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Changes to Tax Credits in 2016

(posted: January 25th, 2016)

Congress made changes to various tax credits in the middle of December in a bill call the Consolidated Appropriations Act, 2016, which you may not be aware of

In particular, the child tax credit, the American opportunity credit, and the earned income tax credit (EITC) now have new restrictions, new penalties, and new due diligence requirements for practitioners.

Child Tax Credit

As tax professionals know, Sec. 24 provides a $1,000 tax credit to a taxpayer whose income is below certain thresholds for each qualifying child under age 17, and Sec. 24(d) makes portions of the credit refundable.

Under the new legislation, the threshold amount for determining whether a taxpayer is eligible for the refundable (or additional) Sec. 24 child tax credit will be a fixed $3,000 (not indexed for inflation).

Retroactive claims: The new rules prohibit retroactive claims of the child tax credit, so taxpayers cannot file returns claiming the credit using an ITIN issued after the year for which the credit is being claimed. The effective date of this provision allows taxpayers to file their 2015 returns without regard to this rule if the returns are timely filed (Section 205 of the Act).

New penalties: Before the new legislation was enacted, there was no penalty for taxpayers who recklessly or fraudulently claimed the child tax credit. Now, individuals who fraudulently claimed the credit are barred from claiming the credit for 10 years. If they are found to have claimed the credit with reckless or intentional disregard of the rules, the bar applies for two years (Sec. 24(g) as amended by Section 208(a)(1) of Division Q of the Act).

IRS claim processing: The Act gives the IRS math error authority, which allows it to disallow improper credits without a formal audit if the taxpayer claims the child tax credit in a period in which he or she is barred from doing so (Sec. 6213(g)(2)(P)). For taxpayers claiming the additional child tax credit after Dec. 31, 2016, the IRS will have additional time to review the refund claim and will not be required to pay the refund before the 15th day of the second month following the close of the tax year (Sec. 6402(m)).

Due diligence: Effective for tax years beginning after Dec. 31, 2015, return preparers will be subject to due-diligence requirements for returns that claim the child tax credit, much as they are currently subject to for returns that claim the EITC. The exact requirements have not yet been defined by the IRS, but it is expected that they will be similar to those for the EITC, which include:

  • submitting a completed checklist with the return
  • completing a prescribed worksheet
  • maintaining records for three years that document their due diligence
  • not knowing, or having reason to know, that any information that was used is incorrect

The penalty for failure to comply with the due diligence requirements will be $500 for each failure (Sec. 6695(g)).

American Opportunity Tax Credit

The American opportunity credit permits taxpayers to claim a credit of up to $2,500 for each eligible student for qualified educational expenses (Sec. 25A) and phases out over certain adjusted gross income amounts.

This credit was originally intended to be effective only from 2009 to 2017 (Sec. 25A(i)). The new regs make the credit permanent.

Reporting requirements: Taxpayers are now required to report the employer identification number of the educational institution to which the taxpayer makes qualified payments under the credit (Sec. 25A(i)(6)(C)). The Act made changes to the reporting requirements for higher education institutions, which will be required to report only qualified tuition and related expenses actually paid on Form 1098-T, Tuition Statement. Both of these provisions are effective for expenses paid after Dec. 31, 2015, for academic periods starting after that date.

Retroactive claims: Similar to the child tax credit, the new law says taxpayers cannot file returns claiming the American opportunity credit using an ITIN issued after the year for which the credit is being claimed. The effective date of this provision allows taxpayers to file their 2015 returns without regard to this rule if the returns are filed by the due date (Section 206(b)(2) of the Act).

New penalties: Individuals are barred from claiming the American opportunity credit for 10 years if they fraudulently claim the credit, and for two years if they are found to have claimed the credit with reckless or intentional disregard of the rules (Sec. 25A(i)(7)).

IRS claim processing: The IRS is given math error authority, which allows it to disallow improper credits without a formal audit if the taxpayer claims the credit in a period in which he or she is barred from doing so (Sec. 6213(g)(2)(Q)).

Due diligence: Similar to the new due-diligence requirements under the child tax credit, effective for tax years beginning after Dec. 31, 2015, return preparers will be subject to due-diligence requirements for returns that claim the American opportunity credit, and these requirements are also as yet unknown,The penalty for failure to comply with the due diligence requirements will be $500 for each failure (Sec. 6695(g)).

Earned income tax credit

The EITC grants a refundable credit to low- or moderate-income taxpayers with earned income. The maximum earned income amount and the credit percentage that apply to a taxpayer are based on the taxpayer's number of qualifying children.

Higher credit amount: The credit rate varies based on how many children a taxpayer has, with the highest amount being 45% for three children. This was originally a temporary provision that was scheduled to expire in 2018, but the Act has made the 45% credit permanent.

The Act made the $5,000 increase to the credit phaseout threshold amounts for married taxpayers filing jointly permanent, and continues the annual inflation adjustments for years after 2015.

Retroactive claims: Similar to the other credits described above, taxpayers now cannot file returns claiming the credit using a Social Security number issued after the year for which the EITC is being claimed. The effective date of this provision allows taxpayers to timely file their 2015 returns without regard to this rule. (Unlike the other credits, taxpayers must have Social Security numbers to claim the EITC, not merely an ITIN (Sec. 32(m)).)

IRS claim processing: For taxpayers claiming the EITC after Dec. 31, 2016, the IRS will have additional time to review the claim and will not be required to pay the refund before the 15th day of the second month following the close of the tax year (Sec. 6402(m)).

For how these changes may affect you, or any other questions, please Contact Us

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