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EARNED INCOME CREDIT

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Disclaimer This publication is intended for education, to provide accurate and authoritative

information in regards to the subject matter covered. This publication is not intended as

rendering any legal, accounting, or professional service. If legal advice or other expert

advice or service is required, a competent professional should be sought.

The author and affiliated parties are not engaged by this text, any accompanying

electronic media, or lecture in the rendering of legal, tax, accounting, or similar

professional services. While the legal, tax, and accounting issues discussed in this

material have been reviewed with sources believed to be reliable, concepts discussed can

be affected by changes in the law or in the interpretation of such laws since this text was

printed. For that reason the accuracy and completeness of this information and the

author's opinions based thereon cannot be guaranteed. In addition, state or local tax laws

and procedural rules may have a material impact on the general discussion. As a result,

the strategies suggested may not be suitable for every individual. Before taking any

action, all references and citations should be checked and updated accordingly.

Copyright © 2014

by 1040 Education LLC

All rights reserved.

Course materials may not be reproduced or stored in a retrieval system without

prior written permission of the publisher and in no case for profit.

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Course Description The Earned Income Credit (EIC) is a tax credit designed for taxpayers who meet low-income guidelines. It is designed to reduce tax liability and in some cases will allow a taxpayer to receive a refund.

This course will describe the requirements taxpayers must meet in order to qualify for an Earned Income Credit and will

cover associated forms

demonstrate how to calculate earned income

show how to claim an earned income credit

present circumstances where claiming an EIC is prohibited

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Resources

Publication 17-Your Federal Income Tax for Individuals Publication 596-Earned Income Credit

Form 1040: Schedule EIC – Earned Income Credit www.gpo.gov www.irs.gov

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Training Objectives

By the end of this course, you should be able to:

File an EIC claim on a tax return

Calculate earned income

Explain the rules for qualifying children

Identify reasons that taxpayers are ineligible for claiming Earned

Income Credits

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Table of Contents Course Description .......................................................................................................................... 3 Resources ........................................................................................................................................ 4 Training Objectives .......................................................................................................................... 5 Earned Income Credit - § 32 Summary ........................................................................................... 7

2012 Income Guidelines and Maximum Credit Amounts ........................................................... 8 Must Have Earned Income .............................................................................................................. 9 Investment income ........................................................................................................................ 10

Disability Benefits ...................................................................................................................... 11 Unqualified Income § 32(i)(2) ........................................................................................................ 11

Form 2555 or 2555-EZ ............................................................................................................... 13 Must have valid Social Security Number ....................................................................................... 14 Must be a United States citizen OR resident alien for the entire filing year ................................. 16 Qualifying Children – The EIC Nuts and Bolts ................................................................................ 17 Relationship ....................................................................................................................... 17 Age ..................................................................................................................................... 17 Residency ........................................................................................................................... 17 Joint Returns ...................................................................................................................... 17

Additional rules regarding EIC ....................................................................................................... 21 Married Children ....................................................................................................................... 21

Qualifying Children Cannot be Claimed By More Than One Person ............................................. 21 Tiebreaker Rules ........................................................................................................................ 22

Divorced, Separated or Living-Apart Parents (Special Rule) ......................................................... 23 Rules for Taxpayers without Qualifying Children .......................................................................... 24

Dependency ............................................................................................................................... 25 Taxpayer as Qualifying Child ..................................................................................................... 26

Forms 4361 & 4029 ....................................................................................................................... 27 Calculating Earned Income ............................................................................................................ 28

Clergy ......................................................................................................................................... 29 Church Employees ..................................................................................................................... 29 Nontaxable Combat Pay ............................................................................................................ 29

Filing 1040 Forms .......................................................................................................................... 31 EIC Disallowance § 32(k) ................................................................................................................ 31

Form 8862 ................................................................................................................................. 32 Math or Clerical Errors .................................................................................................................. 32 What’s NEW? ................................................................................................................................. 34

Form 8867 ................................................................................................................................. 34

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Earned Income Credit - § 32 Summary

EIC in a nutshell

In order to qualify for an Earned Income Tax Credit, the taxpayer must meet the following criteria: 1) Have earned income a certain threshold 2) Possess a valid social security number 3) Be a U.S. citizen or resident alien for the entire year 4) Not file as “married filing separately” 5) Not have investment income over a certain threshold 6) Not file Form 2555 or Form 2555-EZ (have foreign earned income)

