The nation’s Taxpayer Advocate wants taxpayers to know there’s a downside to having too much of a good thing. In this case, it refers to making excessive or improper claims to qualify for a number of tax credits.

The downside is that the IRS has the ability to ban a taxpayer from claiming any of the credits for two years if the credit was improperly claimed through the taxpayer’s “improper or intentional disregard of rules and regulations.”

If the credit was claimed fraudulently, the ban could last up to 10 years.

Taxpayers penalized with such a ban are prohibited from claiming the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), the American Opportunity Tax Credit (AOTC) and the credit for other dependents (ODC) during the ban period.

The Internal Revenue Manual (IRM) lays out the procedures to impose a ban in IRM 4.19.14.7.1, (12-11-2019). 2/10 Year Ban - Correspondence Guidelines for Examination Technicians (CET).

TAS wants taxpayers to avoid a ban

Rules for claiming the refundable credits are similar—but not the same. The Taxpayer Advocate Service says knowing these rules can keep taxpayers out of trouble:

• Allowable EITC and CTC is a function of a taxpayer’s earned income or “modified adjusted gross income” and the number of “qualifying children” in the household.
• A “qualifying child” is a person who, among other things, meets age requirements, bears a specified relationship to the taxpayer, and has the same principal residence as the taxpayer for more than half the year.
• The EITC and CTC age requirements differ, and disabled dependents (regardless of age) may meet the definition of a qualifying child for the EITC, but not for the CTC.
• The amount of allowable AOTC:
  • is a function of “modified adjusted gross income” (like the CTC); and
  • is only partially refundable (like the CTC but unlike the EITC).
• The ODC is available for certain “dependents” who are not eligible to be claimed for the CTC.

The Taxpayer Advocacy Service says the residency requirement trips up many taxpayers who incorrectly claim a child who does not actually qualify as their dependent.

Here’s a list of documents the IRS says taxpayers could use to verify residency in an audit: What to Do If the IRS Audits Your Claim.

What can taxpayers do if the IRS seeks a ban?

Taxpayers who are faced with a possible ban on these refundable credits still have rights. Let’s say a taxpayer has one or more of the credits disallowed on a 2020 return, and the IRS wants to impose a ban.

The first time the IRS conducts an audit and seeks a ban, they are required to speak to the taxpayer before moving forward. The IRS also must record the manager’s approval of the ban on its Correspondence Examination Automation Support (CEAS) database.

From there, the TAS says there are four basic options available to taxpayer:

1. Agree: A taxpayer may agree to the proposed additional assessment and ban.
2. Disagree: If a taxpayer does not agree and does not seek a conference with the IRS Independent Office of Appeals (or does not prevail in an Appeals conference), the IRS will issue a statutory notice of deficiency.
3. Tax Court: Upon receipt of a statutory notice of deficiency, a taxpayer may seek review of the IRS’s determination to impose additional tax in the United States Tax Court. However, it’s not clear whether the Tax Court has jurisdiction to consider whether the ban was properly imposed. I recommended that Congress clarify the Tax Court’s jurisdiction in ban cases in the 2020 and 2021 National Taxpayer Advocate Annual Report to Congress Purple Books.
4. Audit Reconsideration: Once the ban has been imposed, the IRS sends Notice CP 79A, We Denied One or More of the Credits Claimed on Your Tax Return and Applied a Two-Year Ban, reciting that it denied one or more credits claimed on the return and applied a two-year ban. A taxpayer can then ask the IRS for audit reconsideration of the audit findings. (See IRM 4.13.3.17, Audit Reconsiderations EITC 2/10 Year Ban, for those procedures.) In a typical audit reconsideration, the taxpayer believes that the audit resulted in an inappropriate increase in tax liability and requests the IRS to reevaluate the audit findings. Audit reconsideration is an informal process and a highly effective tool for taxpayers and should be considered as an option to resolve the issue. There is no specific time limit for requesting audit reconsideration, but there are deadlines for requesting refunds.

Bans are sometimes launched from shaky ground

In 2019, the Taxpayer Advocate Service published the Annual Report to Congress Research Study. In it, they examined the cases of 3,831 taxpayers who received credit bans as a result of IRS audits of 2016 tax returns. Here are the TAS's findings:

• 54 percent of the time, the bans lacked the required managerial approval;
• 84 percent of the time, the attached Form 886-A did not explain why the ban was imposed; and
• 61 percent of the time, the IRS did not speak to taxpayers in the sample being audited for the first time before imposing a ban, as required by the IRM.

Lastly, the NTA recommends a public education campaign to ensure taxpayers—and tax professionals—are aware of the rules associated with the credits and how they are reported.

Sources: Erroneously claiming certain refundable tax credits could lead to being banned from claiming the credits; Study of Two-Year Bans on the Earned Income Tax Credit, Child Tax Credit, and American Opportunity Tax Credit.