Earned Income Credit - · PDF fileChapter 1 – Earned Income Credit Rules ... Relationship, Age, Residence and Joint Return Tests ..... 4 The Relationship Test

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Earned Income Credit

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Purchase of a course includes a license for one person to use the course materials. Absent specific

written permission from the copyright holder, it is not permissible to distribute files containing course materials or printed versions of course materials to individuals who have not purchased the course. It is also not permissible to make the course materials available to others over a computer network, Intranet, Internet, or any other storage, transmittal, or retrieval system. This document is designed to provide general information and is not a substitute for professional advice in specific situations. It is not intended to be, and should not be construed as, legal or accounting advice which should be provided only by professional advisers.

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Contents

Introduction to The Course ..................................................................................................... 1 Learning Objectives ............................................................................................................... 1

Chapter 1 – Earned Income Credit Rules ................................................................ 2 Introduction ......................................................................................................................... 2 Learning Objectives ............................................................................................................... 2 Eligibility to Receive EIC ......................................................................................................... 2

EIC Rules Applicable to Everyone ......................................................................................... 2 Adjusted Gross Income Limits ........................................................................................... 2 Valid Social Security Number Required ............................................................................... 3 Tax Filing Status .............................................................................................................. 3 Citizenship or Residency ................................................................................................... 3 Foreign Earned Income .................................................................................................... 4 Investment Income ......................................................................................................... 4 Earned Income ................................................................................................................ 4

EIC Rules That Apply Only if the Taxpayer Has a Qualifying Child ............................................. 4 Relationship, Age, Residence and Joint Return Tests ............................................................ 4

The Relationship Test .................................................................................................... 4 The Age Test ................................................................................................................ 5

Student Defined ......................................................................................................... 5 Permanently and Totally Disabled Defined ..................................................................... 6

The Residency Test ....................................................................................................... 6 Exception for U.S. Military Stationed Outside the U.S. .................................................... 6

The Joint Return Test .................................................................................................... 6 Child Must Have Valid Social Security Number .................................................................. 6

Qualifying Child of More than One Person Rule .................................................................... 7 Tiebreaker Rules ........................................................................................................... 7

Qualifying Child of Another Taxpayer Rule .......................................................................... 7 EIC Rules That Apply if Taxpayer Does Not Have a Qualifying Child .......................................... 8

The Age Rule .................................................................................................................. 8 Death of Spouse During Year .......................................................................................... 8

The Dependent of Another Person Rule .............................................................................. 8 The Qualifying Child of Another Taxpayer Rule .................................................................... 8 The Main Home Rule ........................................................................................................ 9

Figuring the Amount of the Earned Income Credit ..................................................................... 9 Calculating Earned Income for EIC Purposes .......................................................................... 9

Taxpayers Not Self-Employed, Statutory Employees, Clergy or Church Employees ................... 9 Self-Employed Taxpayers, Statutory Employees, Clergy and Church Employees .....................11

Summary ............................................................................................................................15 Chapter Review ...................................................................................................................15

Chapter 2 – Earned Income Credit Errors ............................................................. 17 Introduction ........................................................................................................................17 Learning Objectives ..............................................................................................................17 Incidence of Earned Income Credit Errors................................................................................17 Factors Leading to Earned Income Credit Errors .......................................................................18 Estimated Revenue Impact of Earned Income Credit Errors .......................................................18 Common Earned Income Credit Errors ....................................................................................19

Earned Income Credit Errors Involving Qualifying Children .....................................................19 Qualifying Child Requirements ..........................................................................................19

When a Child is Disabled ...............................................................................................20 Avoiding Qualifying Child Earned Income Credit Errors ........................................................20

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Earned Income Credit Errors Involving a Client’s Filing Status .................................................20 Single Filing Status .........................................................................................................21 Head of Household Filing Status .......................................................................................21

Married Persons Living Apart .........................................................................................21 Avoiding Filing Status Earned Income Credit Errors .............................................................22

Earned Income Credit Errors Involving Income Reporting .......................................................22 Avoiding Income Reporting Earned Income Credit Errors .....................................................23

Earned Income Credit Errors Involving Social Security Numbers ..............................................24 Avoiding Social Security Number Earned Income Credit Errors .............................................24


Chapter 3 - EIC Disallowance ............................................................................... 26 Introduction ........................................................................................................................26 Learning Objectives ..............................................................................................................26 IRS Efforts to Reduce Improper EIC Payments .........................................................................26 Claiming EIC after Disallowance .............................................................................................26

IRS Form 8862 Timing .......................................................................................................26 Filing IRS Form 8862 .........................................................................................................27

Exceptions .....................................................................................................................27 Client Consequences of EIC Disallowance ................................................................................27

Disallowance Due to Reckless or Intentional Disregard of EIC Rules .........................................27 Disallowance Due to Fraud..................................................................................................28


Chapter 4 - EIC Due Diligence .............................................................................. 30 Introduction ........................................................................................................................30 Learning Objectives ..............................................................................................................30 Tax Preparer Due Diligence a Statutory Requirement – IRC §6695 .............................................30 Due Diligence Requirements ..................................................................................................31

Eligibility Checklist – IRS Form 8867 ....................................................................................31 Due Diligence Questions to Ask to Avoid Qualifying Child Errors ...........................................32 Eligibility Checklist Best Practices .....................................................................................32

EIC Computation ...............................................................................................................33 Computation Best Practices..............................................................................................33

Know the Law and the Client ...............................................................................................33 When Should a Preparer Ask Additional Questions – Examples .............................................33 Knowledge Requirement Best Practices .............................................................................34

Record Maintenance ...........................................................................................................34 Record Maintenance Best Practices ...................................................................................35

Failure to Meet Due Diligence Requirements ............................................................................35 Consequences for the Tax Return Preparer ...........................................................................35 Consequences for the Preparer’s Employer ...........................................................................36


Answers to Chapter Review Questions ................................................................. 38 Chapter 1 ............................................................................................................................38 Chapter 2 ............................................................................................................................39 Chapter 3 ............................................................................................................................41 Chapter 4 ............................................................................................................................42

Glossary ............................................................................................................... 45

Index ................................................................................................................... 47

Appendix A – Worksheet A ................................................................................... 48

Appendix B – Worksheet B ................................................................................... 49

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Introduction to The Course

The Earned Income Credit (EIC) is a refundable tax credit that has a significant impact on United States revenue. In fact, EIC claims in any year generally total more than $60 billion.

EIC claims are also increasing in both number and amount1. In the ten year period ending in 2010, the

number of EIC claims increased from 19.6 million to 27.4 million, an increase of 39.8%. Not only had the number of claims for EIC increased over the period, the average credit per family also increased by 28.8%, from $1,704 at the beginning of the period to $2,194 in the year the 10-year period ended. The combination of an increased number of EIC claims coupled with an increase in the average credit caused the total amount of EIC claimed to skyrocket by 82.3% over the period from $33.4 billion to $60.9 billion.

In a recent year, 147.4 million individual federal tax returns were filed, and 24.4 million—16.6% of

individual taxpayers—claimed the Earned Income Credit. Based on that percentage, it would not be unexpected that approximately one taxpayer in every six may claim the EIC.

Learning Objectives

Upon completion of this course, you should be able to:

Apply the earned income credit rules to determine if a taxpayer is eligible for the tax credit; Identify the common errors committed in connection with the earned income credit;

Describe the consequences of the IRS’ disallowance of the earned income credit; and Recognize the tax return preparer’s EIC due diligence requirements.

1 Source: Internal Revenue Service, Statistics of Income Division, Table 1, Individual Income Tax Returns: Selected Income and Tax Items for Tax Years 1999 – 2011. http://www.irs.gov/uac/SOI-Tax-Stats-Historical-Table-1

http://www.irs.gov/uac/SOI-Tax-Stats-Historical-Table-1

http://www.irs.gov/uac/SOI-Tax-Stats-Historical-Table-1

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Chapter 1 – Earned Income Credit Rules

Introduction

The earned income credit—usually referred to simply as “EIC” or “EITC”—is a tax credit for certain low-income working taxpayers who meet income, filing status and other requirements. Eligibility to claim the credit requires, among other things, that the taxpayer have an earned income and also have an adjusted gross income (AGI) that is below a specified level. The applicable AGI level generally changes annually.

EIC is a refundable credit and, accordingly, it is available to eligible taxpayers regardless of whether or

not they have a federal income tax liability.

Learning Objectives

When you have completed this chapter, you should be able to:

Recognize the EIC eligibility rules that apply to all taxpayers; Identify the EIC eligibility rules applicable to taxpayers who have a qualifying child; List the EIC eligibility rules that apply to taxpayers who do not have a qualifying child; and

Recognize how the EIC for which an eligible taxpayer qualifies is determined.

Eligibility to Receive EIC

In order to receive EIC, the taxpayer must meet certain requirements. Furthermore, the rules vary depending on whether the taxpayer has a qualifying child. Thus, the applicable EIC rules fall into three categories:

Rules that apply to everyone; Rules that apply if the taxpayer has a qualifying child; and

Rules that apply if the taxpayer does not have a qualifying child.

EIC Rules Applicable to Everyone

Determining whether a taxpayer qualifies for EIC begins with the seven rules that apply to everyone

whether or not the taxpayer has a qualifying child. If the taxpayer meets all the seven rules that apply to everyone, the taxpayer must then meet the additional rules that apply a) if the taxpayer has a qualifying child or b) if the taxpayer does not have a qualifying child.

The rules for everyone relate to:

1. Adjusted gross income (AGI) limits—the taxpayer’s AGI cannot exceed specified levels based on filing status;

2. Social Security number—the taxpayer must have a valid SSN; 3. Tax filing status—taxpayers whose filing status is married filing separate are ineligible for EIC; 4. Citizenship or residency; 5. Foreign earned income—excluded foreign earned income will cause a taxpayer to be ineligible

for EIC; 6. Investment income—investment income cannot exceed a specified amount; and 7. Earned income—an eligible taxpayer must work and receive earned income.

If the taxpayer does not meet all seven of the rules applicable to everyone, the taxpayer cannot

receive the earned income credit.

Adjusted Gross Income Limits

To meet the rule concerning adjusted gross income limits, a taxpayer must have an AGI that is less

than the maximum amount for his or her filing status and number of qualifying children. The applicable AGI limits generally change each year and, for 2015 and 2016, are as shown in the following chart:

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EIC Income Limits

2015 Limits 2016 Limits

Children Married Filing Jointly

Other Than Married Filing

Jointly*

Married Filing Jointly

Other Than Married Filing

Jointly*

3 or more qualifying children

$53,267 $47,747 $53,505 $47,955

2 qualifying children

$49,974 $44,454 $50,198 $44,648

1 qualifying child

$44,651 $39,131 $44,846 $39,296

No qualifying children

$20,330 $14,820 $20,430 $14,880

*Taxpayer’s filing status cannot be married filing separate.

So, a married taxpayer filing a joint federal tax return who has three qualifying children may be eligible to receive EIC if the taxpayer’s AGI is less than $53,505 in 2016. If the same taxpayer filed a federal tax return as other than married filing jointly—as a head of household or an unmarried individual, in other words—he or she may be eligible to receive EIC only if his or her AGI is less than $47,955 in 2016. (Remember, EIC is not available to a taxpayer filing a federal tax return as married filing separate.) However, meeting the AGI requirement is only the first of several applicable

requirements that a taxpayer filing for EIC must meet.

Valid Social Security Number Required

In order to claim the EIC, the taxpayer—and spouse, if filing a joint return—must also have a valid social security number issued by the Social Security Administration. In addition, if a qualifying child is listed on Schedule EIC the child must also have a valid social security number. A social security card

stating “Not valid for employment” is not sufficient for purposes of the EIC.

(Note: If a child was born and died during the year, no social security number is required for the child. In such a case, a tax preparer should attach a copy of the child’s birth certificate, death certificate, or hospital records showing a live birth to the taxpayer’s return.)

Tax Filing Status

A taxpayer who is otherwise eligible to claim the EIC may have a tax filing status of single, married filing jointly or head of household. However, a married taxpayer cannot qualify for the EIC if he or she has a “married filing separate” filing status. If the taxpayer is married, he or she must normally file a

joint return to claim the EIC. (An exception may apply if the taxpayer’s spouse did not live with the taxpayer during the last 6 months of the year. In such a case, the taxpayer may be able to file as head of household and claim the EIC.)

Citizenship or Residency

If the taxpayer (or spouse, if married) was a nonresident alien for any part of the tax year, the

taxpayer cannot claim the EIC unless the taxpayer’s filing status is married filing jointly. (Such filing status is available only if one spouse is a U.S. citizen or resident alien and chooses to treat the

nonresident spouse as a U.S. resident. It is important to keep in mind that making the election to treat the nonresident spouse as a U.S. resident will cause the worldwide income of both spouses to be subject to U.S. taxation.)

If the taxpayer or spouse was a nonresident alien for any part of the year and the taxpayer’s filing status is other than married filing jointly, the EIC is not available.

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Foreign Earned Income

The Earned Income Credit is designed to assist low-income earners and cannot be claimed by a taxpayer who excludes foreign earned income from his or her gross income subject to U.S. taxation. Thus, a taxpayer is ineligible for the EIC if he or she files Form 2555, Foreign Earned Income, or Form

2555-EZ, Foreign Earned Income Exclusion. These forms are used to exclude income earned in foreign countries from the taxpayer’s gross income or to exclude a foreign housing amount.

Investment Income

Paying the EIC to a taxpayer with substantial investment earnings is inconsistent with its intended purpose of providing assistance to low-income earners. Accordingly, a taxpayer eligible for EIC cannot receive more than a minimal amount of investment income.

The EIC rules require that the 2016 investment income of a taxpayer eligible for EIC cannot be greater

than $3,400. If the taxpayer’s 2016 investment income is greater than $3,400, the taxpayer is ineligible for the EIC.

Earned Income

A taxpayer eligible for the EIC must work and have earned income. If the taxpayer is married and files a joint return, the requirements of the earned income rule are met provided at least one spouse works and has earned income.

The income that qualifies as “earned income” includes:

Wages, salaries, tips and other taxable employee pay; Net earnings from self-employment; and Gross income received by the taxpayer as a statutory employee.

Although earned income generally excludes non-taxable pay, a taxpayer can elect to include non-taxable combat pay in earned income for purposes of the EIC.

EIC Rules That Apply Only if the Taxpayer Has a Qualifying Child

If the taxpayer meets all the EIC eligibility rules applicable to all filers—the rules just discussed, in other words—then proceed to the next step. The appropriate next step depends on whether or not the taxpayer has a qualifying child. We will turn our attention now to the rules that apply to a taxpayer

who has met the EIC rules that apply to everyone and has a qualifying child.

Thus, in addition to meeting the EIC rules that apply to everyone, a taxpayer who has a qualifying child must meet certain other rules in order to be eligible to receive the EIC. The rules that a taxpayer with a qualifying child must also meet are:

1. The relationship, age, residence and joint return tests; 2. The qualifying child of more than one person rule; and 3. The qualifying child of another taxpayer rule.

Let’s look at each of these additional rules.

Relationship, Age, Residence and Joint Return Tests

A taxpayer’s child is a qualifying child for purposes of the EIC if the child meets four tests and, unless

the child was born and died in the year, has a valid Social Security number. The four tests the child must meet are:

The relationship test; The age test; The residency test; and The joint return test.

All four tests must be met. If the taxpayer does not meet all four tests, the child is not a qualifying

child for purposes of the EIC.

The Relationship Test

To meet the relationship test, a qualifying child must be the taxpayer’s:

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Son, daughter, stepchild, foster child, or a descendant—the taxpayer’s grandchild or great

grandchild, for example—of any of them; or Brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant—a taxpayer’s

niece or nephew, for example—of any of them.

Although many of the relationships mentioned above are fairly obvious, the definition of a foster child, for purposes of the EIC, should be noted. A “foster child” is one placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. A child left with the taxpayer by its parent would not be a foster child as the term is used in connection with the EIC; the child must be placed with the taxpayer by a placement agency or the court.

