Although available tax credits and deductions abound, going overboard with them or miscalculating them can land you in trouble should the IRS decide to audit you. The IRS does not publicize exactly what triggers an audit -- and some returns are indeed audited at random -- but in general, having a very unusual set of numbers, such as a large earned income tax credit coupled with a high salary -- might serve as a red flag. For this reason, it's important that you take care to claim only those credits to which you're entitled.
What the EITC Is
The EITC is a tax credit designed for low- and moderate-income taxpayers. Your income must fall below certain limits to qualify. For example, if you're married and have one child, you can't have earned more than $36,052 in the 2011 tax year. Your unearned income is limited to $3,150, and you must additionally receive at least some income from an employer, from self-employment, or in exchange for performing any job or service.
The EITC Is Refundable
One of the most attractive aspects of the EITC is that it's refundable. If you claim a credit that exceeds the amount of taxes you owe, the IRS will send you a check for the difference. Because the credit can result in the IRS owing you money instead of the other way around, the government monitors EITC claims, especially if the figures on your tax return seem to be unusual.
The EITC Is Difficult to Calculate
It's easy to miscalculate the amount of EITC you're entitled to. The IRS is aware of this: it admits having overpaid EITCs to about one in every four taxpayers who claim it. EITCs fluctuate depending on each taxpayer's individual circumstances. The amount of your credit can go up or down depending on the number of children you have, whether you're married or single, and how much you earn. Many taxpayers no doubt make honest mistakes when calculating these factors. They don't necessarily intend to claim something to which they're not entitled. They just calculate wrong. Nevertheless, if an audit results, the IRS will still impose consequences.
Another Common Audit Flag
Taxpayers who have children from other relationships are the most likely to make errors. The more children you have, the greater your EITC will be. However, the rules for qualifying children are complicated. You're not entitled to claim the EITC just because you pay child support, or even because you claim your child as a dependent. Your child must actually live in your home at least six months out of the year. The IRS checks returns against the Federal Case Registry, a national database that keeps track of child support cases and identifies custodial and non-custodial parents. If your child lives with you only five months out of the year and you claim the EITC, it's possible that an audit could be triggered. You may also trigger an audit if your ex files a return claiming the EITC for the same child.
If You're Audited
If the IRS audits you and it turns out you claimed too much of an EITC, you'll have to pay back the difference, along with possible interest and penalties. Even if you claimed an EITC correctly, you'll have to substantiate your claims if you are audited. You may have to prove your custodial situation with your child, or provide income documentation to back up your earnings claims. If the IRS takes back your credit, you'll have to file a special form with your next tax return if you want to try to claim the EITC again. Depending on the circumstances, you may also have to wait either two years or ten years before you're eligible for the EITC again, depending on the seriousness of your mistake and whether it was deliberate.
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