The IRS does not need a tip to open a tax preparer investigation. It needs a pattern. Every paid-preparer return carries a preparer tax identification number (PTIN), and when returns filed under one PTIN show statistically unusual credits or refund rates, the preparer — not just the clients — becomes the target. For New Mexico’s small-market preparers serving working families in Albuquerque’s South Valley, immigrant communities in Las Cruces, and ranching country to the east, a PTIN-level anomaly triggers trouble on two fronts: compounding per-return civil penalties and a criminal track running in parallel. The preparer’s clients get pulled in too. This post addresses both audiences.
How does the IRS decide to investigate a tax preparer?
Preparer investigations begin with data, not door knocks. The IRS matches third-party information returns — Forms W-2, 1098, and 1099-K — against filed returns, then scores each return under the discriminant index function (DIF), which compares it to statistical norms for similar filers. A high DIF score on one return means little. But aggregated across a PTIN — one preparer’s clients disproportionately claiming the earned income credit, or reporting Schedule C losses that zero out tax — the pattern puts the preparer’s number on a list.
Much of it is invisible to the preparer: revenue agents audit a sample of client returns filed under the PTIN, interview those taxpayers, and may summons bank records before ever contacting the preparer. By the time an examination notice arrives, the Service often holds a statistical case built from dozens of client files — and in New Mexico, where one storefront may serve much of a community’s EITC-eligible filers, those sample audits sweep local families into examination before anyone understands why.
What civil penalties can the IRS assess against a tax return preparer?
The core preparer penalty statute is 26 U.S.C. § 6694. Section 6694(a) imposes the greater of $1,000 or 50 percent of the fee derived from the return for an understatement caused by an unreasonable position — generally, an undisclosed position lacking substantial authority. Section 6694(b) escalates to the greater of $5,000 or 75 percent of the fee for willful conduct or reckless disregard of rules. Both apply per return — the book of business is the multiplier.
The volume penalties live in 26 U.S.C. § 6695. Most — unsigned returns, unfurnished copies, unretained client lists — are modest and capped annually. The dangerous one is § 6695(g), the due-diligence penalty covering the earned income credit, the child tax credit, the American opportunity credit, and head-of-household status: $650 per failure for returns filed in 2026 under Rev. Proc. 2024-40, with no annual cap.
The arithmetic is sobering. A Las Cruces preparer who files 200 EITC returns in one season without completing and documenting Form 8867 due diligence faces 200 failures at $650 — a $130,000 assessment. And each covered benefit on each return is a separate failure: if those 200 returns also claim the child tax credit and head-of-household status, the count triples to 600 and the exposure reaches $390,000 — on returns that may have generated $150 apiece in fees, before any fraud question is even asked.
How do civil and criminal preparer investigations run in parallel?
First, determine who is asking. An IRS revenue agent signals a civil examination; an IRS Criminal Investigation (CI) special agent means the government is considering prosecution. The tracks are practically intertwined: a civil examiner who develops firm indications of fraud must suspend the exam and refer the matter to CI, so a routine-looking audit can be an eggshell exam — every document produced and explanation offered remains available to prosecutors later.
The criminal workhorse is 26 U.S.C. § 7206(2), which makes it a felony to willfully aid or assist in preparing a return that is false as to any material matter — punishable by up to three years and a $100,000 fine, with each false return a potential count. Separately, 26 U.S.C. § 7216 criminalizes knowing or reckless disclosure or misuse of client return information.
On the civil side, the Department of Justice can sue under 26 U.S.C. § 7407 to enjoin specific conduct — or, where a preparer has “continually or repeatedly” violated the statute, to bar the person from preparing returns entirely — while 26 U.S.C. § 7408 reaches promoter conduct and violations of Circular 230, the practice rules at 31 C.F.R. part 10. The Office of Professional Responsibility can separately censure, suspend, or disbar a practitioner, and the Service can suspend the PTIN itself — a de facto shutdown order.
What should a New Mexico preparer do after an IRS or DOJ contact?
Read every notice for who sent it, what periods it covers, and what it demands, and run a statute-of-limitations analysis before producing anything — the scope of a request telegraphs the government’s theory. Retain counsel before responding: the instinct to clear things up with an examiner is precisely how civil admissions become criminal exhibits.
Counsel should then run a parallel investigation: pull the engagement letters, intake forms, Form 8867 files, and client correspondence for the flagged years; identify the statistical aberrations the Service likely saw; and quantify the potential tax loss, which drives both penalty negotiations and criminal sentencing exposure. Two operational questions need early answers: whether to keep preparing returns — repeating disputed positions can look like willfulness, while a mid-season shutdown harms clients — and how to communicate with clients without violating § 7216 or creating discoverable statements.
Does accountant-client privilege protect you in a preparer investigation?