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2014 Income Guidelines and Maximum Credit Amounts

The following table summarizes AGI limitations and maximum EIC credit amounts:

Single AGI Limit

Married, Filing Jointly AGI Limits

Maximum Credit Amounts

no children $14,590 $20,020 $496

one qualifying child $38,511 $43,941 $3,305

two qualifying children $43,756 $49,186 $5,460

three or more qualifying children

$46,997 $52,427 $6,143

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Example

Sally and Bill are married and file jointly with one qualifying child. This past year they earned $46,000, which disqualifies them from claiming the EIC. However, news of a child on the way in the spring means that even if she earns the same amount next year, she may be eligible for the EIC as married taxpayers filing jointly with two qualifying children are subject to higher limits than those with only one child. (However, her sister Sarah, who has three qualifying children already, cannot benefit from the same strategy as limits do not increase for children added to a brood of three.) Community Property Married taxpayers who live in a state with community property laws and qualify to file as head of household under the special rules for married taxpayers who are living apart calculate their AGI a bit differently. In this case, the AGI includes the portion of the taxpayer’s and spouse's wages that are required to be included in gross income.

Must Have Earned Income

In order to qualify for an Earned Income Credit, the taxpayer must have earned income. As is implied in the name of the credit itself, in order to obtain the credit, the taxpayer must have worked and earned income. If the taxpayer is an employee, earned income refers to all of the taxable income that has been received from the employer. (An exception for nontaxable combat pay exists, which will be explained later). If the taxpayer is self-employed, net-earnings is used to calculating earned income.

If the taxpayer is married and filing jointly, this rule can be met as long as one spouse has earned income.

Earned Income includes

wages, salaries, and tips (and other taxable employee pay) net earnings from self-employment gross income, if received as a statutory employee strike benefits paid by a union

In terms of wages, salaries and tips, employee pay is only considered earned income if it is taxable. For example, certain benefits are not taxable and are not considered earned income. However, the taxpayer can elect to include

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nontaxable combat pay in their earned income when calculating for the EIC. (Nontaxable combat pay is located in box 12 of the W-2 form, and accompanied by code Q.) Inclusion of this pay may increase the amount of Earned Income Credit owed to the taxpayer.

Taxpayers may have net earnings from self-employment if they own their own business or if they are a member of or minister to a religious order.

If the taxpayer is a minister, the amount that he/she receives in the form of a housing allowance as part of income is generally not subject to income tax. However, it is included in net earnings for self-employment and is included in earned income for the Earned Income Cred

Investment income In 2014, taxpayers may not claim the Earned Income Credit unless investment

income is $3,350 or less. Investment income is money earned through:

Interest and Dividends Capital Gains Net Income Royalties and Rental Income from Personal Property Passive Activities

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Disability Benefits

Taxable disability benefits paid are considered earned income until the taxpayer reaches the minimum retirement age. As soon as the taxpayer reaches minimum retirement age, payments would be considered taxable pension and not earned income.

Unqualified Income § 32(i)(2) There are many types of income that are not considered earned income. They

include 1. pensions 2. annuities 3. interest and dividends 4. social security 5. alimony and child support 6. workers' compensation benefits 7. welfare 8. unemployment

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9. veterans' benefits 10. money earned while an inmate

Nontaxable Military Pay and Combat Pay Taxpayers can elect to include nontaxable combat pay as earned income. However, nontaxable pay for members of the armed forces like basic allowances for housing and subsistence are not considered earned income for the EIC.

Community Property Taxpayers that live in a state that has community property laws and are qualified to file as head of household under the special rules for married taxpayers living apart should not include any amount earned by their spouse in their earned income. Though this money is included as gross income on the tax return, it is not used to calculate the EIC under these conditions. However, the entire income earned by the taxpayer is treated as earned income whether or not part of it is attributed to their partner under the state's community property laws. Workfare Payments Taxpayers who receive nontaxable workfare payments may not include these payments as earned income. Workfare payments are cash payments paid to individuals from public assistance programs funded by the federal Temporary Assistance for Needy Families program.

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Form 2555 or 2555-EZ

If the taxpayer is filing form 2555 or form 2555EZ, the income cannot be claimed. These forms are used to report foreign-earned income and that income must be excluded from their gross income. Also, foreign housing allowance must be excluded.

