Working tax credit who qualifies
The rules can be complicated, and, with new due diligence requirements in place, practitioners must get it right.
February 13, 2014
by Nicholas Fiore, J.D.
Some taxpayers with lower-paying jobs may be eligible for an earned income tax credit (EITC), based on their income levels. The EITC is a refundable credit; if the credit amount exceeds the taxpayer’s tax liability, the taxpayer may receive a refund for the excess. The number of returns claiming the EITC has grown in recent years: The IRS reports that 27 million taxpayers received $63 billion in EITC in 2012.
However, there are many requirements that must be met to qualify (Sec. 32 and Regs. Sec. 1.32-2).
Citizenship. To qualify for the EITC, the taxpayer (and spouse, if married) must be a U.S. citizen (or a resident alien) for the entire year.
Nonresident alien. If the taxpayer (or spouse) is a nonresident alien for any part of the year, he or she cannot claim the EITC unless the taxpayer files jointly with his or her spouse. This filing status may be used only if one spouse is a U.S. citizen (or resident alien) and the nonresident spouse elects to be treated as a U.S. resident. If they make this election, the couple will be subject to U.S. tax on their worldwide income, not just the amounts earned in the United States.
Social Security numbers. The taxpayer (and spouse, if married and filing jointly) must have a valid Social Security number. This is also a requirement for any qualifying child.
Note: A taxpayer or spouse who has an individual taxpayer identification number (ITIN) (rather than a Social Security number) is not eligible to claim the EITC.
Filing status. If the taxpayer is married, he or she must generally file as “married filing jointly”; a taxpayer filing as “married filing separately” cannot claim the EITC.
Claiming the EITC
Taxpayers without qualifying children
If a taxpayer does not have any qualifying children, in addition to the requirements already discussed, he or she must meet four additional tests to be eligible for the EITC:
- Be at least age 25 but under 65.
- Not qualify as a dependent of another person. Thus, if another person can claim the taxpayer (or spouse, if filing a joint return) as a dependent but does not, the taxpayer cannot claim the credit.
- Cannot be the qualifying child of another taxpayer—even if the other taxpayer does not claim the EITC or meet all of the requirements to claim the EITC.
- Must have lived in the United States (i.e. the 50 states or the District of Columbia) for more than half the year. Note that this excludes Puerto Rico or U.S. possessions (such as Guam).
Taxpayers with qualifying children
For a taxpayer with children, the children must also meet four tests:
Relationship test. The child must be:
- The taxpayer’s son, daughter, stepchild, foster child, or a descendant of any of them (e.g. a grandchild); or
- The brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them (e.g. a niece or nephew).
Age test. The child must be:
- Under age 19 at year end and younger than the taxpayer (and the taxpayer’s spouse, if filing jointly);
- Under age 24 at year end, a student, and younger than the taxpayer (and the taxpayer’s spouse, if filing jointly); or
- Permanently and totally disabled at any time during the year, regardless of age.
Student. To qualify as a student, during some part of each of any five calendar months during the calendar year, the child must be:
- A full-time student at a school with a regular teaching staff, course of study, and regular student body; or
- A student taking a full-time, on-farm training course given by such a school or a state, county, or local government.
Note that the five calendar months need not be consecutive.
Permanent disability. A child is permanently and totally disabled if (1) he or she cannot engage in any substantial gainful activity because of a physical or mental condition, and (2) a doctor determines the condition has lasted (or can be expected to last) continuously for at least a year or can lead to death.
Residency test. The child must have lived with the taxpayer in the United States (again, the 50 states or the District of Columbia) for more than half the year. Again, Puerto Rico and U.S. possessions are excluded.
Birth or death of child. A child who was born or died during a year is treated as having lived with the taxpayer for more than half that year, if the child lived in the taxpayer’s home for more than half the time the child was alive during the year.
Temporary absences. Time that a taxpayer or a child is temporarily away from home because of a special circumstance is counted as time lived with the taxpayer. Examples of this include illness, school attendance, business, vacation, military service, and detention in a juvenile facility.
