Earned Income Credit (EIC)

1. Earned Income Credit (EIC) • Objectives: • Determine if a taxpayer is eligible for the EIC. • Calculate the EIC. • Lesson: • Explain the meaning of "refundable credit" • List the types of income that may qualify for the EIC • Summarize the rules that everyone must meet to be eligible for the EIC • Explain the rules for a taxpayer with a qualifying child • Explain the rules for a taxpayer without a qualifying child • What resources are available to help determine if a taxpayer qualifies for the EIC

2. A Refundable Tax Credit • The Earned Income Credit (EIC) is a refundable tax credit available to eligible taxpayers who do not earn high incomes. The purpose of the EIC is to reduce the tax burden and supplement the wages of working families whose earnings are less than the maximum for their filing status. Taxpayers who qualify for this credit can receive a refund even if they have no filing requirement, owe no tax, and had no income tax withheld. • The EIC is a valuable credit that is adjusted for inflation every year. In 2011, the maximum earned income credit for families with three or more children is $5,751.

3. Three Sets of Rules • General eligibility rules for everyone • Rules for taxpayers with one or more qualifying children • Rules for taxpayers who do not have a qualifying child When applying these rules, be careful to avoid the most common EIC filing errors: • Incorrectly reporting income • Incorrectly reported social security numbers • Married taxpayers incorrectly filing as a Single or Head of Household • Claiming a child who is not a qualifying child

4. General Eligibility Rules Part A: Rules for everyone • Must have a valid social security number (not ITINs) • Filing status cannot be "Married Filing Separately." • Must be a U.S. citizen or resident alien all year. • Cannot file Form 2555 or Form 2555-EZ (relating to foreign earned income). • Investment income must be $3,150 or less. • Cannot be a qualifying child of another person.

5. Continued Earned income and AGI limitations must be less than: • 43,998 ($49,078 for Married Filing Jointly) if taxpayer has three or more qualifying children • $40,964 ($46,044 for Married Filing Jointly) if taxpayer has two qualifying children • $36,052 ($41,132 for Married Filing Jointly) if taxpayer has one qualifying child • $13,660 ($18,740 for Married Filing Jointly) if taxpayer does not have a qualifying child

6. Types of Earned Income Includes • Taxable wages, salaries, and tips • Union strike benefits • Taxable long-term disability benefits received prior to minimum retirement age • Net earnings from self-employment • Gross income of a statutory employee • Household employee income • Non-Employee compensation • Nontaxable combat pay election

7. Types of Earned Income Does not include • Interest and dividends • Social security and railroad retirement benefit • Welfare benefits • Workfare payments • Pensions and annuities • Veteran’s benefits • Workers’ compensation benefits • Alimony and child support For more info: refer to Link and Learn

8. Combat Pay • Combat pay is never taxable to most Armed Forces members. For the purposes of the EIC only, members of the U.S. Armed Forces who served in a combat zone may elect to include their nontaxable combat pay in their earned income. Doing this may increase or decrease the taxpayer's EIC. • Figure the EIC amount with and without combat pay before making the election. If the election is made, all of the nontaxable combat pay must be included. If both spouses filing a joint return have combat pay, they can individually choose to make the election on the tax return.

9. Self-employment Income Net earnings from self-employment are considered earned income. This includes all income, even pay for side jobs or contract labor, even when taxpayers do not think of themselves as self-employed. Report all self-employment income on Schedule C-EZ, Net Profit from Business, or Schedule C, Profit or Loss from Business. Taxpayers with a reason to file Schedules C and C-EZ should seek the assistance of a professional tax preparer.

10. Household Employee Income Domestic employees, such as housekeepers, are issued Form W-2 only if their earnings are more than $1,700. Add this income to line 7 on Form 1040. Include this income in the computation of the EIC.

11. Earned Income Not Qualifying for EIC One income item that is reported on Form W-2, but does not qualify as earned income for EIC purposes, is income received for work while an inmate in a penal institution. This includes work performed while in a work release program or while in a halfway house.

12. Case Study Ellis had several part-time jobs during the tax year, one of which was providing handyman and gardening services for Mrs. Fulton, a retired widow. Ellis's total earned income from all his jobs was $12,500, including the $750 he earned as a household employee for Mrs. Fulton. Ellis received Forms W-2 from all his employers except Mrs. Fulton. How would you complete line 7 (wages, salaries, and tips) of Ellis's Form 1040?

13. Answer • Ellis's total earned income was $12,500, so you should enter that amount on line 7. • Next to line 7, you should write "HSH" and $750 to indicate that $750 of Ellis's total income was from his work as a household employee for which he did not receive a Form W-2.

14. Tests for Qualifying Children Part B: Rules if you have a qualifying child • Child must meet the relationship, age, and residency tests. • Qualifying child cannot be used by more than one person to claim the EIC

15. No Qualifying Child Part C: Rules if you don’t have a qualifying child • Must be at least age 25 but under age 65 as of December 31. • Cannot be the dependent of another person. • Must have lived in the United States more than half the year

16. Summary • The earned income credit computation is based on filing status, number of qualifying children, earned income, and adjusted gross income. Certain individuals with no children may also qualify. • By using the intake and interview sheet, the interview tips in the Volunteer Resource Guide, and correctly filling out the EIC worksheets, most of the errors that arrive from incorrectly computing the EIC can be avoided. • The EIC is entered in the Payments section of the return.