Question: Katherine is a U.S. citizen living in El Salvador. She purchased a personal residence in that country over 12 years ago and has lived there as her primary residence ever since. Katherine sold her home in May of 2024. The home was originally purchased for $220,000; she made $50,000 in improvements and sold it for $300,000. The sale results in a small gain.

Katherine mentions that she has not yet received Form 1099-S, Proceeds from Real Estate Transactions, but she will receive one. Would Katherine be able to take advantage of the §121 exclusion and how would that be reported on her tax return since the home was in a foreign country?

Answer: Yes, if all the §121 requirements are met, the exclusion can be used on a foreign residence. Section 121 and Reg. §1.121-1 do not explicitly require the residence to be in the United States.

Therefore, as long as Katherine satisfies the ownership and use tests required under §121, she is eligible to exclude the gain from the sale of her principal residence, regardless of its location in a foreign country.

Katherine will report the sale of her foreign principal residence and the exclusion on Form 8949, Sale and Other Dispositions of Capital Assets, and Schedule D (Form 1040), Capital gains and Losses, just as if it was sold in the U.S.

Taxpayers who seek professional tax preparers’ assistance expect the preparer will know how to prepare their returns properly. So does the IRS. To help maintain that standard of professionalism, the IRS has required paid tax preparers who submit a federal income tax return claiming the earned income tax credit (EIC) and other credits to file Form 8867, Paid Preparer’s Due Diligence Checklist, with the return filed after Dec. 31, 2011.

In addition to the EIC, the form is required when a paid preparer prepares a return claiming any of the following:

• Child tax credit (CTC)
• Additional child tax credit (ACTC)
• Credit for other dependents (ODC)
• American opportunity tax credit (AOTC)
• Head of household filing status (HOH)

While Congress put the due diligence requirements in place to reduce the number of individuals who were fraudulently claiming the specified tax credits, submitting Form 8867 along with those claims also provides protection to paid preparers. The form includes a checklist that demonstrates to the IRS that the preparer performed their due diligence if the agency should question whether a taxpayer is entitled to the claimed credits. They also protect clients from the delays or penalties that may result from mistakes.

The penalties a paid preparer may face for not submitting a required Form 8867 can be steep. For 2025, the IRS can assess a $635 penalty for each failure to submit the form as required, up to $2,540 per return or claim. The IRS may also assess due diligence penalties against a preparer’s employer should they not comply with due diligence requirements. If a Form 8867 has been submitted and all or a portion of the claimed credits are disallowed, the client must pay back any amount refunded in error plus any additional assessments.

Penalty exceptions

According to regulations (Reg. §1.6695-2), the due diligence penalty will not be applied to a paid preparer with respect to a tax return or claim for refund if they can demonstrate to the IRS’s satisfaction that, when considering all of the facts and circumstances, both of the following are true:

• The return preparer’s normal office procedures are reasonably designed and routinely followed to ensure compliance with the due diligence requirements
• The failure to meet due diligence requirements with respect to a return or claim for refund was an isolated and inadvertent event

Special rule for firms

Additionally, the regulations explain that a firm employing a tax return preparer who is subject to a due diligence penalty will also be subject to a penalty if any of the following are true:

• One or more principal managers of the firm or branch participated in or knew of the failure to comply prior to the time the return was filed
• The firm did not establish reasonable and appropriate procedures to ensure compliance with due diligence requirements
• The firm disregarded reasonable and appropriate compliance procedures through willfulness, recklessness or gross indifference in the preparation of the tax return or claim for refund for which the penalty was imposed

If you have additional questions about a preparer’s Form 8867 due diligence requirements, NATP has the following on-demand webinars:

• Due Diligence and the Tax Office (included with NATP membership!)
• EIC Due Diligence and Enforcement
• Ethics and Due Diligence Requirements of Tax Preparation (included with NATP membership!)

Question: Diego is an active-duty military member stationed in Germany since last March. His spouse and children (ages 3 and 6) remained in Florida in the home they own together. This is Diego’s first deployment, and his spouse is not sure what filing status to use since Diego has not lived in their home for the last 10 months.

The couple does not want to lose any credits they could be eligible for but are concerned because Box 1 of Diego’s Form W-2, Wage and Tax Statement, only shows $8,000 even though he is employed by the military full time and received other nontaxable pay. The couple’s only other source of income comes from the small business Diego’s spouse owns, which nets $19,000 annually after expenses. Neither Diego nor his spouse attend school currently, but they do have eligible childcare expenses for both children. They are not separated and do maintain their home equally. Which filing status is more beneficial for Diego and his family?

Answer: Married filing jointly is the correct filing status to ensure that Diego and his spouse can claim all the credits they are eligible for, such as the child and dependent care credit. In this case, even though Diego has been out of the home the last six months of the year, his spouse does not qualify for head of household filing status since they maintained the household together. The married filing separately filing status would not benefit the couple because they would not be able to claim certain credits.

Diego and his spouse would also qualify for the earned income credit (EIC) based on their combined adjusted gross income (AGI) of $27,000. For tax year 2024, $62,688 is the maximum AGI eligible for couples filing jointly to claim EIC with two children. Box 1 of Diego’s Form W-2 is smaller than the total pay he received for the year because his taxable income does not include special pay allowances. Those amounts will be listed in Box 12 and can be found on his military leave and earnings statement as well.