3 Tax Credits That Could Lead to an Audit

By Markets Fool.com

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Finishing your taxes feels great, but that relief can quickly turn to panic if you find out you're being audited. While tax forms can be confusing, particularly for those who take advantage of many tax credits and deductions, it makes sense to take a bit of extra time to ensure everything is done correctly. With that in mind, we asked three Motley Fool tax experts to highlight some tax credits that could lead to an IRS audit if done incorrectly.

Dan Caplinger
One of the most confusing areas of tax law involves tax breaks for educational expenses. The biggest problem is that several different provisions offer either tax credits or deductions for certain expenses, and it can be difficult to understand how they interact.

For example, the American Opportunity Tax Credit offers up to $2,500 in tax credits for students who are in their first four years of college. It pays 100% of the first $2,000 in educational costs and 25% of the next $2,000, maxing out once you've spent $4,000 on education. At the same time, another break called the Lifetime Learning Credit offers a 20% credit on up to $10,000 in educational expenses. The rub, though, is that any given student can only claim one of those two credits in any given year -- even if they spent far more than the $14,000 that would theoretically be necessary to max out both credits.

Similar issues come up with the tuition and fees deduction, which allows taxpayers to deduct up to $4,000 in educational expenses. Again, you can't take this deduction in the same year you take one of the two credits for the same student.

If you slip up and try to double-dip, you're almost guaranteed an audit. The better course is to stick with the provision that does you the most good.

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Dan Dzombak
Taxpayers should also be careful when claiming the Earned Income Tax Credit. Based on the IRS' most recent data, 11.3% of math errors on tax returns in 2013 were related to this credit.

The EITC is a refundable tax credit for low- to moderate-income working taxpayers to raise their incomes without discouraging work, and it's principally designed to help those with children. The credit phases in and quickly plateaus, then phases out as your income rises. The fact that it's refundable means that even if you didn't owe any taxes, you can still get money back from this credit.

The tax credit varies in size depending on your income level and the number of qualified children you can claim as dependents. The income limits for tax-year 2014 are as follows:

Number of Qualifying Children Single/Head of Household Married Filing Jointly
0 $14,590 $20,020
1 $38,511 $43,941
2 $43,756 $49,186
3 or more $46,997 $52,427

Source: IRS.

To claim the EITC you must meet the following qualifications:

  • Working
  • Older than 25 but younger than 65
  • Not claimed as a dependent on someone else's return
  • Investment income cannot exceed $3,350

Aside from general math errors, it can also be easy to slip up on the definition of a qualifying child, particularly if you're divorced. So be sure to carefully read the IRS' rules regarding qualifying children and qualifying children of more than one person.

Repayments on the first-time homebuyer tax credit are creating many headaches for taxpayers, having accounted for over 9% of math-related errors in 2013.

One point of confusion is that the law changed from 2008 to 2009. Prior to 2009, the first-time homebuyer tax credit had to be repaid in 15 annual installments. Those who used the credit in 2009 and onward do not have to repay it, save only in a few unlikely circumstances.

For those who must repay the credit, one hiccup is that the repayments accelerate if you sell your home. If you sell before repaying in full, all the remaining installments are generally due in the tax year of the sale, up to the amount of gain on the sale, according to the IRS website. Likewise, in the event the home you purchased is converted into a rental or a second home, the remaining balance is also due in the current year.

Save yourself a potential headache by checking with the IRS before you file. The IRS conveniently created online accounts for everyone who claimed the credit when they purchased a home. These accounts detail the amount you have paid back to date, the amount of the credit you originally received, and the annual repayments that are still due.

The article 3 Tax Credits That Could Lead to an Audit originally appeared on Fool.com.

Dan Dzombak is a long-term investor and writes about happiness. He has no position in any stocks mentioned.Dan Caplinger has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.