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Taking advantage of child refundable tax credits can help you cut your tax bill, but before you claim a credit, you need to determine your eligibility. In addition, new requirements effective for 2016 are designed to help the IRS clamp down on fraudulent claims. All three credits are partially or totally refundable, meaning that they can reduce a taxpayer's liability to zero and cause excess credit to be refunded to the taxpayer, making them a popular target for fraudsters.
The Earned Income Tax Credit (EITC) is a refundable tax credit for working low-income taxpayers. The credit is based on the amount of the taxpayer's work income, along with total income and number of children. For 2016, this credit can be worth as much as $6,269.
Common errors when claiming EITC include claiming a child who does not meet all the qualifying child tests, more than one person claiming the same child, Social Security number or last name discrepancies, over- or under-reporting income or expenses, and incorrect filing status (such as filing single when married).
The Child Tax Credit (CTC) is a tax credit of $1,000 for each of the taxpayer's qualifying dependent children. A portion of the credit not used to offset the taxpayer's liability is refundable. The refund is based on the number of children in the family and on the taxpayer's earned income—this credit may be phased out for taxpayers with higher incomes.
The American Opportunity Tax Credit (AOTC) is a college tuition credit for low-income families. It provides a credit for each eligible student equal to 100% of the first $2,000 spent and 25% of the next $2,000 spent on college tuition and related expenses (books, supplies, and equipment the student needs for a course of study). The maximum credit is $2,500 and 40% is refundable; the credit is phased out based on income.
Common errors when claiming AOTC include claiming a credit for a student that did not attend a qualified educational institution, claiming a credit for eligible education expenses not paid or not considered as paid, claiming a credit for unqualified expenses (such as room and board or insurance), and claiming a credit for an eligible student for more than four years (AOTC is only available for four years for each eligible student).
Education credits cannot be claimed unless the taxpayer includes the employer identification number of the college, university, or vocational school. This number is found on Form 1098-T, the Tuition Statement issued by the educational institution. The new rules require that the taxpayer (or the dependent student) receive a 1098-T form to claim the credit.
Refunds that include the EITC or CTC will be purposely held until February 15, with funds released no earlier than February 27. This delay gives the IRS time to verify the validity of the credit claims, and match them against taxpayer income amounts and information returns that verify college tuition. Self-prepared returns do not have any due diligence checks, so the IRS will hold refunds for even longer and request verification information from many taxpayers who choose to self-prepare.
Expanded due diligence requirements apply to tax preparers also—preparers must complete and submit Form 8867, Paid Preparer's Due Diligence Checklist. Tax preparers must be able to demonstrate tangible proof of eligibility for credits, or face a $510 fine per credit (up to $1,530 per return), which is why we ask clients to complete our Dependency Disclosures Worksheet.
If a taxpayer improperly claims any of these credits, either fraudulently or recklessly, he or she will be banned from claiming that credit for a period of time. The disallowance period is 10 years for fraud, and 2 years for reckless or intentional disregard of rules and regulations.