The Age Test

To meet the age test, a qualifying child must be:

Younger than age 19 at the end of the tax year and younger than the taxpayer (or the taxpayer’s spouse if filing jointly);

Younger than age 24 at the end of the tax year, a student, and younger than the taxpayer (or

the taxpayer’s spouse if filing jointly); or Permanently and totally disabled at any time during the tax year, regardless of age.

For example, a taxpayer’s child who became age 19 during the tax year would not meet the age test since a qualifying child is one who is younger than age 19 at the end of the year unless he or she was a student or permanently and totally disabled during the year. Similarly, a 23 year-old student living with her brother and sister-in-law, both of whom are younger than 23, would not be a qualifying child since at least one of the couple with whom she is living must be older than the student in order for her to meet the age test to be a qualifying child. However, if either the taxpayer or spouse was age 24 or older, the 23 year-old student would meet the age test.

Student Defined

Since meeting one of the age tests depends on the qualifying child being a student, it is important to understand how a student is defined for purposes of the EIC. To qualify as a student, the child must be, during some part of each of any five calendar months during the calendar year either:

1. A full-time student, i.e. one considered to be a full-time student by the school being attended, provided the school has a – a) Regular teaching staff,

b) Course of study, and c) Regular student body; or

2. A student taking a full-time, on-farm training course given by a – a) School described in 1. above, or b) State, county or local government.

The five calendar months of study during the calendar year required under the definition of a student

need not be consecutive months nor does the child need to have been a student for the entire month.

Furthermore, the definition of school is very broad. Thus, a school, for purposes of the EIC, includes:

An elementary school; A junior or senior high school; A college or university; or

A technical, trade, or mechanical school.

Despite the broad definition of “school,” certain types of training do not meet the criteria for the EIC.

Accordingly, taking the following types of training would not qualify the child as a student:

On-the-job training courses; Correspondence schools; and Schools offering courses only through the internet.

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Permanently and Totally Disabled Defined

A child who is permanently and totally disabled is not required to meet the age test for EIC purposes. For a child to be considered permanently and totally disabled, as that term is used in connection with the EIC, two requirements must be met:

1. The child must be unable to engage in any substantial gainful activity because of a – a) Physical condition, or b) Mental condition; and

2. A doctor must determine the condition – a) Has lasted continuously for at least a year, b) Can be expected to last continuously for at least a year, or c) Can lead to death.

The Residency Test

In addition to meeting the relationship and age tests, a child must also meet the residency test. To meet the residency test, a qualifying child must have lived with the taxpayer in the United States for more than half of the year. “United States” means the 50 states and the District of Columbia.

However, the term does not include Puerto Rico or U.S. possessions.

The home at which the child lives with the taxpayer may be any location—including a homeless shelter

or other type of dwelling—in which the taxpayer regularly lives.

A child who was born or who died during the year is treated, for purposes of the EIC, as having lived with the taxpayer for more than half the year if the taxpayer’s home was the child’s home for more than half the time the child was alive during the year.

The child’s temporary absence from the taxpayer’s home due to special circumstances should be considered as time the child lived with the taxpayer. Such special circumstances include:

Illness;

School attendance; Business; Vacation; Military service; and

Detention in a juvenile facility.

Exception for U.S. Military Stationed Outside the U.S.

Although the residency test specifies that the residence at which the child resides with the taxpayer

must be within the United States, an exception applies to U.S. military personnel stationed outside the United States. U.S. military personnel who are on extended active duty stationed outside the United States are deemed to live in the United States during that duty period for purposes of the EIC.

The term “extended active duty” means duty for an indefinite period or for a period of more than 90 days. Once the taxpayer begins serving extended active duty, he or she is still considered to have been on extended active duty even if the taxpayer does not actually serve more than 90 days.

The Joint Return Test

The last test that a child must meet to be considered a “qualifying” child is the joint return test. To meet the joint return test the child cannot file a joint return for the tax year, except when filing the child’s filing a joint tax return is only to claim a refund.

However, even if the child does not file a joint tax return, the child cannot be the taxpayer’s qualifying child, for purposes of the EIC, if the child was married at the end of the year unless:

The taxpayer can claim an exemption for the child; or

The reason the taxpayer cannot claim an exemption for the child is that the taxpayer let the child’s other parent claim the exemption.

Child Must Have Valid Social Security Number

Unless the child was born and died during the year, he or she must have a valid social security number. Thus, a taxpayer cannot claim the EIC based on having a qualifying child if:

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The child’s social security number is missing from the taxpayer’s return or is incorrect;

The child’s social security card says “Not valid for employment” and was issued for use in obtaining a federally funded benefit; or

The child has either of the following rather than a social security number –

o An individual taxpayer identification number (ITIN), which is issued to a noncitizen who cannot obtain a social security number, or

o An adoption taxpayer identification number (ATIN), issued to adopting parents who cannot get a social security number for the child being adopted until the adoption is final.

If a taxpayer has more than one child and only one of the children has a valid social security number, the taxpayer can use only the child with the valid social security number to claim the EIC.

Qualifying Child of More than One Person Rule

It is possible that a child may meet the tests to be a qualifying child of more than one person. However, even if a child meets the tests to be a qualifying child of more than one person, only one person is permitted to treat the child as a qualifying child for purposes of the EIC.

Thus, only that person is permitted to use the child as a qualifying child to take all the following tax

benefits, assuming the taxpayer is eligible for each benefit:

The exemption for the child;

The child tax credit; Head of household filing status; The credit for child and dependent care expenses; The exclusion for dependent care benefits; and The EIC.

The other person cannot take any of these benefits based on the same qualifying child. Accordingly, the taxpayer and the other person cannot divide these tax benefits between themselves based on the

same child. In the event the taxpayer and another person both meet the qualifying child tests, the tiebreaker rules are used to determine which person can treat the child as a qualifying child.

Tiebreaker Rules

When more than one person has the same qualifying child, the tiebreaker rules apply. The tiebreaker

rules are as follows:

If only one of the persons is the parent of the child, the child is the qualifying child of the parent;

If the parents file a joint return together and can claim the child as a qualifying child, the child is treated as the qualifying child of the parents;

If the parents do not file a joint return together but both parents claim the child as a qualifying child, the IRS will treat the child as the qualifying child of the parent – o With whom the child lived for the longer period of time during the year, or o Who had the higher adjusted gross income for the year if the child lived with each parent

for the same amount of time; If no parent can claim the child as a qualifying child, the child is treated as the qualifying child

of the person who had the highest adjusted gross income for the year; and If a parent can claim the child as a qualifying child but no parent does, the child is treated as

the qualifying child of the person who had 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.

Qualifying Child of Another Taxpayer Rule

A taxpayer cannot claim the EIC if he or she is a qualifying child of another taxpayer. A taxpayer is considered a qualifying child of another person only if all of the following are true:

The taxpayer is the other person’s son, daughter, stepchild, grandchild, or foster child; The taxpayer is the brother, sister, half-brother, half-sister, stepbrother, or stepsister (or a

child or grandchild of the brother, sister, half-brother, etc.) of the other person; The taxpayer was –

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o Under age 19 at the end of the tax year and younger than the other person (or

spouse, if the other person files jointly), o Under age 24 at the end of the tax year, a student, and younger than the other person

(or spouse, if the other person files jointly), or

o Permanently and totally disabled, regardless of age; The taxpayer lived with the other person in the United States for more than half of the year;

and The taxpayer is not filing a joint return for the year (or is filing a joint return only as a claim

for a refund).

If taxpayer #1 meets the criteria to be the qualifying child of taxpayer #2, taxpayer #1 cannot claim the EIC even if taxpayer #2 does not claim the EIC or meet all the rules to claim the EIC. For

example, suppose Barbara, a taxpayer, and Barbara’s child lived with Barbara’s mother. If Barbara meets the relationship, age, residency and joint return tests, she is considered the qualifying child of her mother. Accordingly, Barbara’s mother—assuming she meets all other requirements—can claim the EIC. Since Barbara is the qualifying child of her mother, she cannot claim the EIC whether or not Barbara’s mother cannot or does not claim the EIC.

EIC Rules That Apply if Taxpayer Does Not Have a Qualifying Child

A taxpayer may claim the EIC without a qualifying child, provided the taxpayer meets all the rules that apply to everyone and all the following rules that apply to taxpayers without qualifying children. The EIC rules applicable to a taxpayer with no qualifying child are:

1. The age rule; 2. The dependent of another person rule; 3. The qualifying child of another taxpayer rule; and 4. The main home rule.

The Age Rule

A taxpayer claiming the EIC must be at least age 25 but less than age 65 at the end of the tax year. If the taxpayer is married filing a joint return, either the taxpayer or spouse must be at least age 25 but under age 65 at the end of the year. Either spouse, i.e. the husband or wife, may satisfy the age test as long as one of the spouses does. If neither the taxpayer nor spouse is at least age 25 but under

age 65, the taxpayer cannot claim the EIC.

Death of Spouse During Year

A surviving spouse filing a joint return with a deceased spouse who died during the tax year meets the age test if the deceased spouse was at least age 25 but under age 65 at the time of death.

The Dependent of Another Person Rule

A taxpayer claiming the EIC cannot be the dependent of another person, regardless of whether or not the other person actually claimed the taxpayer as a dependent. Thus, if someone else can claim the taxpayer (or the taxpayer's spouse, if filing a joint return) as a dependent, the taxpayer cannot claim

the EIC, even if the other person did not actually claim the taxpayer as a dependent.

The Qualifying Child of Another Taxpayer Rule

A taxpayer claiming the EIC cannot be a qualifying child of another taxpayer. As noted earlier, a taxpayer is a qualifying child of another person if all the following are true:

The taxpayer is the other person’s son, daughter, stepchild, grandchild, or foster child; The taxpayer is the brother, sister, half-brother, half-sister, stepbrother, or stepsister (or a

child or grandchild of the brother, sister, half-brother, etc.) of the other person;

The taxpayer was – o Under age 19 at the end of the tax year and younger than the other person (or

spouse, if the other person files jointly), o Under age 24 at the end of the tax year, a student, and younger than the other person

(or spouse, if the other person files jointly), or o Permanently and totally disabled, regardless of age;

The taxpayer lived with the other person in the United States for more than half of the year;

and

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The taxpayer is not filing a joint return for the year (or is filing a joint return only as a claim

for a refund).

The Main Home Rule

Under the main home rule, a taxpayer claiming the EIC must have lived in the United States more

than half the year. A taxpayer will meet this rule only if he or she lived in the 50 states or the District of Columbia for more than half the year. It does not include Puerto Rico or U.S. possessions. The rule does not require that a taxpayer actually reside in a traditional home; instead, a taxpayer who lived in one or more homeless shelters in the United States for more than half the year will also meet the rule.

U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States during that duty period for purposes of the EIC.

Figuring the Amount of the Earned Income Credit

If the taxpayer meets all of the rules applicable to his or her claiming EIC, the next step is figuring the amount of EIC. Determining the earned income credit is done on either EIC Worksheet A (Appendix A) or EIC Worksheet B (Appendix B).

EIC Worksheet A is used if the taxpayer was not self-employed at any time during the tax year and was not a member of the clergy, a church employee who files Schedule SE, or a statutory employee filing schedule C or C-EZ.

EIC Worksheet B is used if the taxpayer was self-employed at any time during the year or was a member of the clergy, a church employee who files schedule SE or a statutory employee filing schedule C or C–EZ.

The instructions for IRS Form 1040 “Lines 66a and 66b” walk you through the EIC rules—the rules for all filers, for filers with a qualifying child and for filers without a qualifying child—just discussed.

Calculating Earned Income for EIC Purposes

In Step 5 of those Form 1040 EIC instructions, the taxpayer’s earned income for EIC purposes is

calculated. That calculation begins with inserting the total of the taxpayer’s wages, salaries, tips, etc. that appears on Form 1040, line 7. From that line 7 number, various amounts are then deducted to determine the taxpayer’s earned income for purposes of the EIC. If the taxpayer received nontaxable combat pay, the taxpayer may elect to include that nontaxable combat pay in earned income for EIC

purposes. However, electing to include the combat pay in earned income may increase or decrease the EIC.

The amount deducted from the total of the taxpayer’s wages, salaries, tips, etc. that appears on Form

1040 line 7 is the total of the following if included on line 7:

Taxable scholarships or fellowship grants not reported on Form W-2; Amounts received for work performed by the taxpayer while an inmate in a penal institution;

and Amounts received as a pension or annuity from a nonqualified deferred compensation plan or

nongovernmental section 457 plan.

The result of that calculation, plus the amount of nontaxable combat pay (if the taxpayer elects to include it), is the taxpayer’s earned income for EIC purposes.

Taxpayers Not Self-Employed, Statutory Employees, Clergy or Church Employees

The earned income total just calculated may or may not be modified, depending on the taxpayer’s

employment status. If the taxpayer is not a) self-employed, b) a statutory employee filing Schedule C or C-EZ or c) a member of the clergy or person with church employee income filing Schedule SE, the earned income amount is not modified for purposes of the EIC. Instead, it should simply be entered on

Worksheet A in Part 1, box 1.

Part 1 1. Enter your earned income from Step 5. 1

All Filers Using Worksheet A

2. Look up the amount on line 1 above in the EIC Table (right after Worksheet B) to find the credit. Be sure to use the correct column for your filing status and the number of children you have. Enter the

10

credit here.

If line 2 is zero, STOP. You cannot take the credit.

Enter “No” on the dotted line next to line 66a.

2

3. Enter the amount from Form 1040, line 38. 3

4. Are the amounts on lines 3 and 1 the same?

Yes. Skip line 5; enter the amount from line 2 on line 6.

No. Go to line 5.

To determine the amount to be entered in box 2 of Worksheet A, check the Earned Income Credit (EIC) Table in the instructions to Form 1040 for the amount of the taxpayer’s credit based on the taxpayer’s earned income shown in box 1 for the taxpayer’s filing status and number of children. The amount shown should be entered in box 2. An excerpt from a representative Earned Income Credit

(EIC) Table is shown below:

And your filing status is-

If the amount you are looking up from the worksheet is-

Single, head of household, or qualifying widow(er) and the number of children you have is-

Married filing jointly and the number of children you have is-

0 1 2 3 0 1 2 3

At least

But less than

Your credit is-

Your credit is-

19,000 19,050 0 3,114 5,208 5,891 76 3,305 5,460 6,143

19,050 19,100 0 3,106 5,198 5,880 72 3,305 5,460 6,143

19,100 19,150 0 3,098 5,187 5,870 68 3,305 5,460 6,143

For example, suppose the taxpayer’s earned income shown in box 1 is $19,067, the taxpayer files as

single and has one qualifying child. The amount shown in box 2 should be $3,106 (highlighted above). The amount entered in box 3 is the taxpayer’s adjusted gross income shown on line 38 of the taxpayer’s Form 1040. The amounts in boxes 1 and 3 are compared in Part 1, line 4; if they are the same, check “Yes” and enter the amount shown in box 2 in box 6. That is the amount of the taxpayer’s earned income credit.

Part 2

Filers Who Answered “No” on Line 4

5. If you have:

No qualifying children, is the amount on line 3 less than $8,270 ($13,820 if married filing jointly)?

1 or more qualifying children, is the amount on line 3 less than $18,190 ($23,740 if married filing jointly)?

Yes. Leave line 5 blank; enter the amount from line 2 on line 6.

No. Look up the amount on line 3 of the EIC Table to find the

credit. Be sure you use the correct column for your filing status and the number of children you have. Enter the credit here.

Look at the amounts on lines 5 and 2.

5

11

Then, enter the smaller amount on line 6.

Part 3

Your Earned Income Credit

6.

√

This is your earned income credit.

Reminder—

If you have a qualifying child, complete and attach Schedule EIC.

6

Enter this amount on Form 1040, line 66a.

If the amounts shown in boxes 1 and 3 are not the same—the amount in box 3 may be increased due to the taxpayer’s receipt of various income items or reduced because of various above-the-line deductions, such as alimony paid—check “No” in Part 1, line 4 and go to Part 2, line 5 (shown above).

If the amount in box 3 is less than the amount shown on line 5 for the taxpayer’s filing status and number of children, enter the amount shown in box 2 in box 6.

