Due Diligence Checklist for Paid Preparers Under Circular 230
Circular 230 (31 CFR Part 10) requires practitioners who prepare tax returns or provide tax advice to exercise due diligence in determining the correctness of oral or written representations made to the Department of the Treasury. Section 10.22 sets the standard: a practitioner must not willfully, recklessly, or through gross incompetence sign a return or advise a client to take a position that lacks a reasonable basis. Meeting that standard requires documenting the research behind every substantive position you take, and a repeatable checklist makes the difference between consistent compliance and ad hoc guesswork.
What Circular 230 Actually Requires
Three sections of Circular 230 govern practitioner conduct related to return positions and due diligence. Each sets a different standard with different consequences.
Section 10.22: Diligence as to accuracy. This is the broadest requirement. It applies to all written or oral representations to the Treasury Department, not just return positions. A practitioner must exercise due diligence in preparing or assisting in the preparation of returns, in determining the correctness of representations, and in determining the correctness of oral or written representations to the IRS or Treasury. The standard is not perfection. It is the absence of willful, reckless, or grossly incompetent conduct.
Section 10.34: Standards with respect to tax returns and documents. This section sets specific standards for return positions:
| Position Type | Standard Required |
|---|---|
| Undisclosed position | Reasonable basis |
| Disclosed position (Form 8275 or 8275-R) | Reasonable basis + adequate disclosure |
| Tax shelter or reportable transaction | More-likely-than-not |
A practitioner may not sign a return or advise a client to take a position on a return unless the position has at least a reasonable basis. If the position does not meet the substantial authority standard and is not disclosed, the practitioner may be subject to penalties under both Circular 230 and IRC 6694.
Section 10.35: Competence. A practitioner must possess the necessary competence to engage in practice before the IRS. Competence requires the knowledge, skill, thoroughness, and preparation necessary for the matter at hand. If a question is outside your area of competence, Section 10.35 requires you to either obtain the necessary knowledge or refer the matter to someone who has it.
Circular 230 vs. IRC 6694 Preparer Penalties
These are separate enforcement regimes that can apply simultaneously to the same conduct.
| Framework | Enforced By | Consequence | Standard |
|---|---|---|---|
| Circular 230 | Office of Professional Responsibility (OPR) | Censure, suspension, or disbarment from IRS practice | Willful, reckless, or grossly incompetent |
| IRC 6694(a) | IRS (monetary) | Greater of $1,000 or 50% of income derived | Unreasonable position |
| IRC 6694(b) | IRS (monetary) | Greater of $5,000 or 50% of income derived | Willful, reckless, or intentional |
A single return position that lacks adequate research can trigger a monetary penalty under IRC 6694 and a disciplinary proceeding under Circular 230. The monetary penalty hits your bank account. The disciplinary proceeding can end your ability to practice before the IRS.
The Due Diligence Checklist
This checklist applies to any substantive return position or written tax advice. Not every engagement requires every step. Simple positions with clear statutory support (standard deduction amounts, filing status rules) need less documentation than aggressive positions in gray areas.
Step 1: Identify the tax position. State the position in one sentence. Which IRC section(s) does it rely on? What is the factual basis? Writing this down forces clarity. If you cannot state the position precisely, you are not ready to advise on it.
Step 2: Research applicable authority. Start with the statute. Then check Treasury Regulations and Revenue Rulings for the specific provision. For fact-intensive questions, check Tax Court opinions, including memorandum opinions that address similar situations.
Step 3: Check for adverse authority. This is the step most practitioners skip, and it is the step that matters most. Search for authority that contradicts the proposed position. Revenue Rulings that reach the opposite conclusion. Tax Court opinions that rejected a similar argument. IRS nonacquiescences to favorable court decisions. If adverse authority exists, you need to assess whether it is distinguishable from your client's facts. If it is not distinguishable, the position may not meet the reasonable basis standard.