Other Taxpayers who received social security retirement benefits or social security disability benefits at the time they received Conservation Reserve Program payments cannot count those CRP payments as earned income. Taxpayers who are members of a qualified joint venture that reports solely rental real estate income that is exempt from self-employment tax cannot include income or loss from the venture as earned income.

Example

Last year, Fern was laid off of her job. As a single woman with no dependent children, the combined total of pay before she was laid off ($10,000) and the amount she received from unemployment insurance payments subsequently ($8,000) would put her over the income limit for EIC eligibility ($13,980) However, because unemployment checks are not counted as earned income, Fern may still be able to claim an EIC.

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Must have valid Social Security Number In order to claim EIC, the taxpayer (and spouse, if filing jointly) must have a valid Social Security Number (SSN) that has been issued by the Social Security Administration. In addition, any qualifying child that is claimed must also be in possession of a valid SSN unless that child was born or died during the calendar year. In this case, a copy of a birth or death certificate or a hospital record that shows a live birth must be attached to the return.

1. Taxpayers cannot claim Earned Income Credits on the basis of a qualifying child

when ● The Social Security Number for a child is missing or incorrect on the tax

return ● A child has a Social Security Card that is marked as “not valid for

employment” and was issued in order to obtain a federally funded benefit. ● The qualifying child has an individual taxpayer identification number (ITIN) or

an adoption taxpayer identification number (ATIN) instead of a social security card.

2 If the taxpayer is in the possession of a Social Security Card that reads either

“valid for work only with DHS authorization” or “valid for work only with INS authorization,” this is a valid SSN and can be used to claim an EIC.

3. If the taxpayer (or jointly-filing spouse) has a Social Security Card that states it is

“not valid for employment,” and was issued in order to obtain a federally-funded

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benefit such as Medicaid, the taxpayer is ineligible for the EIC. In the case that the taxpayer's immigration status has changed to permanent resident or U.S. Citizen since receiving the Social Security Card that is marked “not valid for employment,” the taxpayer should contact the Social Security Administration for a new card that does not bear this statement. If the new card arrives after filing the return, an amended return can be filed in order to claim the EIC.

4. Missing or incorrect Social Security Numbers, either for taxpayers or their

spouses when filing jointly may translate to EIC ineligibility.

5. If the taxpayer does not have a valid SSN and instead they (or their spouse, if filing jointly) have an Individual Taxpayer Identification Number, they cannot claim the EIC. (These numbers are issued to non-citizens who are ineligible for a SSN, and as such cannot be substituted for one in this instance.)

6. Social Security Numbers can be obtained by filing an application (form SS-5) with

the Social Security Administration. The form is available at local SSA offices online or by calling 1-800-772-1213.

7. If the taxpayer has applied for a SSN but has not yet received it as the filing

deadline approaches, there are two options: The taxpayer can request an automatic six-month extension of time to file

their return, by filling out form 4868. The taxpayer can file their return without claiming the EIC. Then, after

receiving their SSN, they have the option of filing an amended return later.

Example

Susan is a resident of the United States but not a citizen. In order to pay income tax, she was issued an Individual Taxpayer Identification Number. Though she only earned $12,000 last year, she is not eligible for the EIC until she obtains citizenship and a valid Social Security Number.

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Must be a United States citizen OR resident alien for the entire filing year

In the case that the taxpayer or his/her spouse was a nonresident alien for any part of the year, he/she cannot claim EIC unless a joint return is filed. This status is only eligible if one spouse is a U.S. citizen or resident alien and the nonresident spouse is treated as a U.S. resident. In this scenario, both spouses are taxed on their worldwide income and may want to investigate the consequences of this filing status further.

Joint Return A child cannot file a joint return for the same tax year he/she is claimed as a qualifying

child. This is true UNLESS a child and his/her spouse files a claim solely as a claim for a refund.

The taxpayer must NOT

have a filing status of “Married, filing separately” Exception: Married taxpayers whose spouse did not live with him/her during any time in the last six months of the calendar year may be able to file as head of household, not “married, filing separately.” Under these circumstances, they may also qualify for an Earned Income Credit.

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Qualifying Children – The EIC Nuts and Bolts

Certain EIC rules are based upon whether the taxpayer has or does not have a qualifying child.

1. If the taxpayer has a qualifying child,

the child must meet set requirements in terms of age, relationship, residency, and joint-return tests.

the child must not be used to claim more than one EIC.

the taxpayer cannot be a qualifying child for EIC for another person.