However, if the amount in box 3 is not less than the amounts shown on line 5 for the taxpayer’s filing status and number of children, look up the amount on line 3 in the Earned Income Credit (EIC) Table for the taxpayer’s filing status and number of children; then enter that amount in box 5. If an amount is entered in box 5, the amount that should be entered in box 6 is the smaller of the amount in box 5 or the amount in box 2.

When Worksheet A has been completed for the taxpayer, the amount entered in box 6, i.e. the taxpayer’s earned income credit, should be entered on Form 1040, line 66a.

If the taxpayer was a member of the U.S. Armed Forces who served in a combat zone, certain pay is excluded from income. The taxpayer can elect to include this pay in earned income when figuring the EIC but is not required to do so. Making the election to include nontaxable combat pay may increase or decrease the taxpayer’s EIC. So, it is important for the tax preparer to determine the applicable

credit both with the nontaxable combat pay included and with it excluded. The amount of the nontaxable combat pay should be shown in box 12 of Form(s) W-2 with code Q. If the taxpayer is filing a joint return and both the taxpayer and spouse received nontaxable combat pay, the taxpayer and spouse can each make their own election.

Self-Employed Taxpayers, Statutory Employees, Clergy and Church Employees

As noted earlier, the earned income total calculated in Step 5 of the Form 1040 EIC instructions may or may not be modified, depending on the taxpayer’s employment status. If the taxpayer is a) self-

employed, b) a statutory employee filing Schedule C or C-EZ, or c) a member of the clergy or person with church employee income filing Schedule SE, Worksheet B is used to determine the taxpayer’s earned income credit.

Using Worksheet B to figure the EIC is required if the taxpayer answered “Yes” to Step 5, question 3. Answering “Yes” to question 3 indicates that the taxpayer was a) self-employed at any time during the year, b) filing Schedule SE as a member of the clergy or as someone who had church employee income, or c) filing Schedule C or C-EZ as a statutory employee. The tax preparer should complete

Worksheet B, Part 1 if the taxpayer was required to file Schedule SE and:

Was self-employed; Was a member of the clergy; or Received church employee income.

12

Part 1

Self-Employed, Members of the Clergy, and

People With Church Employee Income Filing Schedule SE

1a.

b.

c.

d.

e.

Enter the amount from Schedule SE, Section A, line 3, or Section B, line 3, whichever applies.

Enter any amount from Schedule SE, Section B, line 4b, and line 5a.

Combine lines 1a and 1b.


Subtract line 1d from 1c.

+

=

-

=

1a

1b

1c

1d

1e

The amount to be entered in Part 1, box 1a is the combination of a) net farm profit or loss and farm partnerships, b) minus the amount of Conservation Reserve Program payments if the taxpayer

received social security retirement or disability benefits (current law taxes such program payments otherwise), and c) the net profit or loss from self-employment (from Schedule C, C-EZ and K-1). The amount to be entered in Part 1, box 1b is the amount shown on Schedule SE, Section B, line 4b (for self-employed taxpayers electing an optional method to figure net earnings) and line 5a (church employee income from Form W-2). Enter the total of box 1a and box 1b in box 1c. Enter the amount shown on Schedule SE as a deduction for one-half of self-employment tax (Section A, line 6 or Section

B, line 13) in box 1d. Subtract the amount in box 1d from the amount in box 1c, and enter the result in box 1e.

The amount to be entered in Part 2, box 2a is the net farm profit or loss from Schedule F, line 34 and farm partnerships, Schedule K-1 (Form 1065), box 14, code A. The amount to be entered in box 2b is the net profit or loss from Schedule C, line 31, Schedule C-EZ, line 3, Schedule K-1 (Form 1065), box 14, code A (other than farming) and Schedule K-1 (Form 1065-B), box 9, code J1. Enter the sum of box 2a and box 2b in box 2c.

Part 2

2. Do not include on these lines any statutory employee income, any net profit from services performed as a notary public, any amount exempt from self-employment tax as a result of the filing and approval of Form 4029 or Form 4361, or any other amounts exempt from self-employment tax.

Self-Employed NOT Required To File Schedule SE

a.

b.

c.

Enter any net farm profit or (loss) from Schedule F, line 34, and from farm partnerships, Schedule K-1 (Form 1065), box 14, code A*.

Enter any net profit or (loss) from Schedule C, line 31; Schedule C-EZ, line 3; Schedule K-1 (Form 1065), box 14, code A (other than farming); and Schedule K-1 (Form 1065-B), box 9, code J1*.


*If you have any Schedule K-1 amounts, complete the appropriate line(s) of Schedule SE, Section A. Reduce the Schedule K-1 amounts as described in the Partner’s Instructions for Schedule K-1. Enter your name and social security number on Schedule SE and attach it to your return.

+

=

2a

2b

2c

13

For statutory employees2—those taxpayers who are considered independent contractors under

common law rules and employees by statute for purposes of social security and Medicare contributions—tax preparers must use Part 3 of Worksheet B. In box 3 of the worksheet, simply enter the amount on Schedule C or Schedule C-EZ, line 1.

Part 3

Statutory Employees Filing Schedule C or C-EZ

3. Enter the amount from Schedule C, line 1, or Schedule C-EZ, line 1, that you are filing as a statutory employee.

3

When Parts 1, 2 and 3 of Worksheet B have been completed, the amounts entered in boxes 1e, 2c and 3 need to be added to the taxpayer’s earned income from Step 5. So, enter the taxpayer’s earned

income from Step 5 in Part 4, box 4a. Then add the amounts in Worksheet B boxes 1e, 2c, 3 and 4a and enter the total in box 4b. This amount should also be entered in Part 5, box 6.

Part 4

All Filers Using Worksheet B

4a

b.

Enter your earned income from Step 5.

Combine lines 1e, 2c, 3, and 4a. This is your total earned income.

4a

4b

5.

If line 4b is zero or less, STOP. You cannot take the credit. Enter “No” on the dotted line next to line 66a.

If you have:

3 or more qualifying children, is line 4b less than $47,955 ($53,505 if married filing jointly)? 2 qualifying children, is line 4b less than $44,648 ($50,198 if married filing jointly)? 1 qualifying child, is line 4b less than $39,296 ($44,846 if married filing jointly)?

No qualifying children, is line 4b less than $14,880 ($20,430 if married filing jointly)?

Yes. If you want the IRS to figure your credit, see Credit figured by the IRS, earlier. If

you want to figure the credit yourself, enter the amount from line 4b on line 6 of this worksheet.

No. STOP. You cannot take the credit. Enter “No” on the dotted line next to line 66a.

The total earned income calculated using Worksheet B is the income on which the EIC—the amount

that should be entered in box 7—is based. Thus, to determine the amount to be entered in box 7 of Worksheet B, check the Earned Income Credit (EIC) Table in the instructions to Form 1040 and find the amount of the credit, if any, based on the taxpayer’s total earned income shown in box 6 for the taxpayer’s filing status and number of children. The amount shown should be entered in box 7.

An excerpt from the Earned Income Credit (EIC) Table is shown below:

And your filing status is-

If the amount you are looking up from the worksheet is-

Single, head of household, or qualifying widow(er) and the number of children you have is-

Married filing jointly and the number of children you have is-

0 1 2 3 0 1 2 3

At least

But less than

Your credit is-

Your credit is-

2 Statutory employees enjoy the ability to deduct business expenses without reference to the 2% of AGI threshold applicable to common law employees.

14

23,400 23,450 0 2,411 4,282 4,964 0 3,278 5,425 6,108

23,450 23,500 0 2,403 4,271 4,954 0 3,270 5,415 6,097

23,500 23,550 0 2,395 4,261 4,943 0 3,262 5,404 6,087

For example, suppose the taxpayer’s total earned income shown in box 6 is $23,505, the taxpayer files as married filing jointly and has three qualifying children. The amount shown in box 7 should be $6,087 (highlighted above).

The amount entered on Worksheet B, Part 5 in box 8 is the taxpayer’s adjusted gross income shown on line 38 of the taxpayer’s Form 1040. The amounts in boxes 6 and 8 are compared in Part 5, line 9; if they are the same, check “Yes” and enter the amount shown in box 7 in box 11. That is the amount of the taxpayer’s earned income credit.

Part 5 6. Enter your total earned income from Part 4, line 4b. 6


7. Look up the amount on line 6 above in the EIC Table to find the credit. Be sure to use the correct column for your filing status and the number of children you have. Enter the credit here.



7




No. Go to line 10.

If the amounts in boxes 6 and 8 differ from each other, answer the questions in Part 6, line 10.

Part 6


10. If you have:








10

Part 7


11.

√


Reminder—


11

Enter this amount on

Form 1040, line 66a.

15

If the answer to the questions on line 10 is “Yes,” enter the amount previously entered in box 7 into

box 11. However, if the answer to the questions posed in line 10 is “No,” look up the earned income credit in the EIC Table for the taxpayer’s filing status and number of children using the amount shown in box 8 and put the amount of credit shown in the Table in box 10. If the resulting amounts in boxes

7 and 10 differ from one another, enter the smaller amount in box 11. That is the amount of the taxpayer’s earned income credit.

The amount of any applicable EIC is entered in the appropriate line of the taxpayer's return. (Line 66a on IRS Form 1040.)

Summary

The rules that apply to claiming the earned income credit fall into three categories: a) rules that apply to everyone, b) rules that apply if the taxpayer has a qualifying child, and c) rules that apply if the

taxpayer does not have a qualifying child.

Under the EIC rules that apply to everyone, whether or not having a qualifying child a) the taxpayer’s AGI cannot exceed specified levels based on filing status, b) the taxpayer must have a valid social security number, c) a taxpayer eligible to claim the EIC cannot be married filing separate, d) if the

taxpayer (or spouse, if married) was a nonresident alien for any part of the tax year, the taxpayer cannot claim the EIC unless the taxpayer’s filing status is married filing jointly, e) a taxpayer

excluding foreign earned income is ineligible to claim the EIC, f) the investment income of a taxpayer eligible to claim the EIC cannot exceed a specified amount, and g) a taxpayer otherwise eligible to claim the EIC must work and receive earned income.

If a taxpayer who meets the EIC rules applicable to all filers has a qualifying child, the qualifying child must also meet certain rules. Those rules require that the child a) be a son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother or stepsister of the taxpayer, or a descendant of any of them, b) be younger than age 19 at the end of the year and younger than the

taxpayer or taxpayer’s spouse, younger than age 24 if a student and younger than the taxpayer or taxpayer’s spouse, or permanently and totally disabled regardless of age, c) have lived with the taxpayer in the U.S. for more than half the year, and d) not have filed a joint tax return for the year except to claim a refund. In addition, a child cannot be the qualifying child of more than one person even if the child meets the tests to be a qualifying child of more than one person. In the event the taxpayer and another person both meet the qualifying child tests, the tiebreaker rules are used to

determine which person can treat the child as a qualifying child. Lastly, a taxpayer cannot claim the

EIC if he or she is a qualifying child of another taxpayer.

The EIC rules that apply to a taxpayer with no qualifying child are: a) the age rule pursuant to which, a taxpayer claiming the EIC must be at least age 25 but less than age 65 at the end of the year, b) the dependent of another person rule, under which a taxpayer cannot be the dependent of another person, c) the qualifying child of another taxpayer rule, under which a taxpayer cannot be a qualifying child of another taxpayer, and d) the main home rule under which a taxpayer claiming the EIC must

have lived in the United States more than half the year.

If the taxpayer meets all the rules applicable to his or her claiming EIC, the amount of EIC for which the taxpayer is eligible is determined using EIC Worksheet A—for taxpayers who were not self-employed, not a member of the clergy, not a church employee who files Schedule SE, nor a statutory employee filing schedule C or C-EZ—or EIC Worksheet B for those taxpayers who can be included in one of those categories.

Chapter Review

1. Susan has three qualifying children and files her federal income tax return as married filing separate. In order to qualify for EIC in 2016, she must have an AGI of less than:

A. $53,505

B. $47,955

C. Susan is ineligible for EIC

D. $14,880

16

2. Arthur is married to a nonresident alien who lives in Mexico City. Under what circumstances could

he be eligible for the earned income credit based on 2016 income?

A. Only if he files a federal tax return as married filing jointly

B. Only if the taxpayer was also a nonresident alien for part of the year

C. Only if the taxpayer’s spouse agreed that her foreign income would be subject to U.S. taxation

D. Under no circumstances would the taxpayer be eligible for EIC

3. Shirley and Carl are raising three children: their daughter’s son, Carl’s brother and a child placed with them by its parent. How many qualifying children do they have under the relationship test for purposes of the earned income credit?

A. They have no qualifying children under the relationship test

B. They have two qualifying children under the relationship test

C. They have one qualifying child under the relationship test

D. They have three qualifying children under the relationship test

4. Peter is considered permanently and totally disabled. He is a student at the local community college and lives with his brother and his brother’s wife. What is the maximum age Peter may be and still meet the age test for purposes of the EIC?

A. Younger than age 19

B. Younger than age 21

C. Younger than age 24

D. No age limit applies in this case

5. What is the maximum age an unmarried taxpayer with no qualifying children may be at the end of the tax year and still qualify for the earned income credit?

A. Age 21

B. Age 25

C. Age 64

D. Age 70 ½

17

Chapter 2 – Earned Income Credit Errors

Introduction

Earlier, it was noted that EIC claims in any year generally total more than $60 billion; in 2014, EIC payments totaled $60.1 billion. The IRS estimates that a substantial percentage of EIC payments made are paid in error.

Executive Order 13520, signed on November 20, 2009, increased the accountability of federal agencies generally for reducing improper payments. Accordingly, the Treasury Inspector General for Tax Administration (TIGTA) annually assesses IRS compliance with the executive order. The title of

the 2014 inspector general’s report3—Existing Compliance Processes will not Reduce the Billions of Dollars in Improper Earned Income Tax Credit and Additional Child Tax Credit Payments—speaks volumes.

In this chapter we will look at the most common errors the IRS encounters in handling federal tax

returns containing earned income credit claims, the probable impact of those errors on the federal government’s revenue collection, and the additional questions that tax preparers may be required to

ask their clients.

Learning Objectives


Recognize the incidence of errors in claiming the earned income credit and their probable causes;

Identify the estimated impact of earned income credit errors on federal revenue; List the most common earned income credit errors and their potential problem areas; and

Recognize the additional questions tax preparers need to ask if taxpayer-provided information appears incorrect, inconsistent or incomplete.

Incidence of Earned Income Credit Errors

In 2009, an Executive Order4 was signed by the president under which federal agencies’ accountability

for reducing improper payments increased. Because of that Executive Order, federal agencies, including the Internal Revenue Service, assess their compliance with the executive order through an audit on an annual basis. Accordingly, the Treasury Inspector General for Tax Administration has

completed such an audit and issued a final report on September 29, 2014—a report titled Existing Compliance Processes will not Reduce the Billions of Dollars in Improper Earned Income Tax Credit and Additional Child Tax Credit Payments —in which it reports that the IRS estimates it made $14.5 billion in improper earned income tax credit payments in the prior fiscal year, an amount that represents 24% of all EITC payments for the year..

The report by the Treasury Inspector General for Tax Administration estimates5 the range of improper

EIC payments over the years since 2003 to be as shown in the table below:

Fiscal Year

Minimum Percentage of Improper Earned Income

Credit Payments

Maximum Percentage of Improper Earned Income

Credit Payments

2003 25% 30%

2004 22% 27%

2005 23% 28%

3 https://www.treasury.gov/tigta/auditreports/2014reports/201440093_oa_highlights.pdf. 4 Executive Order 13520, Reducing Improper Payments and Eliminating Waste in Federal Programs,

was signed on November 20, 2009. 5 Ibid, p.6.

https://www.treasury.gov/tigta/auditreports/2014reports/201440093_oa_highlights.pdf

18

2006 23% 28%

2007 23% 28%

2008 23% 28%

2009 23% 28%

2010 24% 29%

2011 21% 26%

2012 21% 25%

An improper EIC payment is deemed to occur if a taxpayer whose EIC claim is selected for review:

Does not substantiate the claim to the IRS’s satisfaction; Is ineligible for the EIC; or Received too large a credit.

As we can see from the estimated range of improper payments, the overall improvement in the incidence of improper EIC payments has been minimal.

