If anyone knew how the IRS determined which individual tax returns for audit, we’d do everything we could to stay under the radar and not be selected for further review.

The IRS audits less than one percent of all tax returns, which is good news, but there’s no way to guarantee you’ll be among the 99 percent who are exempt from an IRS’ audit, but there are several steps you can take to minimize your chances of.

A recent report stated that improper claims for the Earned Income Tax Credit continue to cost the government more than $10 billion a year, and there’s little the IRS can do to eliminate the problem using their existing methods.

The EITC’s complex rules generate higher error rates by taxpayers and paid preparers. It’s also vulnerable to fraudulent claims, despite stringent safeguards that have been built in over the years.

Every year, the IRS conducts 500,000 EITC audits as part of a broader enforcement strategy, and EITC claims are twice as likely to be audited as other tax returns.

The IRS claimed in 2011, that error rates on EITC filings were running from 23 to 28 percent. While they may be overstating the actual level of overpayment, the overpayment level is clearly substantial. The IRS is concluding a new study of EITC overpayments from 2012, which may change the overpayment percentages. But the reality is EITC tax credits are beyond the comprehension of most taxpayers, if only because it’s hard to know if they qualify and why. But, EITC credits are valuable because they provide meaningful savings on a filer’s overall tax contribution and in some cases lead to a tax refund.

The Earned Income Tax Credit (EITC) was established for low to moderate income taxpayers to offset the burden of Social Security taxes and provide an incentive to work. Most tax experts recommend their filers explore their eligibility for receiving the EITC. It is an overlooked credit all too often. If you’re not earning a whole lot of money but are working, you can end up getting back more money than you pay in.
[blockquote author=”Thomas Vorhies, financial planner and author, Escondido, California”]If you didn’t get an EITC last year, that doesn’t mean you won’t get one this year. The economy has been rough on a lot of people. Your tax situation can change in a year. Tax laws change. You should check your status every year.[/blockquote]
The following are five rules to maximize your EITC (if you qualify) and eliminate the chance of filing a fraudulent tax form.

1. Eligibility is limited to low-to-moderate income earners

The general eligibility rule for the EITC is fairly straightforward. Taxpayers must file as individuals or married filing jointly. If married, you, your spouse and your qualifying children must have valid Social Security numbers. You must also be 25 or older but younger than 65. The breakdown for 2013 tax year is as follows:

Earned Income and adjusted gross income (AGI) must each be less than:

  • $46,227 ($51,567 married filing jointly) with three or more qualifying children
  • $43,038 ($48,378 married filing jointly) with two qualifying children
  • $37,870 ($43,210 married filing jointly) with one qualifying child
  • $14,340 ($19,680 married filing jointly) with no qualifying children

Tax Year 2013 maximum credit:

  • $6,044 with three or more qualifying children
  • $5,372 with two qualifying children
  • $3,250 with one qualifying child
  • $487 with no qualifying children

Investment income must be $3,300 or less for the year.

Thomas Vorhies, a financial planner based in Escondido, California, strongly promotes the benefit of the Earned Income Credit to qualifying taxpayers, emphasizing that a credit, unlike a deduction, is “like additional income. It’s basically additional support from the federal government.”

A married couple with three children and adjusted gross income of $51,567 or less could receive up to $6,044. An individual who earns $14,340 and has no children may receive up to $487. There are many variations in between that affect eligibility and it behooves you to file electronically. Those taking the traditional paper and pencil route might miss opportunities.

Although the EITC typically is considered a “low income” credit, a spouse working as the sole income earner of the family, perhaps on an hourly or contract basis, may also qualify.

A married couple could work 2,080 hours in a year, at $23 an hour — what most people would not consider to be necessarily low income — and still qualify for the tax credit.

2. Self-employed can qualify, too

Many filers — especially self-employed individuals — fail to take advantage of credits because they think they are ineligible. Many self-employed people miss out because they don’t think they are eligible. Most self-employed filers don’t think they qualify for it, but they do.

The IRS considers all income that is earned eligible for the credit. That includes wages, salaries, tips and other taxable employee pay, as well as union strike benefits and long-term disability benefits received prior to minimum retirement age. It also covers net earnings from self-employment if you own or operate a business, and gross income received as a statutory employee — an independent contractor under common law rules.

