Claiming the Earned Income Tax Credit? Be Prepared to Substantiate Earned Income

This post originally appeared on Forbes.EITC

Most taxpayers are – or should be – aware of the need to substantiate deductions claimed on a tax return. If you deduct business expenses, charitable donations and other expenses and are chosen for an audit, you may need to provide canceled checks, receipts or credit card statements to prove that you incurred the expense. A recent Tax Court case illustrated a situation in which a taxpayer needed to prove that she earned all of the income she reported on her tax return.

According to court records, Myriam Cadet filed a federal income tax return for 2012 and reported net income of $17,190 earned from her business of selling used clothing at a flea market. Although Cadet was married, her husband lived in Haiti and transferred funds to her monthly to support herself and their three children. On her return, Cadet claimed Head of Household filing status and personal and dependent exemptions for herself and the three children.

Although she reported self-employment tax of $2,111 and withholding from wages of $14, Cadet also claimed an Earned Income Tax Credit (EITC) of $5,891 and additional child tax credits of $2,085, resulting in a claim for a refund of an overpayment of $5,879.Cadet testified that all of her transactions were in cash and she did not maintain any written records of her purchases or sales of clothing. The only documentation she provided was one receipt indicating she paid $689 for booth rental.The IRS determined that Cadet had failed to substantiate her earned income and recalculated earned

Cadet testified that all of her transactions were in cash and she did not maintain any written records of her purchases or sales of clothing. The only documentation she provided was one receipt indicating she paid $689 for booth rental.The IRS determined that Cadet had failed to substantiate her earned income and recalculated earned income of $1,565, including $925 of wages reported on a W-2 and $640 income from her clothing sales after taking into account the deductible portion of her self-employment tax. They then disallowed the entire additional child tax credit and all but $79 of the earned income credit that Cadet had claimed for 2012, reducing her overpayment to $638.

 

The IRS determined that Cadet had failed to substantiate her earned income and recalculated earned income of $1,565, including $925 of wages reported on a W-2 and $640 income from her clothing sales after taking into account the deductible portion of her self-employment tax. They then disallowed the entire additional child tax credit and all but $79 of the earned income credit that Cadet had claimed for 2012, reducing her overpayment to $638.

Because both the EITC and the additional child tax credit are based on the taxpayer having earned income, taxpayers claiming those credits may be asked to provide proof of the existence and amount of that income.

Because Cadet could not provide evidence of her income from the sale of clothing, the IRS took the position, and the Tax Court agreed, that it appeared Cadet might be grossing up her business income enough to maximize her utilization of refundable credits. It’s a good reminder, especially to anyone claiming refundable credits, that deductions aren’t the only items on your tax return that may need to be substantiated.

[Photo credit: Lending Memo]

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How to Protect Your Child From Identity Theft

This post originally appeared on Forbes.

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The Federal Trade Commission (FTC) is hosting Tax Identity Theft Awareness Week from January 25 – 29, with a series of events aimed at educating consumers. Tax identity fraud occurs when someone uses your Social Security number to get a tax refund or a job. You’re probably aware of your own risk of tax identity theft. Data breaches at T-Mobile, Scottrade, CVS, Anthem, and even the IRS itself ranked as some of the largest of 2015, and those were just a few large enough to make national news. With so much of our personal information online comes the risk of that information winding up in the wrong hands. You take measures to guard your own personal and financial data, but are you protecting your kids?

While parents may have a system of alerts and credit checks to protect their own credit, kids are easier targets. Identity theft on a child can go undiscovered for years. You may not become aware until your child is turned down for a job or loan due to a horrible credit history.

Be Aware

Signs that your child’s credit history has been compromised include:

  • your child is denied a bank account or driver’s license
  • credit card and loan offers addressed to your child
  • collection calls or bills addressed to your child
  • being turned down for government benefits because the Social Security number is already in use
  • a notice from the IRS that your child owes income taxes or was claimed as a dependent on another return

Don’t immediately panic if you receive a credit card offer in your child’s name. Financial companies sometimes mistakenly send credit card offers to a minor but be on alert if you suddenly start receiving a lot of mail that would typically be for adults.

Check Your Child’s Credit Report

It isn’t as easy to check a child’s credit report as it is to check your own. You’ll have to mail or fax in documentation proving you are the parent or guardian. Experian, Equifax, and TransUnion each have their own process for checking a minor’s credit report.