Factors Leading to Earned Income Credit Errors

The Treasury Inspector General for Tax Administration identified several factors that have given rise to

the high percentage of errors and continue to function as barriers to reducing them. Principal among those identified factors are:

Complexity of the tax law; Structure of the earned income credit; Confusion among eligible claimants; High turnover of eligible claimants; Unscrupulous tax return preparers; and

Fraud.

The complexity of the tax law and regulations relative to the EIC benefit—a complexity that is seen as a cause of many of the improper EIC payments—is largely a result of the efforts made by Congress to

target the tax credit specifically to its intended recipients as way of minimizing the cost of providing it. To ensure the credit is enjoyed only by those for whom intended and not by others, the rules specifically define those who are eligible.

In addition, improper payments may result from the complex nature of the lives of claiming families. We can see how that family complexity may result in an improper payment by looking at an example.

Suppose that parents of a child are divorced and the non-custodial parent pays child support. Further suppose that the terms of the divorce agreement permit the parent providing the child support to claim the child tax credit. In such a case, the non-custodial parent may reasonably believe—despite being incorrect—that he or she is also permitted to claim the child for purposes of the EIC. However, as the rules provide, the EIC can be claimed only by the parent who has custody of the child for more

than half the year. Clearly, the non-custodial parent would not satisfy that requirement.

Estimated Revenue Impact of Earned Income Credit Errors

Not surprisingly, the extent of the improper EIC payments has a considerable impact on the net tax

revenue received by the federal government. For fiscal year 2013, improper earned income credit errors are estimated to have resulted in erroneous payments amounting to $14.1 billion. The cost to taxpayers of improper earned income credit payments for the ten-year period from 2003 through 2012 is shown in the table below:

Fiscal Year

Minimum Improper EIC Payments in Dollars

(Billions)

Maximum Improper EIC Payments in Dollars

(Billions)

2003 $9.5 $11.5

19

2004 $8.6 $10.7

2005 $9.6 $11.4

2006 $9.8 $11.6

2007 $10.4 $12.3

2008 $11.1 $13.1

2009 $11.2 $13.3

2010 $15.3 $18.4

2011 $13.7 $16.7

2012 $11.6 $13.6

Common Earned Income Credit Errors

Although earned income credit errors may result from a wide range of factors, the IRS reports that more than 80% of all earned income credit errors involve only four issues. The issues that cause a disproportionate share of earned income credit errors are those involving:

Qualifying children; Filing status; Income reporting errors; and Incorrect Social Security numbers.

Let’s briefly consider each of these issues, the appropriate rules governing them and the questions a tax preparer should ask if the information provided by the client appears to be incorrect, inconsistent

or incomplete.

Earned Income Credit Errors Involving Qualifying Children

The earned income credit error most commonly encountered is one involving a qualifying child. In the case of errors involving qualifying children, the child fails to meet all of the four eligibility tests, i.e. the tests related to the child’s age, relationship, residency or joint return. In most cases in which there

is an error the child does not meet either the relationship or the residency test.

Qualifying Child Requirements

As discussed at some length earlier, the applicable rule for claiming a child as a qualifying child for purposes of the EIC requires that:

To be a qualifying child, the child must meet all relationship, age, residency and joint return requirements; and

In the event two people filing separate tax returns claim the same child for purposes of the earned income credit, the tie-breaker rules are used to determine which taxpayer has the valid claim.

Thus, a child is a qualifying child for purposes of the EIC only if the child:

Meets the relationship, age, and residency tests; and Has not filed a joint tax return or, if the qualifying child and spouse have filed a joint tax

return, they –

o Do not have a filing requirement, and o Filed a joint return only to claim a refund (other than the EIC).

In the case of a child who is a qualifying child of more than one person, special rules apply. Specifically:

If the child is a qualifying child of more than one person and neither is a parent of the child – o They can agree with respect to which party can claim the child as a qualifying child, or o If they cannot agree as to who will claim the child as a qualifying child, the IRS applies

the tie-breaker rules; and

20

If the child is a qualifying child of more than one person and one or more of those persons is a

parent of a child, a person other than a parent can claim the child only if his or her AGI is higher than the AGI of any parent of the child.

When a Child is Disabled

In order for a non-disabled child to be considered a qualifying child, he or she must normally meet the relationship, age and residency tests. Accordingly, to meet the age test to be a qualifying child a non-disabled child must be under age 19 at the end of the year or a full-time student under the age of 24 at the end of the year. When a person meets the relationship, residency and joint return tests and is permanently and totally disabled, however, the age requirements applicable to being a qualifying child do not apply.

A person is considered “permanently and totally disabled” for purposes of the EIC if both of the

following conditions apply:

The person cannot engage in any substantial gainful activity due to a physical or mental condition; and

A doctor determines the condition has lasted or can be expected to last continuously for at

least a year or can lead to death.

The term substantial gainful activity is defined and discussed in IRS Publication 524. As discussed in

Publication 524 “Credit for the Elderly or Disabled” substantial gainful activity is the performance of significant duties over a reasonable period of time while working for pay or profit, or in work generally done for pay or profit. Full-time work (or part-time work done at an employer's convenience) in a competitive work situation for at least the minimum wage conclusively shows that the individual is able to engage in substantial gainful activity.

Substantial gainful activity is not work done by the individual to take care of himself or herself or the person’s home. It is not unpaid work on hobbies, institutional therapy or training, school attendance,

clubs, social programs, and similar activities. However, doing this kind of work may show that the individual is able to engage in substantial gainful activity.

The fact that the individual has not worked for some time is not, of itself, conclusive evidence that he or she cannot engage in substantial gainful activity.

Avoiding Qualifying Child Earned Income Credit Errors

It is important, as a way of avoiding EIC errors, for the tax preparer to ask the client additional questions if the preparer believes the information provided by the client is incorrect, inconsistent or

incomplete. Thus, additional questions about the qualifying child and the child’s relationship to the client should be asked of the client if the preparer encounters any of the following:

A client claims a qualifying child other than a son or daughter, the tax preparer should inquire as to –

o the location of the child’s parents, o whether the parent lives in the client’s household,

o whether any other relative lives in the client’s household, and o whether anyone else can claim the child as a qualifying child;

The client’s age is inconsistent with the age of the qualifying child, the tax preparer should verify the relationship between the client and the qualifying child;

The client is very young and has a qualifying child, the tax preparer should ask if the client could be a qualifying child of another person;

The client is a single taxpayer with a young qualifying child but no child care expenses, the tax

preparer should verify the child care arrangements or ask whether anyone else lives in the client’s household; or

The client claims an adult with a disability as a qualifying child, the tax preparer should verify that the adult meets the tax law definition of permanently and totally disabled (discussed above).

Earned Income Credit Errors Involving a Client’s Filing Status

A second common EIC error involves a client’s filing status. A client may qualify for the EIC with a

filing status of Married Filing Joint, Qualified Widow(er) with Dependent Child, Single or Head of

21

Household provided he or she is otherwise qualified for the credit. The only filing status that would

preclude a client’s eligibility for EIC is Married Filing Separate. However, the IRS notes that some married taxpayers falsely state they qualify for single or Head of Household filing status in order to claim more EIC.

Let’s briefly review the requirements for a client to file as Single or Head of Household.

Single Filing Status

A client may file as single only if he or she:

Had never been married; Was legally separated according to applicable state law under a divorce or separate

maintenance decree at the end of the year (if a divorce was not final at the end of the year, the client is considered married); or

Was widowed before the beginning of the tax year and did not remarry before the end of the year.

Head of Household Filing Status

More problematic from the perspective of filing status is the client who wishes to file as Head of Household. The ability to file as Head of Household is limited to unmarried individuals who provide a home for certain other persons and meet one of two tests related to the costs of maintaining a home

during the year.

A client is considered unmarried for purposes of filing as Head of Household if any of the following applies:

The client was legally separated according to applicable state law under a divorce or separate maintenance decree at the end of the year (if a divorce was not final at the end of the year, the client is considered married);

The client was married but lived apart from his or her spouse for the last 6 months of the year

and meets certain other rules applicable to married persons living apart; or The client is married to a nonresident alien at any time during the year and the client does not

elect to treat the spouse as a resident alien.

In addition to being considered unmarried, the client must meet one of the following tests:

The client paid more than half the cost of keeping up a home that was the main home for all of the year of the client’s parent who is claimed as a dependent (the parent does not have to live with the client); or

The client paid more than half the cost of keeping up a home in which the client lived and in which one of the following also lived for more than half the year –

o A person the client can claim as a dependent, except for – The client’s child who is claimed as a dependent because of the rule for

children of divorced or separated parents, A person who is the client’s dependent only because of living with the client

for all the year, or A person the client claimed as a dependent under a multiple support

agreement, o The client’s unmarried qualifying child who is not the client’s dependent, o The client’s married qualifying child who is not the client’s dependent only because the

client can be claimed as a dependent on another person’s return for the year, or

o The client’s qualifying child who is not the client’s dependent because of the rule for

children of divorced or separated parents, even though the client is the custodial parent.

Married Persons Living Apart

A client who is married may be considered unmarried and use a Head of Household filing status in certain cases. The exception permitting a married client to file as Head of Household is limited and only available if all of the following apply:

The client lived apart from his or her spouse for the last 6 months of the year (temporary

absences are considered time living at home);

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The client files a separate return from the spouse;

The client paid more than half the cost of keeping up his or her home during the year; The client’s home was the main home of the client’s child, stepchild or foster child for more

than half the year; and

The client can claim the child as his or her dependent or could claim the child except that the child’s other parent can claim the child under the rule for children of divorced or separated parents.

Avoiding Filing Status Earned Income Credit Errors

A tax return preparer working with a client claiming the EIC who wishes to file as Head of Household should ask additional questions if the preparer believes the client’s filing status may be incorrect. In addition, the preparer should also ask the client to provide the required supporting documents to

prove Head of Household filing status.

A client wishing to file as Head of Household must meet the marriage test, the qualifying person test and the cost of keeping up a home test. The supporting documents6 that must be furnished to the IRS with respect to those tests include:

If the client is divorced or legally separated, the entire divorce decree, separate maintenance decree or separation agreement must be provided;

If the client is married but claims the spouse did not live with him or her during the last 6 months of the tax year, documents verifying the spouse did not live with the client during the last 6 months of the year should be furnished, such as –

o A lease agreement, o Utility bills, o A letter from a clergy member, or o A letter from social services;

To meet the qualifying person test, the following documents should be furnished as appropriate –

o Birth certificates or other official birth documents, o Marriage certificates, o A letter from an authorized adoption agency, o A letter from an authorized placement agency,

o Court documents that verify the client’s relationship to the child, and

o Documents showing the child and the client lived together for more than half the year, including –

School, medical, daycare or social services records, and A letter on the official letterhead from a school, medical provider, social

service agency or place of worship that shows names, common address and dates; and

To show the client paid more than half the cost of keeping up the home for the year, provide – o Rent receipts, o Utility bills, o Grocery receipts, o Property tax bills, o Mortgage interest statement, o Upkeep and repair bills,

o Property insurance statement, and o Other household bills.

Earned Income Credit Errors Involving Income Reporting

Income reporting errors also contribute to a large number of EIC errors. In addition to a taxpayer’s filing status and number of children, the EIC amount for which a taxpayer may be eligible is highly dependent on the amount of income received by the taxpayer during the year.

The Earned Income Credit (EIC) Table identifies the income levels at which EIC is maximized, begins

to decline, and ends for each filing status and number of qualifying children. Thus, we can see the

6 See IRS Form 886-H-HOH, Supporting Documents To Prove Head of Household Filing Status.

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income levels at which these changes occur for a taxpayer filing his or her federal income tax form as

Single, Head of Household or Qualifying Widow(er) by looking at the following representative chart:

Taxpayers Filing Single, Head of Household or Qualifying Widow(er)*

Number of Qualifying Children

EIC is Maximized

EIC begins to Decline

EIC Ends

0 $6,450 $8,150 $14,590

1 $9,700 $17,850 $38,511

2 $13,650 $17,850 $43,756

3 or more $13,650 $17,850 $47,000

*Based on 2014 Earned Income (EIC) Table

For taxpayers whose status is Married Filing Joint, the income levels, although mostly higher,

generally follow the same pattern. Thus, the income levels at which the EIC changes occur for a taxpayer whose filing status is Married Filing Joint are as shown in the next representative chart:

Taxpayers Filing Married Filing Joint Returns*

Number of Qualifying Children

EIC is Maximized

EIC begins to Decline

EIC Ends

0 $6,450 $13,550 $20,020

1 $9,700 $23,300 $43,941

2 $13,650 $23,300 $49,186

3 or more $13,650 $23,300 $52,428

*Based on 2014 Earned Income (EIC) Table

Although the above charts reflect the applicable 2014 EIC table—and the income limits can be expected to be different in other years—the income amounts at which an otherwise eligible taxpayer’s EIC reaches its highest level, begins to reduce and eventually ends are likely to retain this basic design.

In view of the limits applicable to the EIC, it should be clear that taxpayers interested in becoming

eligible for the EIC or increasing the amount of EIC for which they are eligible may have an interest in erroneously reporting income that is greater than or less than their actual income. Such erroneous reporting could include a taxpayer with a Schedule C or Schedule F showing:

Large losses that lower income to qualify for EIC; Bogus or inflated income that maximizes the taxpayer’s EIC; and Income maximizing EIC but reporting no expenses.

Self-employed taxpayers that file a Schedule C or Schedule F are required to report the correct gross income and all permitted deductions on their returns.

Avoiding Income Reporting Earned Income Credit Errors

In order to help avoid income reporting errors, tax return preparers must be aware of potential EIC income reporting problems and ensure they have sufficient income and expense information to enable them to prepare a complete and correct tax return. Some of the income reporting red flags that should cause a tax return preparer to seek additional information from a client are:

W-2 forms and 1099 forms that appear altered or hand-prepared; W-2 forms that vary in appearance from others received from the same employer; W-2 forms with overstated withholding amounts; Schedule C or Schedule F income that appears questionable, particularly income not reported

on a Form 1099; Client income that appears insufficient to support the client and his or her qualifying children; Schedule C or Schedule F income or losses unsupported by records;

Schedule C or Schedule F losses that don’t appear reasonable in light of the business, the client’s income and previous tax returns; and

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Businesses reporting income on Schedule C or Schedule F that show unusually low or no

expenses, particularly when other similar businesses normally incur such expenses.

Tax preparers should ask clients if they have provided all information with respect to their income. In addition, clients claiming income from self-employment that exceeds the aggregate amounts shown on

their Forms 1099 should be asked to explain how they computed their income. Self-employed clients who claim to have expenses that are unsupported by appropriate records should also be asked to explain how they calculated their expenses.

Earned Income Credit Errors Involving Social Security Numbers

The final common error noted in the Inspector General’s report involved social security numbers. Every taxpayer, spouse and qualifying child is required to have a valid social security number in order to claim EIC. If a client’s or spouse’s social security number does not match the Social Security

Administration records or if it is invalid or missing, the IRS may reject the return and disallow any claimed EIC.

Certain documents and identification numbers are not valid for purposes of the earned income credit. Such documents/numbers are:

Individual Taxpayer Identification Numbers (ITINs); Adoption Taxpayer Identification Numbers (ATINs); and

Social Security cards issued to individuals from foreign countries who are lawfully admitted to the United States without Department of Homeland Security work authorization and which bear the legend “NOT VALID FOR EMPLOYMENT.”

Avoiding Social Security Number Earned Income Credit Errors

Generally social security number and math errors are caught automatically by the IRS. Thus, little is requested from the tax preparer with respect to a client’s social security number. However, although the IRS does not require a tax preparer to review a client’s social security cards, it is generally

considered a good practice to do so and to keep a copy of the documents reviewed.

Summary

In 2009, an Executive Order was signed by the president under which federal agencies’ accountability for reducing improper payments increased. The Treasury Inspector General for Tax Administration has

completed an audit and issued a report in which it reports that a) the IRS has made little improvement in reducing improper earned income tax credit payments and b) in fiscal year 2013 it is estimated that 24% of EIC payments were improper. An improper EIC payment occurs if a taxpayer whose EIC claim

is selected for review fails to substantiate the claim to the IRS’s satisfaction, is found to be ineligible for the EIC, or received too large a credit.