Joint return test. A qualifying child cannot file a joint return for the tax year (although there are exceptions for children filing joint returns simply to obtain refunds of withheld taxes).
Qualifying child of more than one person
Sometimes a child meets the tests to be a qualifying child for more than one person. In this situation, only one person can actually claim the child.
This is true for several tax benefits (provided the person is eligible for each), as well as for the EITC:
- The child’s personal exemption.
- The child tax credit.
- Head-of-household filing status.
- The credit for child and dependent care expenses.
- The exclusion for dependent care benefits.
Tie-breaker rules. These rules determine who of several persons may claim the EITC. (They do not apply if the other person is the taxpayer’s spouse and they file a joint return.)
- If one person is the child’s parent, the child is treated as the parent’s qualifying child.
- If the parents do not file a joint return but both claim the child, the IRS will treat the child as the qualifying child of the parent with whom the child lived longer during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent with the higher adjusted gross income (AGI) for the year.
- If no parent can claim the child, the child is treated as the qualifying child of the person with the highest AGI for the year.
- If a parent can claim the child but that parent does not, the child is treated as the qualifying child of the person with the highest AGI for the year, but only if that person’s AGI is higher than the highest AGI of any of the child’s parents who can claim the child. If the child’s parents file a joint return with each other, this rule can be applied by treating the parents’ total AGI as divided evenly between them.
If the other person cannot claim the EITC. If
the taxpayer and another individual have the same qualifying child, but the other person cannot claim the credit (because the person is not eligible or his or her earned income or AGI is too high), the taxpayer may be able to treat the child as a qualifying child. Note, however, that a taxpayer cannot treat the child as a qualifying child to claim the EITC if the other person uses the child to claim any of the other five tax benefits previously listed.
As indicated by its name, this credit is available only to taxpayers who have earned income. If a taxpayer is married and files a joint return, this requirement is met if at least one of the spouses works and has earned income.
Earned income includes:
- Wages, salaries, tips, and other taxable employee pay (when includible in the taxpayer’s gross income for the tax year);
- Net earnings from self-employment (if the taxpayer owns a business or is a minister or member of a religious order); and
- Gross income received as a statutory employee.
It does not include (among other things) interest and dividends; pensions and annuities; alimony and child support; and welfare benefits and unemployment compensation.
Taxable disability benefits received under an employer’s disability retirement plan are earned income until the taxpayer reaches minimum retirement age (generally, the earliest age at which a taxpayer could have received a pension or annuity if he or she were not disabled). Once a taxpayer reaches minimum retirement age, these payments are taxable as a pension and are not earned income. (Note: Payments from a disability insurance policy for which the taxpayer paid the premiums are not earned income, regardless of the taxpayer’s age.)
Foreign earned income. A taxpayer cannot claim the EITC if he or she has foreign earned income and files either Form 2555, Foreign Earned Income. or Form 2555-EZ, Foreign Earned Income Exclusion .
Investment income. A taxpayer may have only a limited amount of investment income; for 2013, this amount must be $3,300 or less. For 2014, the amount is $3,350 or less. Investment income generally includes interest (including tax-exempt interest), dividends, capital gain net income, net rental income, net royalty income, and net passive activity income. Gain treated as long-term capital gain under Sec. 1231(a)(1) will not be considered investment income.
AGI limits. Only taxpayers with income below certain levels are eligible for the EITC. These amounts differ, depending on whether the taxpayer is married and on how many children (if any) the taxpayer has. As a taxpayer’s AGI increases, the credit is phased out, with taxpayers above certain income levels not eligible for any credit at all.
For 2013, the phaseout ranges are:
- $7,970–$14,340 ($13,310–$19,680 for married filing jointly) for a taxpayer with no qualifying children.
- $17,530 –$37,870 ($22,870–$43,210 for married filing jointly) for a taxpayer with one qualifying child.