Here is a list of earned income sources to help you determine if you might qualify for EITC:

Single Filers

[custom_table style=”3″]

Type of return Maximum eligible earinings (dollars) Maximum credits (dollars) Begin Phase-outs (dollars) Break even points (dollars) Credit rate (percent) Phase-out rate (percent)
Childless 6,370 487 7,970 14,340 7.65 7.65
One child 9,560 3,250 17,530 37,870 34.00 15.98
Two children 13,430 5,372 17,530 43,038 40.00 21.06
Three / More children 13,430 6,044 17,530 46,227 45.00 21.06

[/custom_table]

Married couples filing jointly

[custom_table style=”3″]

Type of return Maximum eligible earinings (dollars) Maximum credits (dollars) Begin Phase-outs (dollars) Break even points (dollars) Credit rate (percent) Phase-out rate (percent)
Childless 6,370 487 13,310 19,680 7.65 7.65
One child 9,560 3,250 22,870 43,210 34.00 15.58
Two children 13,430 5,372 22,870 48,378 40.00 21.06
Three / More children 13,430 6,044 22,870 51,567 45.00 21.06

[/custom_table]
3. Investment income can disqualify you

Income derived from investments, whether it is stock dividends, rental properties or inheritance, disqualifies you if it is greater than $3,300 in one year.

For example, if your mother died and left you $500,000, which you’re saving for retirement, but the bank sent a 1099 for the interest, you would not qualify for the Earned Income Credit even though you didn’t touch the money.

Other disqualifying incomes include child support, retirement income, Social Security benefits, unemployment benefits and alimony. Pay received for work while in prison also does not count toward the credit.

4. Eligibility fluctuates

You should verify your EITC eligibility every filing year. Just because you didn’t get it last year doesn’t mean you won’t get it this year. The ongoing economic problems have changed many tax payers’ situations. Your tax situation can change in a year. Tax laws change. You should check every year. Status changes can include a new job, unemployment, loss of an annual bonus, a change in marital status, or a change in a spouse’s employment situation.

If you plan to file your own taxes, go slowly and provide all information correctly. A taxpayer’s status — dependent versus not — marital status, income changes (to) higher or lower and number of dependents will all potentially affect the EITC eligibility.

5. Tax software can help

You should consider using a qualified tax software system to maximize all of the available credits, especially the earned income credit. Many popular software packages are available online for download to your computer.

Because the EITC is one of the most lucrative credits available to struggling Americans, it is also an area most rife with fraud from unscrupulous tax preparers.

There’s a lot of abuse reported in low-income areas where preparers often scam the system by not filing or declaring income to get (a customer) the EITC, or they will hide certain income or claim a lot of deductions. In many cases, an individual will pay exorbitant fees because an accountant promises a big payday.

Someone who is making $20,000 a year will pay $500 for an accountant who promises to get them a lot of money. But $4,000 or $5,000 in taxes and penalties because of errors or fraud isn’t worth it.

Electronic tax programs offer an advantage because — assuming you place checks in all the right boxes — they ensure that you receive the credits to which you are entitled.

Here is a list of the four most popular brands from PC Magazine:

TurboTax Premier Online – TurboTax is rated four and one-half stars – $49.99

H&R Block At Home Deluxe Online – H&R Block is rated four stars – $44.95

Tax Act Ultimate Bundle – Tax Act is rated four stars – $17.99

Complete Tax Premium – Complete Tax is rated three and one-half stars – $29.95

IF You Lose Your EITC

It simply does not pay to be dishonest with the Internal Revenue Service. The IRS may reduce or even revoke your access to the Earned Income Tax Credit for a number of years if the agency determines you have committed fraud or flouted the rules to obtain the credit.

If you have been found to have recklessly disregarded the rules to increase the credit, the IRS may prohibit you from receiving the credit for two years, after which you would have to file a special request form to apply for the right to reclaim the credit, and this is hardly assured.

If the IRS determines you have knowingly supplied fraudulent financial information to claim the EITC, it may penalize the filer by disallowing the credit for 10 years.

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