Did you know that about 25% of Earned Income Tax Credit returns are paid in error? According to the IRS, the three most common errors account for more than 60% of erroneous claims. Professional tax preparers have a legal responsibility to perform due diligence when clients claim certain tax credits, including the EITC. The IRS requires you to:
- Evaluate the information received from the client
- Apply a consistency and reasonableness standard to the information
- Make additional reasonable inquiries when the information appears to be incorrect, inconsistent, or incomplete
- Document additional inquiries and the client’s response
It’s vital that you know these three common EITC errors and how to handle them to ensure your clients’ returns are correct and protect yourself from legal action.
1. Claiming a child who is not a qualifying child
This error occurs when taxpayers claim a child who does not meet all four tests for a qualifying child:
The child must be related to the taxpayer. (Note that adoptions, pending adoptions, foster placements from an authorized agency must meet this requirement with proper documentation.)
The child must meet one of the following age requirements: 1) under 19 and younger than the taxpayer claiming them 2) under 24 and a full-time student for at least five months of the year and younger than the taxpayer claiming them 3) any age and permanently disabled.
The child must live in the same home as the taxpayer for at least half the year.
The child cannot be claimed for the EITC if they file a joint return with another person, such as their spouse.
All four requirements must be met to be a qualifying child under the EITC.
If you are not confident in the information provided by the client, you are required to make additional inquiries to determine if they meet the requirements. If you or your client are unsure if the child meets all the requirements, Form 886-H-EIC covers additional details and documents you may be required to provide to the IRS to prove the child’s eligibility.
2. Married taxpayers incorrectly filing as single or head of household
Taxpayers can make this mistake intentionally or unintentionally. The tax law defining head of household and exceptions is complex, and many mistakenly believe they qualify. Or they may knowingly file incorrectly as single or head of household to claim more EITC.
Again, you may need to ask additional questions of your client. These questions can sometimes feel uncomfortable and probing (i.e., “When did you separate from your husband? How long have you lived apart?”). If you’re uncomfortable asking the necessary probing questions to provide due diligence, consider using Form 886-H-HOH to help you ask your questions. It outlines what a taxpayer must document to support HOH filing status and can help your client understand that you are only asking these questions because the IRS requires it.
3. Income reporting errors
Taxpayers sometimes over-report or under-report income to qualify for or maximize the amount of EITC. Common errors on Schedule C’s include claiming large losses to bring income down, bogus or inflated Schedule C income, and not claiming all business expenses or claiming no expenses.
This article up to date for tax year 2021 (returns filed in 2022).