Chief among the factors identified as contributing to the high level of improper payments are the complexity of the tax law, the structure of the earned income credit, eligible claimant confusion, the high turnover of eligible claimants, unscrupulous tax return preparers, and fraud. Over the ten-year period from 2003 through 2012, the total estimated cost to taxpayers of the improper EIC payments

ranges from $110.8 billion to $132.6 billion and, in 2013 amounted to $14.5 billion. Four factors account for more than 80% of all earned income credit errors: qualifying children, filing status, income reporting errors and incorrect social security numbers.

The earned income credit error most commonly encountered is one involving a qualifying child. In the case of errors involving qualifying children, the child fails to meet all of the four eligibility tests, i.e.

the tests related to the child’s age, relationship, residency or joint return. In most cases in which there is an error the child does not meet either the relationship or the residency test. Accordingly, additional

questions about the qualifying child and the child’s relationship to the client should be asked of the client if the preparer believes the information received is incorrect.

A second common EIC error involves a client’s filing status. A client may qualify for the EIC with a filing status of Married Filing Joint, Qualified Widow(er) with Dependent Child, Single or Head of Household provided he or she is otherwise qualified for the credit. The only filing status that would preclude a client’s eligibility for EIC is Married Filing Separate. However, the IRS notes that some married taxpayers falsely state they qualify for single or Head of Household filing status in order to

claim more EIC.

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Income reporting errors also contribute to a large number of EIC errors. In addition to a taxpayer’s

filing status and number of children, the EIC amount for which a taxpayer may be eligible is highly dependent on the amount of income received by the taxpayer during the year. Taxpayers interested in becoming eligible for the EIC or increasing the amount of EIC for which they are eligible may have an

interest in erroneously reporting income that is greater than or less than their actual income.

The final common error involves social security numbers. Every taxpayer, spouse and qualifying child is required to have a valid social security number in order to claim EIC. If a client’s or spouse’s social security number does not match the Social Security Administration records or if it is invalid or missing, the IRS may reject the return and disallow any claimed EIC.

In all cases involving EIC errors, the tax preparer must ask additional questions of the client if he or she believes the information provided by the client is incorrect, inconsistent or incomplete.

Chapter Review

1. Which of the following types of activity would conclusively show that an individual is able to engage in substantial gainful activity and, therefore, would not be permanently and totally disabled for EIC purposes?

A. Working part-time in a competitive work situation for minimum wage

B. Attending school

C. Volunteering for Meals on Wheels

D. Performing the normal activities of daily living

2. Which of the following is the most commonly encountered earned income credit error?

A. An error involving the taxpayer’s filing status

B. An error involving the taxpayer’s reported income

C. An error involving a qualifying child

D. An error involving an incorrect social security number

3. Helen is a married client with a qualifying child who is interested in filing as Head of Household

and claiming the earned income credit. If she is otherwise qualified for the credit which of the following conditions must she meet in order to qualify?

A. Helen must file her federal tax return as Married Filing Separate

B. Helen’s qualifying child must be an adopted child

C. Helen must be younger than her husband and younger than her qualifying child

D. Helen must have lived apart from her spouse for the last 6 months of the year

4. A taxpayer is ineligible for the earned income credit, even if otherwise eligible, if filing a federal income tax return as:

A. Single

B. Married Filing Separate

C. Head of Household

D. Married Filing Joint

5. What portion of the cost of keeping up a main home must be paid by a taxpayer filing as Head of Household?

A. All the cost of keeping up the house must be paid by the taxpayer

B. At least 25% of the cost of keeping up the house must be paid by the taxpayer

C. More than half the cost of keeping up the house must be paid by the taxpayer

D. No required home maintenance level is required to file as Head of Household

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Chapter 3 - EIC Disallowance

Introduction

Multiple tools are used by the IRS to identify EIC errors and reduce the extent of improper EIC payments. While those efforts are estimated to save almost $4 billion in EIC claims from being paid improperly in any year, they result in a substantial number of denied EIC claims. Those denials impact taxpayers’ EIC claims in subsequent years. This chapter examines the results of EIC disallowance.

Learning Objectives


List the principal tools used by the IRS to verify the propriety of EIC claims and to prevent or recover improper EIC payments;

Identify the additional requirements imposed on taxpayers claiming the EIC following

disallowance; Recognize the exceptions applicable to the requirement that a taxpayer file IRS Form 8862

following disallowance of an EIC claim;

Determine the year in which an IRS Form 8862 must be filed to claim EIC after the IRS has disallowed it; and

Recognize the duration of the prohibition against filing for the EIC in the event a taxpayer’s EIC error is determined to be the result of reckless/intentional disregard of EIC rules or fraud.

IRS Efforts to Reduce Improper EIC Payments

Although the Treasury Inspector General for Tax Administration has reported that the IRS is not in compliance with the executive order to reduce improper payments, the IRS has various tools in place

that it uses to verify EIC claims and prevent or recover improper EIC payments. The tools used by the IRS for this purpose include:

Automatic checking for math errors, including clerical errors and invalid taxpayer identification numbers, a process the IRS reports has protected approximately $320 million in

EIC refunds each year; Pre-refund examinations in which a review is conducted to determine the validity of EIC

claims before payment is made, a step that protected approximately $1.6 billion in EIC

refunds; Document matching in which income claimed on tax returns is matched to income reported

by third parties, a process that has resulted in the disallowance of $1.6 billion in EIC claims in a recent year; and

Post-refund examinations in which the validity of taxpayers’ EIC claims is determined by the IRS after an EIC payment has been made, a step that has protected approximately $.5

billion in EIC refunds annually.

Overall, the IRS efforts to reduce improper EIC payments result in a large amount of revenue protected. In view of those efforts, it’s clear that a fairly substantial number of EIC claims are disallowed entirely or reduced. When that disallowance occurs—either totally or partially—it may have consequences for the taxpayer.

Claiming EIC after Disallowance

Taxpayers whose EIC claim for any year after 1996 was denied or reduced by the IRS may need to

complete Form 8862, Information To Claim Earned Income Credit After Disallowance. IRS Form 8862, if required, must be attached to the current tax return of a taxpayer whose prior EIC claim was disallowed in order to claim the credit for a current year. Whether or not the form is required depends upon the reason for the denial or reduction and certain other factors.

IRS Form 8862 Timing

When the EIC is disallowed, the taxpayer receives a statutory notice of deficiency informing him or her that the EIC would be denied, an adjustment would be made and tax assessed unless the taxpayer

files a petition with the Tax Court within 90 days. If the taxpayer does not act on the notice within the

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90 days and the period ends before the taxpayer may file his or her tax return, a taxpayer claiming

the EIC must file IRS Form 8862 along with the tax return for the current year.

For example, suppose a taxpayer received a statutory notice of deficiency in September 2015 in connection with the disallowance of the EIC and did not file a petition with the Tax Court by the end of

the 90 day period that ends in December 2015. If the taxpayer claims the EIC for tax year 2015 (normally filed by April 15, 2016) an IRS Form 8862, if required, must be attached to the 2015 tax return. However, if the taxpayer received the statutory notice of deficiency in February 2016, any IRS Form 8862 filing would not be required until the tax return for 2016 is filed (usually April 15, 2017).

Filing IRS Form 8862

If a taxpayer whose EIC claim has been disallowed in a prior year wishes to claims the EIC in a current year, IRS Form 8862 must be attached to the client’s tax return unless:

An exception applies; or The client is prohibited from claiming the EIC in the current year because of

reckless/intentional disregard of EIC rules or fraud.

Let’s consider the exceptions to the need to file IRS Form 8862 first.

Exceptions

Exceptions to a taxpayer’s need to file IRS Form 8862 may apply to taxpayers claiming the EIC

whose:

Disallowance of a prior EIC claim was because of a math or clerical error; Prior IRS Form 8862 filing was accepted; or Prior EIC disallowance was for solely a qualifying child and no qualifying child is currently

being claimed.

If a taxpayer’s EIC claim was denied or reduced solely as the result of a math or clerical error—the arithmetic or Social Security number was incorrect, for example—IRS form 8862 should not be

attached to the taxpayer’s tax return; it is not required.

An IRS Form 8862 is not required to be attached to an EIC claimant’s tax return if, after the EIC was reduced or disallowed in a prior year, both of the following apply:

The taxpayer filed IRS Form 8862 in a later year and the EIC claim for that later year was allowed; and

The taxpayer’s EIC has not been reduced or disallowed again for any reason other than for a math or clerical error.

In addition, an IRS Form 8862 would not be required if the only reason for the disallowance of the taxpayer’s EIC claim in the earlier year was due to an IRS determination that a child listed on Schedule EIC was not the taxpayer’s qualifying child and the taxpayer is claiming EIC in the current year without a qualifying child.

Client Consequences of EIC Disallowance

When a client’s claim for EIC has been disallowed by the IRS, certain consequences may follow.

Principal among those consequences are:

Required repayment of any erroneously paid EIC plus possible penalties and interest; The need to file IRS Form 8862 (discussed above) in order to claim the EIC in a subsequent

year; and Possible prohibition of subsequent EIC claims for a period of years.

The most significant consequences for a client in connection with a disallowed EIC claim are those prohibiting him or her from claiming the EIC again for a period of years. Those consequences are

reserved for EIC claimants whose disallowance was due to reckless or intentional disregard of the EIC rules or to fraud.

Disallowance Due to Reckless or Intentional Disregard of EIC Rules

If a taxpayer’s EIC claim has been denied due to an error deemed by the IRS to constitute reckless or intentional disregard of the EIC rules, the taxpayer is prohibited from claiming EIC again for a two-

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year period. The two-year period begins with the first tax year for which the taxpayer has not yet filed

a tax return following the final determination. If the taxpayer has already filed his or her tax return for the current year by the end of the 90 days following receipt of the statutory notice of deficiency, the two-year period begins with the following year for which the taxpayer’s return has not been filed.

For example, suppose the taxpayer claimed the EIC on his or her 2014 tax return. Further suppose that the taxpayer received a statutory notice of deficiency relative to that EIC claim from the IRS in September 2015 indicating an adjustment would be made and tax assessed unless the taxpayer filed a petition with the Tax Court within 90 days. If the taxpayer did not file a petition with the Tax Court within the time allotted, EIC would be denied in December 2015. If the IRS determined the EIC error was due to reckless or intentional disregard of EIC rules, the taxpayer would be prohibited from claiming the EIC for tax years 2015 and 2016. In order to claim the EIC for tax year 2017, the

taxpayer must complete and attach IRS Form 8862.

However, if the taxpayer had received the statutory notice of deficiency in November 2015 and filed the 2015 tax return in January 2016, the 90-day period would not have expired before the 2015 return was filed. Thus, the taxpayer would be barred from claiming EIC for years 2016 and 2017.

Disallowance Due to Fraud

It should be no surprise that more significant consequences follow upon IRS determination that

disallowance of an EIC claim was due to fraud. If the IRS disallows an EIC claim for error and the IRS determines that the error was the result of fraud, the taxpayer is prohibited from claiming the EIC for a period of 10 years after the most recent tax year for which there was a final determination.

For example, suppose that the facts are the same as in the previous example but the IRS had determined the error was due to fraud, the taxpayer would be prohibited from claiming the EIC for the 10-year period 2015 through 2024. In order to claim the EIC for tax year 2025, the taxpayer must complete and attach IRS Form 8862.

Summary

Various tools are used by the IRS to verify EIC claims and prevent or recover improper EIC payments, including a) automatic checking for math errors, b) pre-refund examination of EIC claims, c) document matching to verify taxpayer income, and d) post-refund return examinations. The IRS’ tools designed to identify erroneous EIC claims result in a significant number of EIC claims being reduced or

disallowed entirely.

Taxpayers claiming the EIC and who have had a prior EIC claim denied or reduced may be required to

complete Form 8862, Information To Claim Earned Income Credit After Disallowance and attach it to any subsequent tax return claiming the EIC. Requirement for the form—and whether the taxpayer may claim EIC in the current year—depends upon the reason for the denial or reduction. Accordingly, IRS Form 8862 needs to be attached to the client’s subsequent tax return claiming the EIC unless an exception applies or the taxpayer cannot claim the EIC in the current year.

IRS Form 8862 is not required if a) disallowance of a prior EIC claim was due to a math or clerical

error, b) an IRS Form 8862 was filed and accepted in a prior year subsequent to the disallowance, or c) the disallowance of the claimed EIC was for a qualifying child and no qualifying child is currently being claimed.

The disallowance of a client’s EIC claim results in certain consequences: repayment plus penalties and interest, required IRS Form 8862 filing in the case of a subsequent EIC claim, and the possible prohibition of EIC claims for several years in the case of errors resulting from fraud or the reckless or

intentional disregard of EIC rules. Denial of an taxpayer’s EIC claim because of an error resulting from

a taxpayer’s reckless or intentional disregard of the EIC rules will cause the taxpayer to be prohibited from claiming EIC again for a two-year period. If disallowance is due to an error resulting from fraud, the prohibition applies for a 10 year period.

Chapter Review

1. Shirley claimed the earned income credit last year, and it was disallowed by the IRS. If no exception applies, what additional IRS form must she attach to her current tax return because of the disallowance in order to claim the EIC this year?

A. IRS Form 8867

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B. IRS Form 2555

C. IRS Form 8862

D. IRS Form 8853

2. Which of the following taxpayers whose EIC claim was previously disallowed would be required to

file IRS Form 8862 in order to claim the earned income credit this year?

A. Harry, whose EIC was previously disallowed due to his arithmetic error

B. Sally, whose EIC was previously disallowed for failing to include her self-employed expenses when calculating her income

C. Ellen who is claiming no qualifying children and whose EIC was previously disallowed because a child she claimed was determined not to be a qualifying child

D. Bob, whose EIC was disallowed four years ago but who filed IRS Form 8862 last year that was

accepted

3. Helen received a statutory notice of deficiency stating that her 2013 EIC claim would be denied unless she filed a petition with the Tax Court within 90 days. She received the notice in September 2015 and disregarded it. Assuming Helen claims EIC each year and the reason for the disallowance is not an exception, for which tax year must she file IRS Form 8862?

A. She must file an amended 2013 tax return along with IRS Form 8862

B. She must file an amended 2014 tax return along with IRS Form 8862

C. She must file IRS Form 8862 along with her 2015 tax return

D. She must file IRS Form 8862 along with her 2016 tax return

4. Alan received a statutory notice of deficiency stating that his 2013 EIC claim would be denied unless he filed a petition with the Tax Court within 90 days. He received the notice in August 2015 and disregarded it. If the IRS determined that Alan’s EIC error was due to his reckless disregard of the EIC rules, what is the earliest tax year he can again claim EIC?

A. 2015

B. 2016

C. 2017

D. 2026

5. Harry received a statutory notice of deficiency stating that his 2013 EIC claim would be denied unless he filed a petition with the Tax Court within 90 days. He received the notice in November 2015 and disregarded it. Harry filed his 2015 tax return in January 2016. What is the earliest tax

year after 2015 that Harry can again claim EIC if the IRS determined that his EIC error was due to fraud?

A. 2017

B. 2018

C. 2025

D. 2026

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Chapter 4 - EIC Due Diligence

Introduction

Many taxpayers can be expected to find the earned income credit rules and requirements to be very complicated. In view of that complexity, it should not be surprising that 70% of tax returns claiming the earned income credit are prepared by commercial tax return preparers7. Although the credit is claimed by a minority of taxpayers—generally 16% to 19%, depending upon the year—tax returns claiming the credit constitute a disproportionate percentage (37%) of the audits performed by the IRS8.

The IRS, armed with the authority to impose increased financial and other penalties for the improper preparation of tax returns, can cause a tax return preparer’s failure to comply with due diligence requirements to be costly. In this chapter we will consider the EIC due diligence requirements and look at the penalties that may be imposed on tax return preparers who fail to comply with them and

the preparers’ employers.

Learning Objectives


List the due diligence requirements a tax return preparer must meet when preparing a tax return claiming the earned income credit;

Recognize the records a tax return preparer is required to keep to support a client’s claim for the earned income credit;

Identify the penalties that may be imposed on a tax return preparer for failing to comply with due diligence requirements when preparing a client’s tax return claiming the earned income

credit; and Identify the sanctions that may be imposed on an employer whose employee fails to comply

with EIC due diligence requirements.

