The Earned Income Credit - Part I

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The Earned Income Credit, Part I
Requirements for the Credit

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By Roy Lewis

The earned income tax credit (EIC) was enacted in 1975 to provide working, low-income taxpayers with children some relief from the Social Security tax, and to improve incentives to keep working. The emphasis here is on low-income taxpayers -- but, in many cases, the term "low-income" is really in the eye of the beholder.

[Please note: All of the income limitations we list in this article related to the EIC are indexed for inflation, so they change each year. We've given amounts for tax year 2000, but please double-check income limits for other tax years.]

For 2000, if you have two or more qualifying children and your modified Adjusted Gross Income (AGI) is less than $31,152, you could qualify for the credit. On the other end of the spectrum, if you have no qualifying children, your modified AGI must be less than $10,380 before the EIC kicks in. It's quite possible that you qualify for the EIC and don't even know it, which is why we want to bring it to your attention.

If your income is greater than the thresholds noted above, you might want to just skip this section. But, before you move to the next section, think for a second. Is it possible that any of your friends, family, or relatives qualify for the EIC? If so, you might want to take a few minutes to read more about it.

As mentioned above, the EIC was originally introduced to assist low-income working taxpayers who have children. It has been expanded to include working individuals with no children. So, don't think that just because you don't have any qualifying children you are not eligible for the credit. You might be.

General Requirements

To qualify for the EIC, you must meet all of the following requirements:
  1. You must have earned income. Earned income isn't just what shows up on your W-2 form. It also includes other stuff such as Schedule C and F (Business and Farm) income. And, it also includes other nontaxable income. We'll spend more time on the definition of earned income for EIC purposes later on.

  2. Your investment income cannot be more than $2,400 for 2000. How is investment income defined? We'll discuss that in more detail later in the section.

  3. Your filing status is not Married Filing Separately. If you file separately, you will not be eligible to receive the EIC regardless of your income status.

  4. You, your spouse (if you are filing jointly), and the qualifying child must all have Social Security numbers. As you might know, for dependent purposes, you can use other identifying numbers (such as ITINs or ATINs). But, for EIC purposes, these other numbers will not work. Social Security numbers must be reported.

  5. You or your spouse cannot be the qualifying child of another person.

  6. You cannot file Form 2555 or Form 2555EZ (the Foreign Earned Income exclusion forms). If you exclude foreign income, you will not be eligible for the EIC.

  7. If you are a nonresident alien for any part of the year, you generally can't claim the credit. But, if you are a nonresident alien, check out IRS Publication 596 since there are some limited exceptions that might help you out. These exceptions would also include special rules for military personnel stationed outside the U.S.
If you meet all of the requirements noted above, read on... the news might be good.

Qualifying Child?

As we noted earlier, the EIC was originally put into place to assist working taxpayers who have children, but was subsequently expanded to include taxpayers without children. As you can expect, the rules are different, so let's take a few minutes to look at those differences.

If you do have children, those children must be "qualifying" children. To be considered a "qualifying" child, all three of the following requirements must be met:
  1. Relationship Test: The child must be your son, daughter, adopted child, grandchild, stepchild, or foster child. A foster child is defined as a child cared for by you as your own child. Unlike the relationship test for dependents, the EIC test has a much more narrow scope.

  2. Age Test: The child must be under age 19 at the end of the tax year. If the child is a full-time student, the child must be under age 24 at the end of the tax year. If the child is permanently and totally disabled at any time during the tax year, the child can be of any age.

  3. Abode Test: The child must have lived in your home for more than six months during the year. If your child is a foster child, that child must have lived in your home for all 12 months during the year. Generally, this home must be within the U.S. But, remember that there are special exceptions for military personnel stationed outside of the U.S., so check out IRS Publication 596 for information on those exceptions.

Do You Qualify for the EIC?

If you are a qualifying taxpayer and you also have qualifying children, you could be in business for the EIC. Just a few other requirements that must be met:

For tax-year 2000, your earned income and modified AGI must each be less than:
  • $27,413 if you have one qualifying child, or
  • $31,152 if you have two or more qualifying children.
In addition, you must attach Schedule EIC to your tax return to provide information about your qualifying children. And, that's it... well... almost. There is one more important issue that you've got to remember when dealing with the EIC. If a child is a qualifying child for more than one person, only the person with the higher modified AGI is eligible for the credit.

Example: Peter and Mary are unmarried and lived together for the entire year. They care for Mary's 10-year-old son, Paul. Since they are not married, they file separate tax returns. Peter's income is $50,000 and Mary's income is $12,000. Assume that Paul can be considered a qualifying child for either Peter or Mary. Can Peter or Mary pick and choose who should receive the credit? Nope. In this situation, neither Peter nor Mary will be eligible for the credit. Why?

Peter's income is well above the AGI limitations, which would preclude the credit for him. And, while Mary's income is well within the AGI limitations, she is not allowed to claim the EIC for Paul because of the law that says only the person with the higher modified AGI is eligible for the credit if the child is a "qualifying" child for more than one person. In this case, that would be Peter and only Peter.

Now then... what would happen if Paul could not be considered Peter's qualifying child? That would be just fine. Paul would only be a qualifying child for Mary, and Mary would receive the credit. So, if you are thinking of "playing house" with your significant other without the benefit of marriage, don't let this one little quirk in the EIC rules trip you up.

No Kids... No EIC? Not Exactly.

What if you are a low-income taxpayer and have no children? As noted above, you might still get a bite (although a small bite) of the EIC apple. If you do not have at least one qualifying child, you must meet all of the following requirements to claim the EIC:
  1. Your earned income and modified AGI, for tax year 2000, must each be less than $10,380;
  2. You must be at least 25 years old, but less than 65 years old, at the end of the tax year. If you are married, either spouse can meet the age requirement;
  3. You (or your spouse, if married) cannot qualify as a dependent on any other person's tax return;
  4. Your main home must be in the U.S. for more than half of the year; and
  5. You are not required to complete Schedule EIC.
So, there you have it. If you meet all of these qualifications, you are eligible for the EIC. Whoopee!!! But, let's also think about this for a moment. We noted that the EIC was written into law to help the low-income working taxpayer. Don't you think these rules and regulations seem a bit complex for the "average" or "low-income" taxpayer to understand? So do we. It's nice, we suppose, to offer such a program for low-income taxpayers, but does it have to be this complicated?

The IRS believes that millions of dollars in EIC payments to taxpayers are going unclaimed because of the complexity of the rules and requirements. The IRS is doing everything it can to notify taxpayers that they may be missing out on EIC payments. But, there are still people who fall through the cracks because of the complexity of the laws surrounding the EIC. Don't let one of those people be you or someone you know.

In Part II, we'll look at some additional definitions and requirements regarding the Earned Income Credit.
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