely on client-provided information?"
- Red Flag Questions: "Which situation requires further inquiry?"
- Consequences Questions: "What can result from a due diligence failure?"
The key is to remember: All IRS matters, reasonable care, can rely in good faith, but must inquire about red flags.
Under Circular 230, when must practitioners exercise due diligence?
Can a practitioner rely on client-provided information?
What should a practitioner do when client information appears incomplete?