2 If the taxpayer does NOT have a qualifying child, he/she must be between the ages of 25 and 65. have lived in the United States for more than half of the year. NOT be the dependent or qualifying child of another person.

Example After having a child last year, 18 year-old Dawn remained under her parents' roof. Though she works full time, both she and her parents qualify for an Earned Income Credit in terms of income; however, EIC rules prevent Dawn from claiming her infant. Dawn is disqualified from receiving EIC at all. Despite having a child, Dawn is a dependent and qualifying child. As you will read below, this means that Dawn's child can also be a qualifying child to his/her grandparents.

1. Rules for Qualifying Children §, In order for a child to be claimed as a qualifying child for an Earned Income Credit, he/she

must meet requirements in the following four areas:

Relationship

Age

Residency

Joint Returns

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Relationship A qualifying child must be related to the taxpayer in one of the following ways: Son, Daughter, Stepson, Stepdaughter, or Foster Child Brother, Sister, Stepbrother, Stepsister, Half-Brother or Half-Sister Descendants of any of the above (for example, grandchildren, nieces or

nephews.)

Adopted and Foster Children Adopted children are not legally distinct from other children and are consequently treated the same. Foster children can be qualifying children when placed in the taxpayer's care by a legal authority such as a court order, judicial decree, tribal authority, or authorized placement agency.

Age Qualifying children must meet certain requirements in terms of age. These requirements

vary slightly depending upon student status and disability and fall into three categories. Children must meet one of the following guidelines:

Child must be under the age of 19 at the end of the tax year and must be younger than the taxpayer (or spouse, if filing jointly).

Disabled - In order to be a qualifying child for EIC, there is no age limit for a child who is permanently and totally disabled; however, certain requirements must be met to meet the disability eligibility. A child is considered permanently and totally disabled if he/she cannot

participate in gainful activity due to mental or physical condition. A doctor must determine that his/her condition has or will last continuously for

at least one year or has the potential to be fatal. It is important to note that both of these criteria must be met.

Student The qualifying person must be enrolled as a student and under 24 years of age at the

end of the tax year and must be younger than the taxpayer (or spouse, if filing jointly). Must be enrolled full time (as defined by the school) during some portion of any five months during the calendar year at either a school that has a regular teaching staff, course of study, and student body or an on-farm training course administered by a school, a state, or county or local government

In addition to the above definition, examples of schools are elementary school, middle school, junior high school, high school, college, university, technical school, trade school, or mechanical school. Students who work in a vocational capacity as part of coursework or training are also considered full-time students. It is important to note for EIC purposes, on-the-job employee training courses, correspondence schools, and schools that are entirely online are not considered schools.

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Example Marsha, age 22 and her husband who is 21, have given her brother a place to stay for the past year while he attends a nearby university. Her brother is 23 years old and is enrolled full time. Though her brother is considered a full-time student and fulfills the relationship and residency tests, he is not a qualifying child as he is older than both Marsha and her spouse.

Residency § 7701 Children of the taxpayer must have lived with the taxpayer in the

United States for more than half of the calendar year. For income tax purposes, the United States refers to the 50 states and Washington D.C. An exception to this rule concerns military personnel stationed outside the United States. Military personnel, who are on extended active military duty and are stationed in places other than the U.S., are considered to live in the United States in terms of obtaining the EIC.

It is not necessary to reside in a traditional home in order to establish residency with your child. A home is considered any location that the taxpayer regularly lives and can include places such as homeless shelters.

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Example

David is a citizen of the United States, who spent April to November living in Puerto Rico where his Arizona-based company required him to work on a project. Because he is unmarried, did not maintain a residence in his hometown, and rented an apartment while he was there, David does not need to bother applying for the EIC because he does not meet residency requirements.

Birth or Death of a Child In the case of a child who was born or died during the calendar year, if the child's home was the taxpayer's home during the entire time he/she was alive, it is considered his/her residence.

Temporary Absences Temporary absences due to special circumstances count as time the child lived at home. Special circumstances include the following: illness vacation school attendance vacation juvenile detention

Kidnapped Children In the case of a kidnapped child, if the child lived with the taxpayer for more than half of the calendar year prior to being kidnapped, he/she is considered to be residing with the taxpayer. This is true for all years that the child is not returned until the year child would have turned 18, OR the year it is determined the child is dead

Law enforcement officials must presume that the kidnapped child has not been abducted by a member of his/her family or the taxpayer's family. If a qualifying child meets these requirements and has been kidnapped, the taxpayer is to write “KC” instead of a number on line 6 of Schedule EIC.

