What Happens If You Wrongly Claim Tax Credits?

Claiming tax credits can reduce your tax bill, but errors—intentional or not—can lead to serious consequences. The IRS scrutinizes credit claims, and mistakes may result in additional taxes, penalties, or even audits. Even if unintentional, errors can have financial repercussions.

Understanding the consequences of wrongly claiming a tax credit can help you avoid costly mistakes and stay compliant with tax laws.

Disallowances and Added Tax Liability

If the IRS disallows a tax credit, it removes it from your return, increasing your tax bill. This means you may owe more than expected since the credit would have reduced your liability or increased your refund. The IRS typically notifies taxpayers of a disallowance through a CP79 or CP2000 notice, explaining the adjustment and any additional amount due.

The financial impact depends on the credit and amount claimed. For example, if you incorrectly received the Earned Income Tax Credit (EITC) for $3,995 in 2024 but were ineligible, that amount is added back to your taxable income. If you’re in the 12% tax bracket, this could result in an additional $479 in taxes owed, not including penalties or interest. Refundable credits, such as the Child Tax Credit (CTC), can create an even larger repayment obligation since they can generate refunds beyond what was paid in taxes.

Disallowed credits can also affect future eligibility. If the IRS determines the claim was made recklessly or without reasonable basis, it may impose a two-year ban on claiming the credit. In cases of fraud, this restriction extends to ten years. To reinstate eligibility, taxpayers must file Form 8862, but approval is not guaranteed.

Penalties and Interest Charges

Filing a return with an improperly claimed credit can result in penalties beyond repaying the amount owed. The IRS imposes accuracy-related penalties when an error causes an underpayment. This penalty is typically 20% of the underpaid tax if the mistake is due to negligence or disregard of tax rules. For example, if an incorrect credit claim led to an additional $2,000 in taxes owed, the penalty could add another $400.

If the IRS determines the claim was fraudulent, penalties are far more severe. The fraud penalty is 75% of the underpayment, meaning a $5,000 understatement due to a fraudulent claim could result in an additional $3,750 penalty. Fraud cases may also lead to criminal charges, with potential fines and imprisonment for tax evasion.

Interest charges further increase the total amount owed. The IRS calculates interest daily on unpaid taxes and penalties, using the federal short-term rate plus 3%. If the base rate is 4%, the total interest rate would be 7%. Interest accrues from the original due date of the return until the balance is fully paid, compounding over time.

Adjusting Your Return

Correcting an incorrectly claimed tax credit requires filing an amended return using Form 1040-X. This form allows taxpayers to correct errors by providing the correct figures and explanations for the changes. The IRS processes amended returns separately from original filings, which can take up to 20 weeks. During this period, interest continues to accrue on any outstanding balance.

If an incorrect claim led to an overpayment and the IRS issued a refund that should not have been received, repaying the excess amount as soon as possible can prevent additional interest charges. If the refund has already been spent, setting up a payment plan through the IRS Online Payment Agreement tool can help manage repayment. The IRS offers short-term payment plans for balances under $100,000 and long-term installment agreements for larger amounts, though setup fees may apply.

Submitting an amended return voluntarily can demonstrate good faith compliance, which may reduce penalties. While this does not eliminate the possibility of further review, it can lessen scrutiny compared to waiting for the IRS to identify the issue first.

Effects on Future Filings

An incorrect credit claim can have lasting consequences. Taxpayers flagged for improper claims may face additional scrutiny in future filings. The IRS tracks filing patterns, and a history of errors can result in delayed processing times, increased requests for supporting documentation, and a higher likelihood of income verification checks before refunds are issued.

For those who frequently claim refundable credits, such as the Additional Child Tax Credit (ACTC), prior mistakes can lead to extra compliance measures. The IRS may require additional forms, such as Form 8867 (Paid Preparer’s Due Diligence Checklist), even for self-prepared returns. Some taxpayers may also need to verify their identity through the IRS Identity and Tax Return Verification Service (ID.me) before receiving refunds, especially if past returns included questionable claims.

Potential Audits or Reviews

Incorrectly claiming a tax credit increases the likelihood of an audit. While not every mistake leads to a full examination, certain errors raise red flags. The IRS uses automated systems and manual reviews to detect inconsistencies, and taxpayers with a history of disallowed credits or amended returns may be at greater risk of selection.

Audits can take different forms, ranging from correspondence audits—where the IRS requests documentation by mail—to more in-depth field audits conducted in person. If a tax credit claim is questioned, the IRS may ask for proof of eligibility, such as income records, dependent verification, or business expense documentation. Failure to provide adequate evidence can result in the loss of the credit and additional penalties. If the IRS suspects intentional misrepresentation, the audit could expand to multiple years of returns, increasing potential liabilities.