Tax Preparer Due Diligence a Statutory Requirement – IRC §6695

Due diligence is a requirement imposed by statute on all tax return preparers completing tax returns in which the earned income credit is claimed. That statutory mandate is imposed by §6695(g) of the Internal Revenue Code. As noted in the inset below, §6695(g) imposes a financial penalty on any

income tax return preparer failing to comply with the due diligence requirements related to determining a taxpayer’s eligibility for the credit or its amount. The financial penalty was increased by subsequent legislation from $100 to $500 for returns filed after December 31, 2011.

Sec. 6695. Other assessable penalties with respect to the preparation of

income tax returns for other persons

(g) Failure to be diligent in determining eligibility for earned income credit Any person who is an income tax return preparer with respect to any return or claim for refund who fails to comply with due diligence requirements imposed by the Secretary by regulations with respect to determining eligibility for, or the amount of, the credit allowable by section 32 shall pay a penalty of

$100 for each such failure.

The term “due diligence” is one used in a wide range of applications. As used with respect to a tax

preparer’s federal income tax preparation, the term refers to the requirement that a tax preparer meet a particular standard of care. That standard is defined by the Internal Revenue Service.

7 Robert Greenstein and John Wancheck, “Earned Income Credit Overpayment and Error Issues,” April 19, 2011, Center on Budget and Policy Priorities. http://www.cbpp.org/cms/?fa=view&id=3445. 8 Ibid.

http://www.cbpp.org/cms/?fa=view&id=3445

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Due Diligence Requirements

The due diligence requirements imposed by the Internal Revenue Service relative to a paid tax return preparer’s preparation of a return claiming the earned income credit require the preparer to meet four standards. Those standards require the preparer to:

1. Complete and submit an earned income credit checklist; 2. Compute the applicable earned income credit using a worksheet; 3. Know the law relative to earned income credits and his or her client; and 4. Maintain appropriate records related to preparation of the tax return.

Let’s consider each of these due diligence requirements in some detail.

Eligibility Checklist – IRS Form 8867

The earned income credit eligibility checklist is provided by the IRS Form 8867. It contains five

sections:

Part I covers the EIC rules for all taxpayers; Part II covers the EIC rules that apply only to taxpayers with children;

Part III covers the EIC rules applicable to taxpayers without a qualifying child; Part IV asks the tax preparer several questions designed to ensure the preparer has complied

with the EIC due diligence requirements; and

Part V identifies various records the preparer relied on to determine the taxpayer’s EIC eligibility.

The various questions posed on IRS Form 8867 act as memory-joggers and identify areas about which the tax preparer should obtain information from the taxpayer. For example, Part I of IRS Form 8867 is reproduced below:

Part I All Taxpayers

1 Enter preparer’s name and PTIN

2 Is the taxpayer’s filing status married filing separately? □Yes □No

If you checked “Yes” on line 2, stop; the taxpayer cannot take the EIC. Otherwise, continue

3 Does the taxpayer (and the taxpayer’s spouse if filing jointly) have a social security number (SSN) that allows him or her to work or is valid for EIC purposes? See the instructions before answering □Yes □No

If you checked “No” on line 3, stop; the taxpayer cannot take the EIC. Otherwise, continue.

4 Is the taxpayer (or the taxpayer’s spouse if filing jointly) filing Form 2555 or 2555-EZ (relating to the exclusion of foreign earned income)? □Yes □No

If you checked “Yes” on line 4, stop; the taxpayer cannot take the EIC. Otherwise, continue.

5a Was the taxpayer (or the taxpayer’s spouse) a nonresident alien for any part of 20XX? □Yes □No

If you checked “Yes” on line 5a, go to line 5b. Otherwise, skip line 5b and go to line 6.

b Is the taxpayer’s filing status married filing jointly? □Yes □No

If you checked “Yes” on line 5a and “No” on line 5b, stop; the taxpayer cannot take the EIC. Otherwise, continue.

6 Is the taxpayer’s investment income more than $3,350? See the instructions before answering □Yes □No

If you checked “Yes” on line 6, stop; the taxpayer cannot take the EIC. Otherwise, continue.

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7 Could the taxpayer be a qualifying child of another person for 20XX? If the taxpayer’s filing status is married filing jointly, check “No.” Otherwise, see instructions before answering □Yes □No

If you checked “Yes” on line 7, stop; the taxpayer cannot take the EIC. Otherwise go to Part II or Part III, whichever applies.

Treasury Regulations, Subchapter A, §1.6695-2(b)(1) prescribe the due diligence requirements a paid

tax return preparer must meet with respect to completion and submission of IRS form 8867. According to the regulations, a paid tax return preparer is required to complete the form based on information provided by the taxpayer to the tax return preparer or otherwise reasonably obtained by the preparer and provide the completed form for submission as follows:

In the case of a signing tax return preparer who electronically files the tax return or claim for refund, the completed Form 8867 must be electronically filed with the tax return or refund claim;

In the case of a signing tax return preparer who does not file the tax return or claim for refund electronically, the completed Form 8867 must be provided to the taxpayer for

inclusion when filing the tax return or claim for refund; and In the case of a non-signing tax return preparer, the completed Form 8867 must be

provided to the taxpayer in electronic or non-electronic format for inclusion when filing the tax return or claim for refund.

Due Diligence Questions to Ask to Avoid Qualifying Child Errors

As noted earlier, the most common EIC error involves qualifying children. If a tax return preparer believes that the information provided by the client with respect to qualifying children is incorrect, inconsistent or incomplete, he or she should ask questions to resolve the inconsistency and/or obtain complete information. The following situations offer examples:

If a client claims a qualifying child that is not the client’s son or daughter, the tax return preparer should ask –

o Where are the child’s parents? o Does the child’s parent live in the client’s household? o Does any other relative of the child live in the household?

o Can anyone else claim the child for purposes of the earned income credit? If the client’s age is inconsistent with the age of the qualifying child, the tax return preparer

should verify the relationship between the client and the child. If the client with a qualifying child is very young, the tax return preparer should ask if the

client could be a qualifying child of another person. If the client is a single taxpayer with a young qualifying child and an earned income but no

childcare expenses, the tax return preparer should ask – o What child care arrangements do you make? o Does anyone else live in your household?

If the client claims an adult with a disability as a qualifying child, the tax return preparer

should verify that the adult meets the tax law definition of permanently and totally disabled.

Eligibility Checklist Best Practices

The following best practices are recommended to help preparers complete and submit a correct IRS Form 8867:

Ask all the applicable questions to complete Form 8867 for all EIC clients every year; Couch the questions in non-technical terms so that clients can more easily understand what is

being asked;

Ask enough questions to accurately determine the client’s filing status and whether the client has a qualifying child; and

Attach Form 8867 to every EIC claim and be sure to submit it with every electronic EIC claim prepared.

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EIC Computation

Worksheet A or Worksheet B (self-employed, members of the clergy, statutory employees and people with church employee income), both of which are included as appendices, should be used to calculate the amount of earned income credit, if any, for which the client is eligible. The worksheet shows what

is included in the computation and is generally included in tax preparation software. The tax return preparer should keep a copy of the EIC worksheet (or an equivalent document) to show how the earned income credit was computed.

Treasury Regulations, Subchapter A, §1.6695-2(b)(2) also prescribe the due diligence requirements a paid tax return preparer must meet with respect to computation of the amount of the earned income credit. Pursuant to the applicable regulations, a tax return preparer must complete the EIC Worksheet based on information the preparer has received from the taxpayer or otherwise reasonably obtained.

Alternatively, the preparer may record his or her EIC computation, including the method and information used to make the computation, in the preparer’s files.

Computation Best Practices

It is a computation best practice NOT to rely on computer software to ensure the earned income credit

is correctly computed; computer software programs may miss one or more of the special rules that apply to the credit, such as the ability to classify nontaxable combat pay as earned income for EIC

purposes. So, preparers should review the EIC computation for accuracy and completeness—whether or not computed by a software program—to help ensure clients don’t fail to receive the credit for which they are eligible.

Know the Law and the Client

To meet the EIC due diligence requirements, a tax preparer must know the law and regulations relative to the earned income credit. However, equally important is that the tax preparer know the client. Accordingly, tax preparers are required to ask appropriate questions and obtain all the relevant

facts.

With respect to the knowledge component of the EIC due diligence requirements, tax preparers are required to:

Know the law with respect to the EIC to ensure the tax preparer is asking the client the right

questions in order to get all relevant facts; Take into account the information provided by the client and what the tax preparer knows

about the client;

Neither know nor have reason to know that any information used to determine the client’s eligibility for, or amount of, the EIC is incorrect, inconsistent or incomplete;

Make additional inquiries if a reasonable and well-informed preparer would know the information is incomplete, inconsistent or incorrect; and

Document any additional questions asked of the client and the client’s answer at the time of the interview.

Section 1.6695-2 of the regulations also speaks to the knowledge component of the EIC due diligence regulations. According to Treasury Regulations, Subchapter A, §1.6695-2(b)(3), the tax return preparer, in determining the taxpayer’s eligibility for the EIC or its amount, must not base such determinations on information the preparer knows—or has reason to know—is incorrect. Furthermore, the preparer is expected to be proactive in ensuring the information used is correct.

Thus, preparers cannot ignore the implications of information furnished to or known by them and are

required to make reasonable inquiries if the information provided appears to be incorrect, inconsistent

or incomplete. The standard provided by the applicable regulations states that a tax return preparer must make reasonable inquiries if a reasonable and well informed tax return preparer knowledgeable in the law would conclude that the information furnished to the tax return preparer appears to be incorrect, inconsistent or incomplete.

When Should a Preparer Ask Additional Questions – Examples

The regulations also offer the following examples to guide preparers in dealing with situations in which information provided to them may be incorrect, inconsistent or incomplete.

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In the first example provided, a 22 year-old taxpayer wants to claim two sons, ages 10 and 11, as

qualifying children for purposes of the EIC. Since the age of the taxpayer appears inconsistent with the ages of the children claimed as sons, the preparer must make additional reasonable inquiries regarding the relationship between the taxpayer and the children.

In the second example, an 18 year-old female taxpayer with an infant has earned income of $3,000 and states that she lives with her parents. She wants to claim the infant as a qualifying child for the EIC. Because of the taxpayer’s age, income and her living with her parents, the information given to the preparer appears to be incomplete and inconsistent. Accordingly, the preparer is required to make additional reasonable inquiries to determine if the taxpayer is the qualifying child of her parents. As a qualifying child of her parents, she would be ineligible to claim the EIC.

A third example offered by the explanatory material is one in which a taxpayer wants to claim his

niece and nephew as qualifying children for the EIC. In such a case, the tax preparer should make reasonable inquiries to determine whether the children meet EIC qualifying child requirements and ensure that the possibility the children will be claimed by their parents or other relatives for purposes of the EIC is fully considered.

A final example is one in which a Schedule C taxpayer claims to have two qualifying children and wants to claim the EIC. She indicates that she has $10,000 in business earnings and no expenses.

Because it is very unlikely that a self-employed individual would have no business expenses, the information appears incomplete. Accordingly, the preparer must make additional reasonable inquiries regarding the taxpayer’s business to determine whether the information regarding both her income and her expenses is correct.

Knowledge Requirement Best Practices

Several best practices apply to a preparer’s meeting the due diligence knowledge requirement when preparing EIC tax returns. The IRS urges preparers to:

Apply common sense to the information supplied by the client and consistently ask oneself “Does the whole picture make sense to me?”

Ask additional questions about any information received from the client that appears to be inconsistent or incomplete;

Ask additional questions to ensure clients are not over-reporting or under-reporting income;

Be sure Schedules C and F include all income and expenses; Guide self-employed clients without records so that a reconstruction of income and expenses,

ensuring all required items are included on the return; and Document all additional questions asked to comply with the knowledge requirement and the

client’s responses to them.

Record Maintenance

In addition to completing and submitting an eligibility checklist, computing the EIC using an appropriate worksheet, and asking the appropriate questions to obtain all the relevant facts, a tax

preparer must also maintain appropriate records relative to each client’s EIC, as prescribed in Treasury Regulations, Subchapter A, §1.6695-2(b)(4). Such records may be kept in either paper or electronic format; irrespective of how records are maintained, the tax preparer must be able to produce them if asked by the IRS.

The records that must be kept by the tax return preparer are the following:

A copy of IRS Form 8867, Paid Preparers Earned Income Credit Checklist;

The EIC Worksheet (Worksheet A or B, as appropriate);

A record of any additional questions asked of the client by the preparer to comply with EIC due diligence requirements and the client’s answers to those questions; and

Any documents provided by the client used by the preparer to determine eligibility for, or the amount of, the EIC.

The tax return preparer must keep the required documents for a period of three years from the latest of the following:

The original due date of the tax return (not including any extension for filing);

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The date the tax return or claim for refund is electronically filed by a signing tax return

preparer; or The date the tax return or claim for refund is presented to the client for signature by a signing

tax return preparer.

If the tax return preparer prepares only part of the return or claim for refund, the preparer must keep the part of the return he or she was responsible for completing for three years from the date submitted to the signing tax return preparer.

Record Maintenance Best Practices

The following best practices are suggested to enable preparers to meet the record maintenance requirements of EIC due diligence:

Make sure to keep copies of any client-provided documents relied upon to determine eligibility

for or amount of EIC; Ensure that an accurate copy of any original document can be reproduced; Keep all client records containing personal identifiable information in a secure environment to

safeguard client privacy;

Make back-up copies of electronic records and keep them in a separate, secure location; and Be aware of the applicable record retention time frames.

Failure to Meet Due Diligence Requirements

As noted earlier in the course, incorrect EIC returns may significantly affect a tax return preparer’s client. In addition, however, a tax return preparer’s failure to meet all four due diligence requirements—a) completing and submitting an EIC checklist, b) computing the applicable earned income credit using a worksheet, c) obtaining sufficient knowledge of the law and the client relative to the EIC, and d) maintaining the required EIC-related records—can result in significant penalties imposed on the tax preparer and his or her employer. Those penalties may be assessed even if the

EIC computation and filing is otherwise correct.

Let’s consider the tax preparer and employer penalties.

Consequences for the Tax Return Preparer

The failure of a tax return preparer to comply with the EIC due diligence requirements can be

expensive with respect to both financial penalties and the adverse consequences for the tax preparer’s career. If the IRS examines the EIC claims of a tax return preparer and finds that he or she did not meet all for due diligence requirements, the following penalties may be assessed:

a $500 penalty for each failure to comply with EIC due diligence requirements for returns required to be filed after December 31, 2011 (IRC §6695(g));

a minimum penalty of $1,000 if the tax return preparer prepares a client return and the IRS finds any part of the amount of taxes owed is due to an unreasonable position (IRC §6694(a)); and

a minimum penalty of $5,000 if the tax return preparer prepares a client return and the IRS

finds any part of the amount of taxes owed is due to a reckless or an intentional disregard of rules or regulations (IRC §6694(b)).

In addition to these not-insignificant financial penalties, a tax return preparer who has failed to comply with EIC due diligence requirements may be:

Suspended or expelled from IRS e-file;

Subject to disciplinary action by the IRS Office of Professional Responsibility; and The subject of injunctions that bar the tax return preparer from preparing tax returns or which

impose conditions on the tax returns that may be prepared.

To help assist in meeting the EIC due diligence requirements, tax return preparers should consider:

Printing the questions asked by the preparer during the client interview and the client’s answers, reviewing the questions and answers with the client and having the client sign the document; and

Creating an interview sheet for clients to complete and sign before meeting with the preparer.

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However, despite the client’s signature on either or both of the suggested documents, the tax return

preparer is not relieved of the requirement to perform appropriate EIC due diligence.

Consequences for the Preparer’s Employer

In addition to the various penalties that may be imposed on the tax return preparer resulting from the

failure to meet the EIC due diligence requirements, the IRS can also penalize an employer or employing firm if the employee preparer fails to comply with those requirements, provided certain other conditions apply. Those conditions, under which a penalty could be assessed on an employer for an employed tax return preparer’s failure to meet due diligence requirements, are as follows:

Management participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements;

The firm failed to establish reasonable and appropriate procedures to ensure compliance with

the due diligence requirements; or The firm established appropriate compliance procedures but disregarded those procedures

through willfulness, recklessness, or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate or to conclude that the

employee was not complying.

