Due Diligence notes · TAX & CREDIT LAB

Due Diligence notes

I also hear tax pros say, “My software makes me compliant.”

And then they find out the hard way that the software is only covering Form 8867 requirements, not the knowledge requirement.

Putting notes in your software is not enough if you are not addressing additional inquiries.

Another big misconception is thinking that asking every client the same questions make you compliant.

It’s not about asking questions.

It’s about asking the right clarifying questions.

Notes are a hot topic right now because many tax pros are receiving warning letters and going through Due Diligence examinations.

Additional inquiries are required when information is:

1. Inconsistent

2. Incomplete

3. Does not make sense

4. Conflicts with documents

Examples of when additional inquiries are required:

1. Relatives claiming dependents who are not their child

2. Different addresses on documents

3. Dependents with different last names

4. Low income but claiming Head of Household

5. Business losses with no clear funding source

Let me explain why additional inquiries must be different for every client, especially when you are dealing with Schedule C clients.

No two businesses are the same.

Every client’s income and expenses will look different based on their industry, how they operate, and how they spend money in their business.

Because of that, the additional questions you ask one client will not automatically apply to the next client.

As tax pros, we all have basic qualifying questions that we ask every Schedule C client. That part is normal and expected. But Due Diligence does not stop there.

Here’s where additional inquiries come in.

You may have a client whose income and expenses mostly look reasonable for their profession, but you notice one expense that is unusually high and another expense that is unusually low compared to what you normally see in that industry.

Even if everything else looks fine, those two items require additional inquiries.

You would need to ask follow up questions to understand:

Why the cell phone expense is so high for that type of business

Why another expense is unusually low

How those amounts were calculated

And whether those expenses are truly business related

Now let’s look at a different client.

You may have another Schedule C client where the income and most of the expenses look reasonable for their profession, but there is one expense listed that is not typically written off in that industry.

In this situation, Due Diligence requires more than just confirming the amount.

You would need to ask:

What the expense is for

How the expense is used in the business

And most importantly, how the expense is ordinary and necessary for that specific industry

This is why additional inquiries can never be one size fits all.

Each client’s situation tells a different story, and your questions and notes must reflect that specific story.

This is how you meet the knowledge requirement.

This is how your notes support why the client qualifies.

And this is how you protect yourself during a Due Diligence examination.

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