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Additional rules regarding EIC

Married Children

Married children cannot serve as qualifying children even if they do not file a joint

return with their spouse unless

the taxpayer can claim an exemption for their (married) child, OR

the taxpayer cannot claim an exemption because they allowed the child's other parent to claim the exemption in accordance with the “Special rules for divorced or separated parents or parents who live apart.

Example

Steven's 18 year-old daughter is married but lived with Steven the entire year while her husband worked on an oil rig in the Gulf of Mexico. Despite their physical separation, they file jointly at the end of the year. As a result, Steven is unable to claim his daughter as a qualifying child despite his support

Qualifying Children Cannot be Claimed By More Than One Person

Although it is possible for a child to meet the tests of being a qualifying child for more than one person, only one person may actually claim the child to qualify for an Earned Income Credit.

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In addition to the EIC, a child can only be claimed by a taxpayer for a number of tax benefits, such as ● The child tax credit ● An exemption ● Head of household status ● The credit for child and dependent care expenses ● Exclusion of dependent care benefits

These benefits cannot be divided between people and can only be claimed by the one taxpayer who claims the child for the EIC. While unnecessary in the case of married parents filing jointly, there are a number of “tiebreaker rules” which help to determine who should claim a child in the case where that child meets the test of being a qualifying child for more than one parent.

Tiebreaker Rules

In order to determine which taxpayer can claim a child as a qualifying child for the

above tax benefits, there are four established rules:

If only one of the people vying to claim the child is his/her parent, the child is treated as the qualifying child of the parent

In the case when the parents are not filing jointly and each can claim the child, the parent with whom the child lived with longer during the year can claim the child OR if the amount of time with each parent is equal, the parent that had the higher Adjusted Gross Income that year can claim the child

If no parent can claim the child as qualifying, the taxpayer with the highest AGI may claim him/her.

If a parent can but chooses not to claim his/her child, the person who has the higher AGI may (provided that their AGI is higher than the parent or parents who chose not to) claim their child. If the parents file jointly, the AGI is determined by dividing their total AGI evenly between them.

The tiebreaker rules can help determine who between two people can claim a child as qualifying. If the taxpayer who is determined to be able to claim the child does not qualify for the EIC for other reasons, the next taxpayer in line might be able to claim the child; however, this is not the case if the first taxpayer chooses to claim any of the six available benefits listed above using that particular child as a qualifier.

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Example

Shirley and her nine-year-old nephew (the son of her brother) lived with her father for the entire year. Shirley is 30 years old and employed part time. Last year she earned $14,000 from that job. Her father earned $25,000 from his full-time job. Her nephew's parents, who file jointly, earned an Adjusted Gross Income of about $8,500 last year and resided in a different state for the year. Shirley's brother and sister-in-law do not pass the tests to claim their son as a qualifying child, but Shirley and her father do. Because Shirley's father has a higher AGI than Shirley, he is the only one who can ultimately treat his grandchild as a qualifying child.

Divorced, Separated or Living-Apart Parents (Special Rule)

If all of the following conditions are met, a child will be treated as the qualifying child of his/her noncustodial parent and may be claimed as an exemption and for a child tax credit but not for EIC. The parents are divorced or legally separated under the decree of divorce or

separate maintenance, have a written separation agreement, or have lived apart during the entirety of the last six months of the calendar year (regardless of marital status.)

The child received more than half of his/her support from his/her parents The child was in the custody of one or both parents for more than half of the year Either

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The custodial parent signs a statement declaring he/she will not claim the child as a dependent for the year (such as form 8332) and the noncustodial parent attached said form to their return. OR

A decree of divorce or separate maintenance from prior to 1985, still applicable, that provides that the noncustodial parent can claim the child as the dependent, and the noncustodial parent provides at least $600 in support in the year.

If all of these conditions are met by the noncustodial parent, he/she may be able to claim the child in order to obtain a tax exemption and a child tax credit; however, the custodial parent (or other qualifying taxpayer) can claim the EIC and other associated tax benefits claiming the child as a qualifying child. Tiebreaker rules may also be applied.

Rules for Taxpayers without Qualifying Children

If the taxpayer is childless or does not meet the requirements for a qualifying child that are outlined previously, he/she has a set of parallel requirements that must be met.