If you request a credit report for your child and none is available, their social security number and other information haven’t been used. Because creditors don’t always report to all three agencies, if you do suspect identity theft you’ll want to check all three.

You probably won’t want to go through the hassle of checking all three bureaus annually but if you suspect your child has been a victim, you should check as soon as possible. It’s also a good idea to check your child’s credit report close to his or her 16th birthday. If there has been any fraud, you will have time to correct it before your child applies for a job or loan or needs to rent an apartment.

You may be able to freeze your child’s credit. A credit freeze keeps your credit report from going out to potential lenders unless you take steps to temporarily lift the freeze prior to applying for credit. Some states will only allow you to place a freeze on your child’s credit if they’ve already been victimized, but others have laws requiring the credit bureaus to create an empty credit file for your child just so you can freeze it. Again, you’ll have to order the credit freeze with all three credit bureaus separately.

Be Cautious About Releasing Sensitive Information

As a parent, the best thing you can do to protect your child is to be cautious when divulging your child’s information.

  • Don’t give out your child’s social security number. If a business asks for your child’s social security number, ask if you can provide an alternate identifier – perhaps just the last four digits of their social security number.
  • Shred all documents, even school records and seemingly benign information with your child’s name on it. Thieves can use that data to gain access to more information.
  • Make sure that any activity your child participates in uses the information properly and handles it with care. If a sports team requires a birth certificate for sign up, ask how the information is stored and what safeguards are in place during storage.
  • Teach your children to keep personal information private when they are online. Social networking sites can be a goldmine for identity thieves.

If you discover your child has been a victim of identity theft, file a police report and get a copy of the report. Contact each of the three credit reporting bureaus to notify them of the fraud, and follow their advice for next steps.

Three Things You May Need In Order to E-File Your Tax Return

This post originally appeared on Forbes.

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http://www.401kcalculator.org/

 

The IRS and certain states are putting safeguards in place to combat tax-related identity theft and refund fraud for the 2016 tax filing season, which opened yesterday. These safeguards may mean supplying more information in order to verify your identity and delays in processing refunds, but are necessary in order to curb fraudulent refunds, which totaled $5.8 Billion from 2011 through October 2014. If you intend to e-file your federal or state income tax return, here are a few things to keep in mind.

The IRS has partnered with certain large payroll service providers, such as ADP and Paychex,  to include a 16-digit verification code on some Form W-2s. The code will appear in a separate, labeled box. If the field is populated, the IRS is asking preparers to enter the code. The code is not needed for paper filed returns.

For this filing season, the code is being used only to test the capability of verifying the authenticity of W-2 data. The IRS has stated that omitted and incorrect W-2 verification codes will not delay the processing of the return, as they are just being used to see whether the codes are useful in evaluating the integrity if W-2 information.

 You May Need Your Driver’s License Number to File in Some States

You do not currently need a driver’s license number to file your federal return but certain states request driver’s license numbers or state ID numbers on electronically filed state income tax returns.

In most states, providing a driver’s license number is voluntary. Returns can be e-filed for taxpayers without either a driver’s license number or a non-driver ID (such as a child or invalid) without being rejected for e-filing, but all e-filed individual returns that lack a number may be manually reviewed to determine if more information is needed to verify the taxpayer’s identity before a refund is issued (i.e. it will take longer to receive your refund if you don’t provide a driver’s license or ID number).

However, some tax preparers are reporting that tax software companies are requiring driver’s license numbers in order to e-file in certain states. There may be some kinks until the IRS, states, and tax software providers get these new requirements worked out.

If You Were a Victim of Identity Theft Last Year, You May Receive a PIN From the IRS

The IRS mails an Identity Protection PIN (IP PIN) to taxpayers who were victims of tax-related identity theft. The IP PIN is a six digit number that must be input in order to e-file returns with an identity theft indicator on the account. Unfortunately, taxpayers received IP PIN letters with an incorrect year listed. If you received an IP PIN on a CP01A notice dated January 4, 2016, the IP PIN is valid for use on individual tax returns filed in 2016.

Many taxpayers ask about proactively requesting an IP PIN from the IRS to avoid issues with refund fraud. Currently, the IP PIN program is only available to taxpayers who were victims of tax-related identity theft, taxpayers who filed federal returns last year as residents of Florida, Georgia, or the District of Columbia, or taxpayers who received an IRS letter inviting them to “opt-in” to get an IP PIN.