Summary

The requirement that a paid tax return preparer perform appropriate due diligence with respect to preparing a return claiming the earned income credit is imposed by statute, and preparers failing to meet that requirement are subject to a financial penalty. The financial penalties range from $500 to $5,000 for each failure to comply with the due diligence requirements, depending on whether the preparer failed to meet the due diligence requirements and whether the failure was due to an unreasonable position or reckless and intentional disregard of the rules.

Pursuant to the IRS-imposed due diligence requirements, a preparer must a) complete and submit an

earned income credit checklist (IRS Form 8867), b) compute the applicable earned income credit using a worksheet, c) know the client and the law relative to earned income credits, and d) maintain appropriate records related to preparation of the tax return.

Tax preparers are expected to be proactive in ensuring the information used is correct. Accordingly, they must know the EIC law to ensure they are asking clients the right questions in order to get all

relevant facts. They must take into account the information provided by their clients as well as what the tax preparers know about them, and they are required to ask additional questions if a reasonable

and well-informed preparer would know the information supplied by the client is incomplete, inconsistent or incorrect. The questions and the answers the preparers receive from their clients must be documented. In preparing and submitting a tax return or claim for a refund, a tax preparer must not know or have reason to know that any information used to determine the client’s eligibility for, or amount of, the EIC is incorrect, inconsistent or incomplete.

Tax preparers must also maintain appropriate records relative to each client’s EIC, in paper or

electronic format, and be able to produce them if asked by the IRS. The EIC-related records that must be kept by the tax preparer are a) a copy of IRS Form 8867, b) the EIC Worksheet used, c) a record of additional questions asked of the client and his or her answers to them, and d) copies of client-provided documents used to determine eligibility for, or the amount of, the EIC.

The required documents must be maintained by the preparer for no less than three years from the latest of a) the original due date of the tax return, b) the date the tax return or claim for refund is electronically filed by a signing tax return preparer, c) the date the return or refund claim is given to

the client for signature by a signing tax return preparer, or d) the date given to the signing tax return preparer if the (non-signing) tax preparer prepares only part of the return or claim for refund.

Tax return preparers failing to meet EIC due diligence requirements may be subject to a) suspension or expulsion from IRS e-file, b) disciplinary action by the IRS Office of Professional Responsibility, and c) an injunction barring them from preparing tax returns or the imposition of conditions on the tax returns that may be prepared.

Employers who employ tax return preparers may also be subject to penalties if an employee fails to

comply with due diligence requirements. A penalty could be assessed on an employer for an employed tax return preparer’s failure to meet due diligence requirements if a) management participated in or

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knew of the failure to comply with the due diligence requirements before the return was filed, b) the

firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements, or c) the firm disregarded established procedures through willfulness, recklessness, or gross indifference.

Chapter Review

1. Ellen, a paid tax return preparer, failed to comply with the EIC due diligence requirements in completing her client’s tax return for 2015. If the IRS determined that her failure was NOT due to reckless disregard for the EIC rules or maintaining an unreasonable position, what maximum financial penalty could be imposed?

A. $100

B. $500

C. $1,000

D. $5,000

2. You are preparing a tax return for eighteen year-old Karen whose earned income was $4,000. She has a two year-old daughter, and both live with Karen’s mother. The initial questions to ask in order to determine if Karen is eligible to claim the earned income credit should be focused on which of the following?

A. Whether Karen’s daughter is a qualifying child

B. Whether Karen has incurred any child care expenses

C. Whether Karen can be claimed as her mother’s qualifying child for EIC purposes

D. Whether Karen’s daughter has a valid social security number

3. Julie is single and age 25. If she wants to claim her 24 year-old sister, Helen, as a qualifying child for purposes of the earned income credit, which of the following questions should you ask as a tax return preparer to determine if Helen could be a qualifying child in light of her age?

A. Was Helen a full-time student during the year?

B. Was Helen permanently and totally disabled at any time during the year?

C. Did Helen have any unearned income from a foreign source?

D. Does Helen have any children?

4. Philip is age 24 and claims two children, ages 14 and 15 as his daughters. What questions should a tax return preparer ask if Philip claims them as qualifying children for EIC purposes?

A. Do the children receive any income from a foreign source?

B. Are the children attending school?

C. Does Philip file a Married Filing Joint tax return?

D. What is the client’s relationship to the children?

5. Philip completed a part of a client’s federal income tax return and provided it to the signing tax return preparer on February 15, 2015. If the tax return was due on April 15th, the taxpayer

received a six month automatic extension to October 15th and the return was filed on May 15th,

what is the earliest date Philip may destroy the document?

A. February 15, 2018

B. April 15, 2018

C. May 15, 2018

D. October 15, 2018

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Answers to Chapter Review Questions

Chapter 1

Question 1 Feedback

A. Your answer is incorrect. A married taxpayer filing a joint federal tax return who has three qualifying children may be eligible to receive EIC if the taxpayer’s AGI is less than $53,505 in 2016. However, Susan files as married filing separate and this limit does not apply to that filing status. Please try again.

B. Your answer is incorrect. A taxpayer with three qualifying children filing a federal tax return as

other than married filing jointly—as a head of household or an unmarried individual, in other words—may be eligible to receive EIC only if his or her AGI is less than $47,955 in 2016. This limit, however, is not applicable to a taxpayer filing as married filing separate. Please try again.

C. Your answer is correct. EIC is not available to a taxpayer filing a federal tax return as married filing separate, irrespective of the taxpayer’s AGI or number of qualifying children.

D. Your answer is incorrect. The limiting AGI you chose applies to certain taxpayers filing a federal tax return as other than married filing jointly and who have no qualifying children. Please try again.

Question 2 Feedback

A. Your answer is correct. If the taxpayer (or spouse, if married) was a nonresident alien for any part of the tax year, the taxpayer cannot claim the EIC unless the taxpayer’s filing status is married filing jointly.

B. Your answer is incorrect. If the taxpayer or spouse was a nonresident alien for any part of the year and the taxpayer’s filing status is other than married filing jointly, the EIC is not available. Please try again.

C. Your answer is incorrect. For Arthur to be eligible for EIC, both his and his spouse’s worldwide income would be subject to U.S. taxation. However, that is a result of Arthur’s choice that could make him eligible for EIC. Please try again.

D. Your answer is incorrect. Arthur may be eligible for EIC. However, the possible answer to

Arthur’s ability to claim EIC lies in his federal income tax filing status. Please try again.

Question 3 Feedback

A. Your answer is incorrect. To meet the relationship test, a qualifying child must be the taxpayer’s a) son, daughter, stepchild, foster child, or a descendant of any of them or b) brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them. At the very least, their grandson and Carl’s brother would appear to meet the

relationship test. Please try again. B. Your answer is correct. Although Carl’s brother and the couple’s grandson meet the

relationship test, the third child does not. A “foster child” is one placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of

competent jurisdiction. A child left with the taxpayer by its parent would not be a foster child as the term is used in connection with the EIC; the child must be placed with the taxpayer by a placement agency or the court.

C. Your answer is incorrect. Although the couple’s grandson would meet the relationship test, it is not the only child that would. Please try again.

D. Your answer is incorrect. Not all of the three children meet the relationship test. Please try again.

Question 4 Feedback

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A. Your answer is incorrect. You correctly identified the maximum age a qualifying child may be

who is not a student or disabled. However, in this case, Peter meets both of those conditions. Please try again.

B. Your answer is incorrect. Age 21 is not a qualifying child’s limiting age with respect to the age

test for EIC eligibility. Please try again.

C. Your answer is incorrect. Peter would normally need to be younger than age 24 at the end of the tax year and younger than the taxpayer (or the taxpayer’s spouse if filing jointly) since he is a student. However, Peter’s disability affects the usual age test. Please try again.

D. Your answer is correct. A child meets the age test for purposes of the EIC, regardless of his or her age, if permanently and totally disabled at any time during the tax year.

Question 5 Feedback

B. Your answer is incorrect. Age 21 is not a limiting age for purposes of the earned income credit. However, a taxpayer must be at least age 25 to claim EIC. Please try again.

C. Your answer is incorrect. That is the minimum age at which a taxpayer must be in order to

claim the earned income credit. Please try again.

D. Your answer is correct. A taxpayer claiming the EIC must be at least age 25 but less than age 65 at the end of the tax year. If the taxpayer is married filing a joint return, either the

taxpayer or spouse must be at least age 25 but under age 65 at the end of the year. Either spouse may meet the age test as long as one of the spouses does. If neither the taxpayer nor spouse is at least age 25 but under age 65, the taxpayer cannot claim the EIC. Thus the maximum age at which a taxpayer may claim the EIC is age 64.

E. Your answer is incorrect. Age 70 ½ is the age at which required minimum distributions must begin under certain IRAs and qualified plans. It has no relevance to the earned income credit. Please try again.

Chapter 2

Question 1 Feedback

A. Your answer is correct. The term “substantial gainful activity,” as it is used in connection with

a person who is permanently and totally disabled, is defined and discussed in IRS Publication 524. As discussed on page 4 of Publication 524 “Credit for the Elderly or Disabled,” substantial gainful activity is the performance of significant duties over a reasonable period of time while working for pay or profit, or in work generally done for pay or profit. Full-time work (or part-

time work done at an employer's convenience) in a competitive work situation for at least the minimum wage conclusively shows that the individual is able to engage in substantial gainful activity.

B. Your answer is incorrect. While attending school may show that the individual could possibly be able to engage in substantial gainful activity, it is not conclusive evidence of it. Substantial gainful activity is not work done by the individual to take care of himself or herself or the

person’s home. It is not unpaid work on hobbies, institutional therapy or training, school attendance, clubs, social programs, and similar activities. Please try again.

C. Your answer is incorrect. The ability to engage in substantial gainful activity is NOT conclusively shown by the individual’s engaging in unpaid work on social programs. Please try

again.

D. Your answer is incorrect. An individual’s ability to take care of himself or herself does not, in itself, conclusively demonstrate the person’s ability to engage in substantial gainful activity.

Please try again.

Question 2 Feedback

A. Your answer is incorrect. Although errors involving the taxpayer’s claiming an incorrect filing status are among the four most common, it is not the most common. Please try again.

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B. Your answer is incorrect. Errors involving the reported income of a taxpayer claiming the

earned income credit happen commonly. However, it is not the EIC error most commonly encountered. Please try again.

C. Your answer is correct. The earned income credit error most commonly encountered is one

involving a qualifying child. In the case of errors involving qualifying children, the child fails to meet all of the four eligibility tests, i.e. the tests related to the child’s age, relationship, residency and joint return. In most cases in which there is an error the child does not meet either the relationship or the residency test.

D. Your answer is incorrect. EIC errors involving a taxpayer’s, spouse’s or qualifying child’s social security number are fairly common but are not the error most frequently encountered. Furthermore, such social security number errors are automatically caught by the IRS. Please

try again.

Question 3 Feedback

A. Your answer is incorrect. Married Filing Separate is the only filing status that would render the client ineligible for the earned income credit. Please try again.

B. Your answer is incorrect. A qualifying child may be a son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of

them regardless of the taxpayer’s filing status. Please try again.

C. Your answer is incorrect. Although a qualifying child must meet an age test, such a test has no relevance with respect to the taxpayer’s filing as Head of Household. Please try again.

D. Your answer is correct. The exception permitting a married client to claim the earned income credit while filing as Head of Household is limited and only available if certain conditions apply. Among the important conditions that apply is a condition that requires the client to have lived apart from his or her spouse for the last 6 months of the year (temporary absences are

considered time living at home).

Question 4 Feedback

A. Your answer is incorrect. Taxpayers filing a federal income tax return as Single may qualify for the earned income credit. Please try again.

B. Your answer is correct. A client may qualify for the EIC with a filing status of Married Filing Joint, Qualified Widow(er) with Dependent Child, Single or Head of Household provided he or she is otherwise qualified for the credit. The only filing status that would make a client

ineligible for EIC is Married Filing Separate.

C. Your answer is incorrect. Although a taxpayer’s status as Head of Household requires that he or she meet specific requirements, a Head of Household filer may be eligible for the earned income credit. Please try again.

D. Your answer is incorrect. Married Filing Joint is an acceptable filing status for a taxpayer claiming the earned income credit. Please try again.

Question 5 Feedback

A. Your answer is incorrect. Although a taxpayer who paid all the cost of keeping up a house would be considered a head of household, provided he or she met the other requirements applicable to that status, paying the entire cost is not required. Please try again.

B. Your answer is incorrect. A taxpayer who paid 25% of the cost of keeping up a main home would not meet the requirement to file as Head of Household. Please try again.

C. Your answer is correct. In addition to being considered unmarried, a client wishing to file as

Head of Household must pay more than half the cost of keeping up a main home and meet other requirements.

D. Your answer is incorrect. Filing as Head of Household requires a taxpayer to meet certain main home maintenance requirements. Please try again.

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Chapter 3

Question 1 Feedback

A. Your answer is incorrect. Although paid tax preparers are required to complete IRS Form 8867, the form is not required because of EIC disallowance nor required to be filed by a

taxpayer. Please try again.

B. Your answer is incorrect. If a taxpayer files IRS Form 2555, Foreign Earned Income Exclusion, the taxpayer is ineligible for EIC. Please try again.

C. Your answer is correct. A taxpayer whose EIC claim for any year after 1996 was denied or reduced by the IRS may need to complete Form 8862, Information To Claim Earned Income Credit After Disallowance.

D. Your answer is incorrect. IRS Form 8853 is used in connection with Archer MSA and Qualified

long-term care premium deductions and is not used with the earned income credit. Please try again.

Question 2 Feedback

A. Your answer is incorrect. The disallowance of a prior EIC claim because of a math or clerical error is an exception to the need for the taxpayer to file IRS Form 8862 in order to claim the EIC in a subsequent year. Please try again.

B. Your answer is correct. Sally must file IRS Form 8862 in order to claim the EIC. However, if her failure to include her expenses in calculating her self-employed income is deemed to be the result of fraud or the reckless or intentional disregard of EIC rules, she could be barred from the credit for several years.

C. Your answer is incorrect. When a prior EIC claim was disallowed solely because of a qualifying child and the taxpayer is claiming this year with no qualifying child, the taxpayer does not have to file IRS Form 8862. Please try again.

D. Your answer is incorrect. If a claim for EIC was previously disallowed and the taxpayer subsequently filed an IRS Form 8862, no further filing of the form is required provided EIC is not subsequently disallowed for other than a math or clerical error. Please try again.

Question 3 Feedback

A. Your answer is incorrect. Helen is not required under IRS rules to file an amended 2013 tax return or to file IRS Form 8862 with it. Please try again.

B. Your answer is incorrect. The 2014 tax return would normally have been previously filed, and

an amended return is not required nor is IRS Form 8862 required with such a return. Please try again.

C. Your answer is correct. If the taxpayer does not act on the statutory notice of deficiency within the 90 days and the period ends before the taxpayer may file his or her tax return, a taxpayer claiming the EIC must file IRS Form 8862 along with the tax return for the current year. Since Helen received a statutory notice of deficiency in September 2015 and did not file a petition

with the Tax Court by the conclusion of the 90 day period that ends in December 2015 she must attach an IRS Form 8862 to her 2015 tax return.

D. Your answer is incorrect. If the 90-day period following Helen’s receipt of the statutory notice

of deficiency ended after she could have filed her 2015 tax return, she would not be required to file IRS Form 8862 until she filed her 2016 tax return. However, the 90-day period following Helen’s receipt of the statutory notice of deficiency ended in December 2015 before she could have filed her 2015 tax return. Please try again.

Question 4 Feedback

A. Your answer is incorrect. Alan is barred from claiming EIC for a two-year period after the most recent tax year for which there was a final determination. The two-year period does not run from the tax year for which the disallowed EIC was filed. Please try again.