● Age In order to qualify for the EIC, taxpayers must be at least 25 years of age but

under the age of 65 at the end of the calendar year. Under circumstances where the taxpayer is married and filing jointly, either one of the spouses must meet the age requirement. It is not necessary that both spouses meet this requirement.

If the taxpayer is filing a joint return with a spouse who died in the filing year, and that spouse was at least 25 but under 65 at the time of their death, the age requirement has been met.

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Example Sharon is 74 years of age and is filing a joint return with her late husband who passed away in October at the age of 64. Although her husband would have turned 65 in November and because he was 64 at the time of his death, Sharon passes the age test.

Dependency

Taxpayers who can be claimed as a dependent on another person's return or taxpayers who have a spouse that can be claimed as a dependent on another person's return are not eligible to receive an Earned Income Credit. This is true whether or not the person that can claim them as a dependent.

a. If the taxpayer is not filing a joint return, they meet this criteria if

● On form 1040 or 1040A, they checked box 6a ● On form 1040EZ, they did not check the “you” box and did enter $9,350 on that line

b. If the taxpayer is filing a joint return, they meet this rule if ● On form 1040 or 1040A, they checked both box 6a and box 6b ● On form 1040EZ neither the taxpayer nor their spouse checked either

the “you” box or the “spouse” box on line 5

Example 1

In the past year, 28-year-old Stuart returned home to live with his parents. Stuart is employed full-time and not currently enrolled in school. Last year he earned $8,000, and this year when filing his return, he claimed the exemption for himself by not checking the “you” box on Line 5 of the 1040EZ form, and entering $9,350 on that same line. Despite eating almost all of their food, Stuart's parents cannot claim him as a dependent, and in this regard he is qualified to apply for the Earned Income Credit.

Example 2

Horace, who is 18-years-of age, lives at home with his parents. Last year he earned $3,000 dollars. Despite his parents’ decision not to claim him, Horace is not eligible for an Earned Income Credit because they could have claimed him as a dependent if they chose to.

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Taxpayer as Qualifying Child

If the taxpayer (or spouse, if filing jointly) is a qualifying child of another person, he/she cannot receive EIC. This is true even if the person who is able to claim and does not claim the Earned Income Credit. Whether or not the taxpayer is claimed as a qualifying child, the taxpayer may not receive EIC if he/she meets all of the following criteria in regard to another person: 1. The taxpayer is that person's

● son ● daughter ● stepchild ● grandchild ● foster child ● brother ● sister ● half sibling ● step sibling

2. The taxpayer was younger than the person (or their spouse, if filing jointly) AND ● under the age of 19 at the end of the year ● under the age of 24 at the end of the year, and a student ● permanently and totally disabled

3. The taxpayer lived with the person for more than half of the calendar year in the United States.

4. The taxpayer is not filing a joint return or only filing a joint return in order to claim a refund.

Example

Ashley is 18 years old, a student at the local community college, and has never lived anywhere other than her parents' home. Last year, she earned $14,000 from a work-study program at her college. Because she meets the requirements to be a qualifying

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child for both of her parents, she is ineligible to receive the Earned Income Credit whether or not they choose to claim Ashley as a dependent or as a qualifying child.

Forms 4361 & 4029 Form 4361 is the “Application for Exemption from Self-Employment Tax for use by Ministers, Members of Religious Orders and Christian Science Practitioners,” and form 4029 is the “Application for Exemption from Social Security and Medicare Taxes and Waiver of Benefits.” Both forms, when approved, exempt some income from social security taxes, which has ramifications when calculating Earned Income Credits.

Form 4361 Even with an approved exemption, income received from performing ministerial duties as an employee, still figures into the calculations for earned income. However, money received for performing these same duties, but not as an employee, is not counted towards earned income. This type of income might include fees for speaking engagements or performing ceremonies.

Form 4029 If the taxpayer has an approved form 4029, taxable employee compensation such as wages, salaries and tips are counted as earned income. Additionally, losses are not to be subtracted from wages when calculating earned income. That said, money received as a self-employed individual do not count towards earned income.

Example

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Donald is a pastor at a church and has an approved form 4361, which allows him to be exempt from self-employment tax on some of his earnings. As a result, when he goes to calculate his Earned Income Credit, he will include his regular salary that is paid by the church. However, the money that he earned performing weddings in the previous year is exempt and not counted as earned income.

Calculating Earned Income The self-employed, statutory employees, and members of the clergy (or church members) file Schedule SE on form 1040. When they fill out Part 4 of the worksheet, they figure their earned income using Worksheet B in the 1040 instructions.