Step 4: Document the research. Record the sources consulted, the analysis performed, and the conclusion reached. Citation-backed research tools make this step easier because the sources are already identified and linked. The documentation should be specific enough that another practitioner could review your memo and understand why you concluded the position is supportable.
Step 5: Assess the confidence level. Based on the authority you've found, determine where the position falls:
- Reasonable basis: roughly a 20% or greater likelihood of success on the merits. This is the minimum for any return position.
- Substantial authority: stronger than reasonable basis, often described as a 40% or greater likelihood. Required for undisclosed positions to avoid accuracy-related penalties under IRC 6662.
- More-likely-than-not: greater than 50% likelihood. Required for tax shelter and reportable transaction positions.
Step 6: Determine disclosure requirements. If the position meets reasonable basis but not substantial authority, consider whether disclosure on Form 8275 (general positions) or Form 8275-R (positions contrary to regulations) is appropriate. Disclosure protects both the client (from accuracy-related penalties under IRC 6662) and the preparer (from penalties under IRC 6694).
Step 7: Retain the research memo. File the memo with the engagement workpapers. If the return is examined three years later, you need the memo to demonstrate the due diligence you exercised at the time the position was taken. Reconstructing your research after the fact is not due diligence.
Common Circular 230 Violations
The Office of Professional Responsibility (OPR) publishes disciplinary actions in the Internal Revenue Bulletin. Common patterns in recent enforcement:
Failing to research before advising. Taking a position based on experience or general knowledge without checking current authority. Tax law changes frequently. A position that was correct last year may be wrong this year due to new legislation, regulations, or court decisions.
Relying on client representations without verification. Section 10.34(d) allows practitioners to rely in good faith on information furnished by a client. But that reliance has limits. If the information is implausible, inconsistent, or contradicted by documents in the practitioner's possession, reliance is not reasonable.
Signing a return with a position below the reasonable basis threshold. This is a clear Section 10.34 violation. If the authority supporting a position does not meet reasonable basis, the position should not appear on the return unless the practitioner advises the client against it and the client insists (in which case, the practitioner should consider whether to withdraw from the engagement).
Failure to maintain competence. Taking on work in an area where the practitioner lacks the knowledge required by Section 10.35, without obtaining the necessary training or consultation. Knowing what research tools your credential requires is part of maintaining competence.
How Documentation Protects You
In a Circular 230 disciplinary proceeding, the burden of proof is on the IRS. The government must establish the violation by a preponderance of the evidence. A documented research memo is the single strongest piece of evidence that due diligence was exercised.
Without documentation, the defense amounts to testimony about what you recall thinking at the time. That is not persuasive. With documentation, you can show the specific authority you consulted, the analysis you performed, and why you concluded the position was supportable. The memo doesn't need to be long. It needs to be specific.
Consider the difference:
Weak: "I believed the position was correct based on my experience."
Strong: "I researched the position under IRC 199A(d)(2) and Treas. Reg. 1.199A-5(b)(2)(xi). The client's business does not fall within the listed specified service activities. I reviewed the preamble discussion in T.D. 9847, which addresses the scope of the SSTB categories, and found no adverse authority in published Revenue Rulings or Tax Court opinions. The position meets the substantial authority standard."
The second version demonstrates due diligence. The first does not.
The Bottom Line
Due diligence under Circular 230 is not optional. It is the baseline professional standard for anyone practicing before the IRS. Section 10.22 applies to every return you sign and every representation you make. The checklist above makes the process repeatable and the documentation defensible.
For CPA firms building consistent research standards, a firm-wide checklist ensures every practitioner meets the same bar regardless of experience level. The investment in documented research pays for itself the first time a position is challenged.
Tax Orator indexes Circular 230 alongside Treasury Regulations, Revenue Rulings, Tax Court opinions, and the full authority hierarchy. The Discovery plan gives you 10 free queries to test whether the tool surfaces the right authority for your due diligence research.