- $17,530 –$43,038 ($22,870–$48,378 for married filing jointly) for a taxpayer with two qualifying children.
- $17,530–$46,227 ($22,870–$51,567 for married filing jointly) for a taxpayer with three or more qualifying children.
For 2014, the phaseout ranges are:
- $8,110–$14,590 ($13,540–$20,020 for married filing jointly) for a taxpayer with no qualifying children.
- $17,830–$38,511 ($23,260–$43,941 for married filing jointly) for a taxpayer with one qualifying child.
- $17,830–$43,756 ($23,260–$49,186 for married filing jointly) for a taxpayer with two qualifying children.
- $17,830–$46,997 ($23,260–$52,427 for married filing jointly) for a taxpayer with three or more qualifying children.
If a taxpayer’s AGI falls within one of these ranges, his or her EITC must be reduced by the applicable phaseout percentage multiplied by the difference between the taxpayer’s AGI and the bottom of the range. The phaseout percentages are:
- 7.65% for a taxpayer with no qualifying children.
- 15.98% for a taxpayer with one qualifying child.
- 21.06% for a taxpayer with two or more qualifying children.
Community property. If a taxpayer is married but qualifies to file as head of household under the special rules for married taxpayers living apart and lives in a state with community property laws, the taxpayer’s AGI includes that portion of both the taxpayer’s and the spouse’s wages that the taxpayer is required to include in gross income.
Computing the EITC
The EITC is computed by multiplying the taxpayer’s earned income for the year (up to a maximum amount) by an applicable credit percentage based on the number of qualifying children that the taxpayer has.
Maximum earned income amount. The maximum amount that can be taken into account in calculating the EITC for 2013 is
- $6,370 for a taxpayer with no qualifying children.
- $9,560 for a taxpayer with one qualifying child.
- $13,430 for a taxpayer with two or more qualifying children.
Maximum earned income amount. The maximum amount that can be taken into account in calculating the EITC for 2014 is
- $6,480 for a taxpayer with no qualifying children.
- $9,720 for a taxpayer with one qualifying child.
- $13,650 for a taxpayer with two or more qualifying children.
Applicable credit percentages. The percentages used in this calculation are
- 7.65% for a taxpayer with no qualifying children.
- 34% for a taxpayer with one qualifying child.
- 40% for a taxpayer with two qualifying children.
- 45% for a taxpayer with three or more qualifying children.
Maximum credit amounts. Therefore, the maximum EITC that can be claimed in 2013 is
- $487 for a taxpayer with no qualifying children.
- $3,250 for a taxpayer with one qualifying child.
- $5,372 for a taxpayer with two qualifying children.
- $6,044 for a taxpayer with three or more qualifying children.
Maximum credit amounts. Therefore, the maximum EITC that can be claimed in 2014 is
- $496 for a taxpayer with no qualifying children.
- $3,305 for a taxpayer with one qualifying child.
- $5,460 for a taxpayer with two qualifying children.
- $6,143 for a taxpayer with three or more qualifying children.
Return preparer due diligence
The IRS estimates that 22% to 26% of all EITC claims submitted contain some type of mistake. While some of those mistakes may be attributable to the complex rules outlined above, the IRS has been stepping up enforcement efforts against practitioners, including sending letters to return preparers who it suspects have filed inaccurate EITC claims.
Paid preparers must meet certain due-diligence requirements when preparing a return that claims the EITC. These include a requirement to complete and file Form 8867, Paid Preparer’s Earned Income Credit Checklist. with the taxpayer’s income tax return on which the credit is claimed. Practitioners must also not know or have any reason to know that any information used to determine a taxpayer’s eligibility or compute the credit is incorrect.
The consequences to practitioners of filing inaccurate EITC claims include a penalty assessment under Sec. 6695(g), losing IRS e-file privileges, and other sanctions that could include barring preparers from tax return preparation. Taxpayers who file false EITC claims can be barred from claiming the credit for up to 10 years.
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