For others, taxpayers should use the worksheet that is in Step 5 of the 1040 instructions for lines 64a and 64b. If filing using form 1040A, the worksheet is located in the instructions for lines 41a and 41b. 1. The worksheet for figuring earned income is located in Step 2 of the 1040EZ form

instructions for lines 9a and 9b.

2. To use the worksheets that are located in the instructions of these forms, taxpayers begin with the amount of money listed on line 7 of form 1040 and 1040A or line 1 of 1040EZ. That amount is then reduced by any amount that was included on that line and described by any of the following:

Income Type Description

Scholarships or Fellowship Grants

If not reported on a W-2 form, these are not considered earned income.

Inmate's Income Money received for work performed while the taxpayer is an inmate in the penal system,

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including work in a work-release program or while at a halfway house, are not earned income.

Pension or Annuity from deferred compensation plans

If the taxpayer receives money from a non-qualified deferred compensation plan or a nongovernmental section 457 plan, this is not considered earned income.

Income of the type described above should be subtracted from income totals that are noted at “wages, salaries, and tips” of tax return forms, if they were originally included in those totals. Additionally, there are some categories of subtractions that apply to certain populations, as described below.

Clergy Members of the clergy who file schedule SE can subtract the amount of money located on line 2 that was included in the total located on line 7. The resulting number should be entered in the first space of the Step 5 worksheet of 1040 form instructions for lines 64a and 64b. The dotted line next to line 64a should read “Clergy.”

Church Employees

In terms of calculating earned income, a church employee is defined as an employee of a church or qualifying church organization that is exempt from employer social security and medicare taxes. This does not include ministers or members of religious orders.

● If the taxpayer is a church employee and received wages in that capacity that

were included, in any amount, on BOTH line 5a and line 7, that amount should be subtracted from line 7 and the resulting total entered into the appropriate worksheet.

Nontaxable Combat Pay

Taxpayers have the option of including nontaxable combat pay in their earned income total for the EIC. If the taxpayer chooses to include this income, he/she must include the total nontaxable combat pay they received.

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In the case that the taxpayer is filing a joint return with a spouse who also

earned nontaxable combat pay, each spouse has the right to make his/her own determination whether or not to include that money in the earned income.

The amount of nontaxable combat pay that was earned can be found in box

12 of the W-2 form, with code Q. The choice to include nontaxable combat pay in earned income may increase

or decrease the taxpayer's EIC. It is a good idea to calculate both options (including and not including pay) before making a final determination.

As a rule of thumb, if your earned income without your combat pay is less

than the following amounts, then you may benefit from electing to include it. If it is more than these amounts, you will not benefit from deciding to include your nontaxable combat pay in your earned income: ● $13,980 with no qualifying children ● $36,920 with one qualifying child ● $41,952 with two qualifying children ● $45,060 with three or more qualifying children

Example Sheila is a single mother to three children whose father is deceased. None of her children can be claimed as qualifying children by anyone else. Last year Sheila earned $53,000, a total that includes $8,000 in nontaxable combat pay. Because her earned income without the nontaxable combat pay is $45,000, it is unlikely that Sheila will benefit from choosing to include it as her earned income. Because it is up to her, she elects not to include it.

● Keeping these things in mind, a taxpayer can figure his/her EIC by using the EIC worksheet. If a taxpayer is claiming a qualifying child or children, he/she should complete Schedule EIC and attach it to the return.

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Filing 1040 Forms Those filing Form 1040 have the option of using either EIC Worksheet A or EIC Worksheet B to calculate the amount of the Earned Income Credit.

a. EIC Worksheet A is for use by taxpayers who were NOT self-employed at any time

in the previous year and were not church employees or members of the clergy filing a Schedule SE, or a statutory employee that is filing Schedule C or C-EZ.

b. Worksheet B is for use by taxpayers who were self-employed during the previous

year, were a member of the clergy or church employee filing Schedule SE or worked as a statutory employee filing Schedule C or C-EZ

EIC Disallowance § 32(k) In some circumstances, taxpayers may be prohibited from claiming the EIC. Taxpayers who have had their Earned Income Credit denied or reduced after 1996 may be required to complete a form. They may also be prohibited from claiming the EIC for a number of years.

