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The Consequences of Earned Income Credit Abuse
February 25, 2011
A couple of weeks ago I received a call from a single mother who needed some help. This mother had no filing requirement, so she had decided to let the father of her child claim the child on his tax return. When the father went to file his taxes, however, the return was rejected. The reason is that someone had already filed a tax return claiming the child as their own. When I spoke to the mother, she was fairly certain who had inappropriately and illegally claimed her child, but was not certain. Regardless, that person absolutely should not have claimed the child, but did so anyway. Why would this happen? For that person, the reward for claiming the child and taking the deductions and credits outweighed the risk. A single person with adjusted gross income below $35,535 and a qualifying child could potentially receive as much as $3,050 in refundable Earned Income Tax Credits (commonly referred to as “EITC” or “EIC”). For those not familiar with refundable credits, the simple explanation is that a refundable credit is a credit which first reduces tax liability, and if any credit remains after zeroing out that tax liability, the rest essentially becomes cash in hand. Combine this with other credits such as the Additional Child Tax Credit, a person with one child could be looking at a tax refund in excess of $4,000. This is serious money, and a major reason why the earned income tax credit is the most widely abuse credit available to individuals. For those who qualify, the EITC is a legitimate way for families with low-to-moderate incomes to get by in any economic climate. Whether times are good or bad, there will always be people who struggle to make ends meet. However, these tough times have also resulted in an increased number of fraudulent EITC filings. The current climate may lend to desperation, but it is important to know the consequences of erroneously claiming these tax credits. If someone’s EITC is denied due to the reckless or intentional disregard for its qualifying rules, the penalty, in addition to the mandatory repayment of the credit with penalties and interest, is the disallowance of claiming the EITC for the next two tax years.1 If someone’s EITC is denied due to fraud (i.e., you knew you should not claim it but did so anyway), then the disallowance period could last as much as ten years.2 I realize that in today’s society the desire for immediate gratification far outweighs the desire for long-term planning. Just keep in mind that the IRS is focused on weeding out and preventing EITC abuse and should be taken seriously. Real World Scenario – The father whose return was originally rejected is now forced to submit his return in the mail. He will claim the child and write a small memo stating that he is rightfully entitled to claim the child as his dependent, not the perjured filer who the claimed the child earlier. Since the child’s social security number will pop up on two separate returns, both returns will be flagged for review. Once the father proves his case, the next step for the IRS is to adjust the perjured filers return, disallow the credit, and ask for an explanation. The perjured filer will owe the credit back with penalties, interest and depending on the answer, a disallowance of two to ten years for claiming the credit. Does that sound worth it to you?