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B. Your answer is incorrect. When it has been determined that a taxpayer’s EIC error is due to

the reckless or intentional disregard of the EIC rules, he or she is barred for two years after the most recent tax year. Please try again.

C. Your answer is correct. If a taxpayer’s EIC claim has been denied due to an error deemed by

the IRS to constitute reckless or intentional disregard of the EIC rules, the taxpayer is prohibited from claiming EIC again for a two-year period after the most recent tax year for which there was a final determination. Since Alan received the statutory notice of deficiency in August 2015 and did not file a petition with the Tax Court by the conclusion of the 90 day period that ended in November 2015 he is barred from claiming EIC for tax years 2015 and 2016. He may again file for EIC in connection with the tax return reporting his 2017 income.

D. Your answer is incorrect. If Alan’s EIC error had been determined to be the result of fraud, he

would be barred from claiming the EIC again until 2026. In this case, however, the IRS determined the error was due to his reckless disregard for the rules rather than fraud. Thus, a different duration applies. Please try again.

Question 5 Feedback

A. Your answer is incorrect. Harry would have been able to again claim EIC as early as 2017 if his error had been due to a reckless or intentional disregard of the EIC rules. However, his error

was due to fraud. Please try again.

B. Your answer is incorrect. A taxpayer whose EIC error is determined to be due to fraud is subject to a 10-year ban on claiming EIC. Furthermore, that ban begins following the most recent tax year for which there was a final determination. Please try again.

C. Your answer is incorrect. The period of the EIC ban begins following the most recent tax year rather than the most recent calendar year. Please try again.

D. Your answer is correct. If a taxpayer’s EIC claim has been denied due to an error deemed by

the IRS to constitute fraud, the taxpayer is prohibited from claiming EIC again for a ten-year period after the most recent tax year for which there was a final determination. Since Harry received the statutory notice of deficiency in November 2015 and did not file a petition with the Tax Court by the conclusion of the 90 day period that ended in February 2016 after the taxpayer filed his 2015 tax return he is barred from claiming EIC for tax years 2016 through

2025. He may again file for EIC in connection with the tax return reporting his 2026 income.

Chapter 4

Question 1 Feedback

A. Your answer is incorrect. Although the financial penalty was $100 for the failure to comply with EIC due diligence requirements, that penalty was increased for returns filed after December 31, 2011. Please try again.

B. Your answer is correct. IRC section 6695(g) imposes a financial penalty on any income tax return preparer failing to comply with the due diligence requirements related to determining a

taxpayer’s eligibility for the credit or its amount. The financial penalty was increased by subsequent legislation from $100 to $500 for returns filed after December 31, 2011.

C. Your answer is incorrect. A minimum penalty of $1,000 may be assessed if the tax return preparer prepares a client return and the IRS finds any part of the amount of taxes owed is due to an unreasonable position. In this case that condition, i.e. maintaining an unreasonable

position, was not found. Please try again.

D. Your answer is incorrect. A minimum penalty of $5,000 may be imposed if the tax return

preparer prepares a client return and the IRS finds any part of the amount of taxes owed is due to a reckless or an intentional disregard of rules or regulations. Please try again.

Question 2 Feedback

A. Your answer is incorrect. Although the status of Karen’s daughter as a qualifying child could affect the EIC for which she is eligible, the answer to a more central question related to whether Karen herself is eligible should be asked. Please try again.

43

B. Your answer is incorrect. While a taxpayer’s expenses for child care could reduce Karen’s net

income and may affect her EIC, they do not affect her eligibility to claim the credit. Please try again.

C. Your answer is correct. A taxpayer who is the qualifying child of another taxpayer cannot claim

the EIC whether or not the other taxpayer claims the EIC. Thus, it is important to ensure that Karen is not the qualifying child of her mother based on the relationship, age, residency and joint return tests.

D. Your answer is incorrect. Whether or not Karen’s daughter has a valid social security number would affect Karen’s ability to claim her as a qualifying child. However, it would not affect her eligibility for the EIC. Please try again.

Question 3 Feedback

A. Your answer is incorrect. In order for Helen to be a qualifying child of her younger sister on the basis of her being a full-time student she would need to be under the age of 24. Since Helen is 24 years old, the answer to that question would not help to determine if she could be a qualifying child. Please try again.

B. Your answer is correct. A person of any age who is permanently and totally disabled at any time during the year may be a qualifying child provided he or she meets the relationship,

residency and joint return requirements.

C. Your answer is incorrect. While the extent of Helen’s income could affect the earned income credit, it would not affect her status as a qualifying child. Please try again.

D. Your answer is incorrect. Helen’s being a parent of a child would not necessarily affect her possible status as a qualifying child of her sister. Please try again.

Question 4 Feedback

A. Your answer is incorrect. The children’s foreign income, if any, would not affect their status as

qualifying children. However, they must meet the relationship, age, residency and joint return tests. Please try again.

B. Your answer is incorrect. Since the children are not between the ages of 19 and 23, their

attendance (or nonattendance) at school does not affect their qualifying child status. Please try again.

C. Your answer is incorrect. The client is not required to file a joint tax return; he simply must not file a tax return as Married Filing Separate. The joint tax return test applies to children

claimed as qualifying children. Please try again.

D. Your answer is correct. Because the taxpayer’s age appears inconsistent with the ages of the children claimed as his daughters, the preparer must make additional reasonable inquiries regarding the relationship between the taxpayer and the children.

Question 5 Feedback

A. Your answer is correct. Although a signing tax return preparer must keep the required

documents for a period of three years from the latest of a) the original due date of the tax return (not including any extension for filing), b) the date the tax return or claim for refund is electronically filed by a signing tax return preparer, or c) the date the tax return or claim for refund is presented to the client for signature by a signing tax return preparer, a tax return

preparer who prepares only part of the return or claim for refund must keep the part of the return he or she was responsible for completing for three years from the date submitted to the signing tax return preparer. Thus, the document may be destroyed on February 15, 2018.

B. Your answer is incorrect. If Philip had been the signing tax return preparer he would have been able to destroy the document three years after April 15, 2015. However, that requirement does not apply to a tax return preparer who prepares only a part of the return. Please try again.

C. Your answer is incorrect. Extensions of the time to file do not enter into the three-year period a taxpayer’s documents must be maintained. Please try again.

44

D. Your answer is incorrect. Even though the taxpayer could have delayed filing his or her tax

return until October 15th, that date does not start the required three-year document holding period since extensions of time to file are not considered. Please try again.

45

Glossary

Age rule The age rule requires that a taxpayer claiming the EIC must be at least age 25 but less than age 65 at the end of the tax year.

Dependent of another person rule

A taxpayer claiming the EIC cannot be the dependent of another person, regardless of whether or not the other person actually claimed the taxpayer as a dependent.

Disabled child (permanently and

totally)

To be considered a permanently and totally disabled child for EIC purposes, the child must be unable to engage in any substantial gainful activity

because of a physical or mental condition, and a doctor must determine the condition has lasted continuously for at least a year, can be expected to last continuously for at least a year, or can lead to death.

Document matching Document matching is a process used by the IRS to reduce improper EIC payments in which income claimed on tax returns is matched to income reported by third parties.

Earned income Earned income, for EIC purposes, includes a) wages, salaries, tips and other taxable employee pay, b) net earnings from self-employment, and c) gross income received by the taxpayer as a statutory employee.

Joint return test One of the tests to determine whether a taxpayer’s child is a qualifying child for purposes of the EIC. To meet the joint return test the child cannot file a joint return for the tax year, except when the child’s filing a joint tax return is only to claim a refund.

Main home rule Under the main home rule, a taxpayer claiming the EIC must have lived in

the United States more than half the year.

Qualifying child A taxpayer’s child is a qualifying child for purposes of the EIC if the child meets the a) relationship test, b) age test, c) residency test, and d) joint return test.

Qualifying child of another taxpayer rule

A taxpayer claiming the EIC cannot be a qualifying child of another taxpayer.

Relationship test One of the tests to determine whether a taxpayer’s child is a qualifying child for purposes of the EIC. To meet the relationship test, a qualifying child must be a) the taxpayer’s son, daughter, stepchild, foster child, or a descendant of any of them, or b) the taxpayer’s brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them.

Residency test One of the tests to determine whether a taxpayer’s child is a qualifying child

for purposes of the EIC. To meet the residency test, a qualifying child must have lived with the taxpayer in the United States for more than half of the year. “United States” means the 50 states and the District of Columbia. However, the term does not include Puerto Rico or U.S. possessions.

School A school, for purposes of the EIC, includes an elementary school, a junior or senior high school, a college or university, or d) a technical, trade, or mechanical school.

46

Student A student, for EIC purposes, includes a person who, during some part of each of any five calendar months during the calendar year was a full-time student or a student taking a full-time, on-farm training course given by a school or state, county or local government.

Tiebreaker rules EIC rules that apply when more than one person has the same qualifying child.

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Index

Adjusted gross income (AGI) limits, 6 Adoption taxpayer identification number

(ATIN), 11 Age rule for taxpayers without a qualifying

child, 12, 19 Answers to chapter review questions, 43

Asking the client additional questions, importance of, 24

Avoiding income reporting errors, 28 Calculating earned income, 13 Child born and died during the year, 10

Child’s temporary absence from the taxpayer’s

home, 10 Citizenship or residency, 6 Combat pay, 8 Common earned income credit errors, 23 Common sense, need to apply, 39 Dependent of another person ineligible for EIC,

12

Disabled, permanently and totally (defined for EIC), 9

Due diligence a statutory requirement, 35 Earned income, 6 Earned income (defined for EIC), 8 Earned income credit, 6 Earned income credit eligibility checklist - Form

8867, 36

Earned income credit income limits, 27 Effect of EIC errors on net tax revenue

estimated, 22 EIC 2012 investment income limitation, 8 EIC adjusted gross income limits, 6

EIC due diligence standards, 36 EIC qualifying child of another taxpayer rule,

11, 19 EIC qualifying child of more than one person

rule, 11, 19 EIC qualifying child rules, 8, 19 EIC rules applicable to a taxpayer with no

qualifying child, 12, 19 EIC rules that apply to everyone, 6 EIC, figuring the amount of the credit, 13, 19 Employer penalties for preparer's failure to

comply with due diligence requirements, 41 Errors involving a qualifying child, 23 Exceptions to taxpayer’s need to file Form

8862, 32 Factors affecting EIC errors, 22 Foreign earned income, 6 Form 8862, iv, 31, 32, 33, 34, 46, 51, 53 Foster child (definition for EIC), 9 Fraud, 33

Head of Household tax filing status, 25

Improper EIC payments, 22 Incorrect, inconsistent or incomplete client

information, 21, 23, 24, 29, 37, 38, 41 Individual taxpayer identification number

(ITIN), 11 Inmate in a penal institution, 13

Investment income, 6 Knowledge component of EIC due diligence

requirements, 38 Main home rule, 13 Maintaining an unreasonable position,

consequences of, 40

Maintaining appropriate records, 39 Married filing separate, 6 Married persons living apart, 26 Nongovernmental section 457 plan income, 13 Nonqualified deferred compensation plan

income, 13 Qualifying child of another taxpayer ineligible

for EIC, 12 Reckless or intentional disregard of rules,

consequences of, 40 Reckless or intentional disregard of the EIC

rules, 32 Relationship, age, residence and joint return

tests, 8

Reliance on computer software, 38

Rules that apply to everyone, 6 School (defined for EIC), 9 Self-employed, statutory employees, clergy

and church employees, 15 Single tax filing status, 25

Social Security number, 6, 8, 32 Student (defined for EIC), 9 Substantial gainful activity (defined for EIC),

24 Surviving spouse, 12 Tax filing status, 6 Tax return preparer's failure to comply with

EIC due diligence requirements, consequences of, 40

Taxable scholarships or fellowship grants deducted, 13

Tiebreaker rules when more than one person has same qualifying child, 11

U.S. military personnel stationed outside the

United States, 13 When a client’s age is inconsistent with the age

of a qualifying child, 37 When a qualifying child is not the client’s son

or daughter, 37 Worksheet A, 13, 51

Worksheet B, 13, 52

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Appendix A – Worksheet A

Worksheet A – 20XX EIC – Lines 66a and 66b

Before you begin: √ Be sure you are using the correct worksheet. Use this worksheet only if you

Answered “No” to Step 5, question 3. Otherwise use Worksheet B.

Part 1 1. Enter your earned income from Step 5. 1

All Filers Using Worksheet A

2. Look up the amount on line 1 above in the EIC Table (right after Worksheet B) to find the credit. Be sure to use the correct column for your filing status and the number of children you have. Enter the credit here.



2




No. Go to line 5.

Part 2


5. If you have:








5

Part 3


6.

√


Reminder—


6

If your EIC for a year after 1996 was reduced or disallowed, see

Form 8862, who must file, earlier, to find out if you must file Form 8862 to take the credit for 20XX.

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49

Appendix B – Worksheet B

Worksheet B – 20XX EIC – Lines 66a and 66b

Use this worksheet if you answered “Yes” to Step 5, question 3.

√ Complete the parts below (Parts 1 through 3) that apply to you. Then, continue to Part 4.

√ If you are married filing a joint return, include your spouse’s amounts, if any, with yours to figure the amounts to enter in Parts 1 through 3.

Part 1

Self-Employed, Members of the Clergy, and

People With Church Employee Income Filing Schedule SE

1a.

b.

c.

d.

e.


Enter any amount from Schedule SE, Section B, line 4b, and line 5a.



Subtract line 1d from 1c.

+

=

-

=

1a

1b

1c

1d

1e

Part 2

2. Do not include on these lines any statutory employee income, any net profit from services performed as a notary public, any amount exempt from self-employment tax as a result of the filing and approval of Form 4029 or Form 4361, or any other amounts exempt from self-employment tax.

Self-Employed NOT Required To File Schedule SE

a.

b.

c.

Enter any net farm profit or (loss) from Schedule F, line 34, and from farm partnerships, Schedule K-1 (Form 1065), box 14, code A*.

Enter any net profit or (loss) from Schedule C, line 31; Schedule C-EZ, line 3; Schedule K-1 (Form 1065), box 14, code A (other than farming); and Schedule K-1 (Form 1065-B), box 9, code J1*.


*If you have any Schedule K-1 amounts, complete the appropriate line(s) of Schedule SE, Section A. Reduce the Schedule K-1 amounts as described in the Partner’s Instructions for Schedule K-1. Enter your name and social security number on Schedule SE and attach it to your return.

+

=

2a

2b

2c

Part 3

Statutory Employees Filing Schedule C or C-EZ

3. Enter the amount from Schedule C, line 1, or Schedule C-EZ, line 1, that you are filing as a statutory employee.

3

Part 4


4a

b.

Enter your earned income from Step 5.

Combine lines 1e, 2c, 3, and 4a. This is your total earned income.

4a

4b

5.

If line 4b is zero or less, STOP. You cannot take the credit. Enter “No” on the dotted line next to line 66a.

If you have:

3 or more qualifying children, is line 4b less than $47,955 ($53,505 if married filing jointly)? 2 qualifying children, is line 4b less than $44,648 ($50,198 if married filing jointly)? 1 qualifying child, is line 4b less than $39,296 ($44,846 if married filing jointly)?

No qualifying children, is line 4b less than $14,880 ($20,430 if married filing jointly)?

Yes. If you want the IRS to figure your credit, see Credit figured by the IRS, earlier. If

you want to figure the credit yourself, enter the amount from line 4b on line 6 of this worksheet.

No. STOP. You cannot take the credit. Enter “No” on the dotted line next to line 66a.

50

51

Worksheet B – 20XX EIC – Lines 66a and 66b – Continued

Part 5 6. Enter your total earned income from Part 4, line 4b. 6


7. Look up the amount on line 6 above in the EIC Table to find the credit. Be sure to use the correct column for your filing status and the number of children you have. Enter the credit here.



7




No. Go to line 10.

Part 6


10. If you have:





credit. Be sure you use the correct column for your filing status and the number of children you have. Enter the credit

here.



10

Part 7


11.

√


Reminder—


11

Enter this amount on

Form 1040, line 66a.

If your EIC for a year after 1996 was reduced or disallowed, see

Form 8862, who must file, earlier, to find out if you must file Form 8862 to take the credit for 20XX.

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