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Form 8862

If a taxpayer's EIC was denied or reduced after 1996 for any reason other than clerical or math error, he/she must complete form 8862 and attach it to their return. Form 8862 is an “Information to Claim Earned Income After Credit Disallowance,” and should be filed in the event of a past denial except under the following circumstances: ● The taxpayer filed an 8862 form in a year subsequent to denial and was granted

an EIC, and he/she has not had EIC reduced or disallowed again for any reason other than math or clerical error, OR

● The taxpayer is claiming his/her EIC without a qualifying child. In the past, the IRS determined that taxpayer’s attempt to claim a qualifying child was not valid If either of the above is true, the taxpayer is eligible to take the EIC without

filing form 8862 provided all other requirements are met. It is also not necessary to file form 8862 in cases where the taxpayer

remains prohibited from claiming an EIC. These are ● If it has been two years or less since a final determination was made that

an EIC claim was due to reckless or intentional disregard of the EIC rules, or

● If it has been ten years or less since a final determination was made that an EIC claim was due to fraud 1. Under these circumstances, the taxpayer need not file an 8862 form,

and he/she may not collect EIC. 2. If the taxpayer is required to attach a completed form 8862 to his/her

return and fails to do so, the IRS considers this to be a math or clerical error and the result will be an automatic denial of an EIC claim.

3. In some cases, additional forms along with form 8862 must be attached to returns in order to successfully claim an EIC.

Math or Clerical Errors If the taxpayer had an EIC denied or reduced because of math or clerical errors, it is not necessary to attach form 8862 to the return in subsequent years. Examples of math or clerical errors are incorrect addition or providing an incorrect Social Security Number. In these cases, the IRS can correct the mistakes that were made.

Example In 2009, Sarah claimed an EIC with a qualifying child. This claim was questioned by the IRS, and Sarah was ultimately unable to prove that the child was her qualifying child. As

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a result, the IRS issued a call for an adjustment, and Sarah was eventually denied an Earned Income Credit entirely. In 2010, Sarah qualified for an EIC but this time she did not attempt to claim a qualifying child. Because the previous denial was based on a qualifying child and Sarah subsequently elected to file without a child, she was not required to file a form 8862.

EIC Prohibitions If an EIC claim was denied not because of a math or clerical error but because of fraud or reckless or intentional disregard for the rules, the taxpayer is prohibited from claiming Earned Income Credit for a number of years. If the IRS determines that the error was due to reckless or intentional disregard

for EIC rules, the prohibition is two years long. If it is determined by the IRS that the error was caused by fraud, the prohibition lasts ten years. During the prohibition periods, the taxpayer may not claim Earned Income Credits.

The period of time is determined by the date of denial as explained in the

example below.

Example

In March of 2009, Ryan claimed the Earned Income Credit on his tax return. The IRS determined that Ryan was not, in fact, entitled to an EIC. They also determined that the error was due to fraud. In October of 2009, the IRS sent out a statutory notice of deficiency and stated that Ryan needed to file a petition with the Tax Court within 90 days or an adjustment and tax assessment would be made. Ryan took no court action. Under these circumstances, Ryan would be unable to claim the EIC for ten years starting when it was denied in January 2010. Ryan is not allowed to claim the EIC from tax years 2010 to 2019, and the next time he attempts to claim the EIC, he will be required to attach form 8862 to his return.

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What’s NEW?

Form 8867

Starting with the 2013 tax year, paid tax preparers are required to file form 8867 with returns that claim the Earned Income Credit. This form is a checklist designed to help tax preparers meet due diligence requirements. Failure to meet due diligence requirements could result in a $500 penalty per occurrence for preparers.

a. For returns or claims for refund filed electronically, submit Form 8867 to IRS electronically with the return.

b. Keep copies of any documents your client gives you that you use to determine eligibility for or the amount of the EITC

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c. Verify the identity of the person giving you the return information and keep a record of who provided the information and when you received it.

d. Keep your records in either paper or electronic format, but make sure you can produce if IRS asks for them.

e. Keep these records for three years from the latest date of the following that apply: The original due date of the tax return (This does not include any extension of

time for filing.), or If you electronically file the return or claim for refund and sign it as the return

preparer, the date the tax return or claim for refund is filed, or If the return or claim for refund is not filed electronically and you sign it as the

return preparer, the date you present the tax return or claim for refund to your client for signature, or

If you prepare part of the return or claim for refund and another preparer completes and signs the return or claim for refund, you must keep the part of the return you were responsible to complete for three years from the date you submit it to the signing tax return preparer.