Far less than most preparers assume. The federally authorized tax practitioner privilege, 26 U.S.C. § 7525, extends attorney-client-style confidentiality to tax advice from CPAs and enrolled agents — but only in noncriminal matters before the IRS and noncriminal federal tax proceedings. Once an investigation turns criminal, the privilege evaporates — and return preparation itself is generally not privileged advice at all.
The solution comes from United States v. Kovel, 296 F.2d 918 (2d Cir. 1961): the defense attorney — not the client — engages an accountant to assist in rendering legal advice, wrapping the accountant’s work inside the attorney’s privilege so the defense can reconstruct returns and quantify tax loss without creating a subpoena target. Critically, the preparer’s longtime accountant is usually the wrong Kovel accountant — that person may already be a fact witness. Counsel who holds both a law license and CPA training can run this analysis inside the privilege from day one.
What should you do if your tax preparer is under IRS investigation?
Your preparer’s misconduct does not excuse your returns. In United States v. Boyle, 469 U.S. 241 (1985), the Supreme Court held that reliance on an agent is not reasonable cause for a late filing — the duty to comply is nondelegable. The signature on Form 1040 is yours, and the IRS routinely audits an expanding circle of a targeted preparer’s clients, often through correspondence audits covering two or three open years at once. Even an innocent victim owes the corrected tax plus interest.
Penalties are a different fight. Boyle distinguishes clerical duties from substantive judgment: you cannot delegate the obligation to file, but good-faith reliance on a professional’s substantive advice can be reasonable cause abating accuracy-related penalties — if you gave the preparer complete information and reviewed the return within your competence. A taxpayer who never saw fabricated Schedule C losses has a genuine defense; one who signed a return showing a business they never operated does not. Get your file back, have the flagged years independently reviewed, and if returns went unfiled, address that before the IRS does — the firm’s guide to unfiled tax returns in New Mexico maps that path. And do not let the preparer who caused the audit represent you in it.
| Authority | Conduct | Exposure | Who bears it |
|---|---|---|---|
| § 6694(a)/(b) | Unreasonable position; willful or reckless conduct | Greater of $1,000/50% of fee; $5,000/75% of fee, per return | Preparer |
| § 6695(g) | EITC/CTC/AOTC/HOH due-diligence failures | $650 per failure (2026 filings), no annual cap | Preparer |
| § 7407 / § 7408 | Repeated violations; Circular 230 breaches | Injunction up to a total bar from preparing returns | Preparer |
| § 7206(2) | Willfully aiding false returns | Felony: 3 years and $100,000 per count | Preparer |
| Circular 230 / OPR; PTIN action | Practice misconduct | Censure, suspension, disbarment; PTIN suspension | Preparer |
| Audit adjustments and accuracy penalties | Incorrect returns filed under targeted PTIN | Tax, 20% penalty, interest across multiple years | Client |
Frequently Asked Questions
Will I be audited if my tax preparer is under IRS investigation?
Quite possibly. The IRS builds preparer cases by auditing samples of returns filed under the preparer’s PTIN, expanding the sample when it finds problems. Clients commonly face correspondence audits covering multiple open years and remain liable for corrected tax and interest even when the errors were entirely the preparer’s doing.
Can I avoid penalties by blaming my tax preparer?
Sometimes — but only penalties, not the tax. Under United States v. Boyle, the duty to file and pay is nondelegable. Good-faith reliance on a professional’s substantive advice can abate accuracy-related penalties if you gave the preparer complete information and had no reason to know the return was wrong.
What is a Kovel arrangement and why does it matter?
A Kovel arrangement is an engagement in which a defense attorney hires an accountant to assist in providing legal advice, extending attorney-client privilege to the accountant’s analysis. It matters because the § 7525 practitioner privilege does not apply in criminal matters.
How much is the EITC due-diligence penalty in 2026?
For returns filed in 2026, the § 6695(g) penalty is $650 per failure. Each covered benefit on each return is a separate failure, and there is no annual cap, so one high-volume season can produce six-figure exposure.
Should a preparer keep filing returns while under investigation?
Get counsel’s input immediately. Continuing to file returns with the positions under examination can supply evidence of willfulness, while stopping abruptly harms clients. Many preparers tighten intake and documentation, decline high-risk returns, and continue compliant work while the matter proceeds.
How North Star Law Firm Can Help
North Star Law Firm handles preparer penalty examinations, due-diligence audits, and parallel IRS investigations for clients across New Mexico — Albuquerque, Santa Fe, Las Cruces, and beyond — and represents taxpayers audited because of their preparer’s conduct. Phillip Zagotti, JD/CPA, represents New Mexico taxpayers before the IRS and the U.S. Tax Court under Circular 230; his combined legal and accounting background allows privileged reconstruction of the numbers driving these cases. The firm provides IRS audit defense, help with unfiled tax returns, and broader federal tax defense strategy. If the IRS or DOJ has contacted you — as a preparer or as a client — contact North Star Law Firm for a free consultation.