the expert in tax education. applications & due diligence of the earned income credit
TRANSCRIPT
The Expert in Tax Education
The Expert in Tax Education
Applications & Due Diligence of the Earned Income Credit
The Expert in Tax Education
Applications & Due Diligence of the Earned Income Credit
Developed by Raven Deerwater, EA, Ph.D
Presented by XXXX
Summer 2014
Objectives of the Course• Understand the 15 rules
determining eligibility for the EIC
• Apply the 15 rules determining eligibility for the EIC in many different situations
Objectives of the Course• Be aware and comfortable with
questions you need to ask clients when there is a potential EIC claim.
• Understand the IRS-recommended Best Practices for Due Diligence of practitioners who sign returns that include the EIC.
Opening Scenario
Matt Matticks, age 48, comes into your office with his daughter Sondra Matticks, age 25, whose baby, Skee, was born on July 28, 2013. Sondra is unmarried and lived with Matt all year, earning $9,245 during 2013. Matt is unmarried, having divorced Sondra’s mother 10 years ago, and made $22,425 as a bookkeeper. Who qualifies for EIC?
Which of the following changes your answer?
• Sondra earns $29,945
• Sondra has two other kids, aged 2 and 4
• Sondra is 17, not 25
• Sondra is 17, and Sondra’s mother gets to claim dependency for Sondra as part of the divorce agreement
Eligibility for Earned Income Credit
There are 14 official rules for determining who is eligible for the Earned Income Credit (EIC). They fall into 3 categoriesA. Rules for Everyone
B. Rules to Determine a Qualifying Child
C. Rules if There is No Qualifying Child
Part A. Rules for Everyone
Rule 1. Adjusted Gross Income (AGI) Limitation
Rule 2. Taxpayer Must Have a Valid Social Security Number
Rule 3. Taxpayer’s Filing Status Cannot Be Married Filing Separately
Rule 4. Taxpayer Must Be a U.S. Citizen or Resident Alien All Year
Part A. Rules for Everyone
Rule 5. Taxpayer Cannot File Form 2555 or Form 2555-EZ
Rule 6. Investment Income Limitation
Rule 7. Taxpayer Must Have Earned Income
Part B. Rules to Determine a Qualifying Child
Rule 8. Relationship, Age, Residency, and Joint Return Tests
Relationship Test
The qualifying child must have the following relationship to the taxpayer:• daughter, son, stepchild, adopted child, foster
child• brother, sister, half brother, half sister,
stepbrother, stepsister• OR a descendant of any of them
Age Test
The qualifying child must be • younger than taxpayer (or spouse, if filing
jointly) AND • under 19 at end of year (or a full-time student
under 24) OR • permanently and totally disabled, regardless
of age
Residency Test
The qualifying child must have lived with the taxpayer in the U.S. for more than half of the year.
Joint Return Test
The qualifying child cannot have filed a joint return (unless solely for claim of refund).
Example 1
Raina graduates high school on May 27, and starts a full-time job. She turns 19 on November 14. Can her parents claim her for EIC?
Solution to Example 1
While she does not count as under 19, she does qualify as a full-time student since she was in high school for the first five months of the year.
Example 2
Lilly, age 21, and Connor, age 25, are married. Lilly’s brother, Greg, age 23, lives with them and attends the state university full-time. Can Lilly and Connor claim Greg for the EIC?
Solution to Example 2
Yes. Greg meets the relationship requirement by being Lilly’s brother. Since Greg is a full-time student under 24, and younger than Lilly’s spouse, he meets the age requirement. He also meets the residency and joint return requirements. (Note: if Greg was older than both Lilly and Connor, he would not meet the age requirement.)
Part B. Rules if You Have a Qualifying Child
Rule 9. Only One Taxpayer Can Claim Any Individual Qualifying
Child
Rule 9.
For a given child, the following six tax benefits are linked:• 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• The EIC
IRS Tie-Breaking Rules
1. The child’s parent has precedence over anyone else. The parents can choose between them who will take the child.
2. If both parents file claims for the same child, the one who lived with the child longer has precedence. If that doesn’t break the tie, then the one with the higher AGI has precedence.
IRS Tie-Breaking Rules
3. If no parent has a claim, then the qualifying child goes to the person with the highest AGI.
4. If a parent can make a claim, they can allow another to take the claim if the child qualifies and that person has a higher AGI than that of any other parent who can claim the child. (For a joint return, each spouse is considered to have ½ the AGI.)
Example 3
Louisa and Frank are not married, but live together with their 2-year-old son, Caleb. Louisa has an AGI of $14,500 and Frank has an AGI of $13,000. Who can take Caleb for the EIC?
Solution to Example 3 Either Louisa or Frank can take 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. They cannot split up these tax benefits. If they do not work it out between themselves, the IRS will choose Louisa for these benefits as she has the higher AGI.
Example 4
Jon and Martha are divorced. Their 3-year-old daughter, Mia, lives with Martha full-time. Jon provides spousal support and child support. Who can take Mia for the EIC?
Solution to Example 4
Because of the residency test, only Martha can take Mia for the EIC. However, due to the divorce, Jon may qualify for the exemption for the child and the child tax credit.
Example 5
Ron and Linda are married and live with their 4-year-old twins, Sam and Scarlett, as well as Ron’s mother. Ron and Linda file jointly and have an AGI of $28,000. Ron’s mother has an AGI of $22,000. Who can take Sam or Scarlett for the EIC?
Solution to Example 5
Ron and Linda have first claim on the EIC. However, if they choose not to take the EIC, Ron’s mother also qualifies to take the twins for the EIC, as her AGI is greater than $14,000, which is half of the joint AGI of the married couple.
Part B. Rules if You Have a Qualifying Child
Rule 10. Taxpayer Cannot Be a Qualifying Child of Someone Else
Example 6
Gary is 21 and lives with his mother, Maya, and his son, Adam. Gary is a full-time student and earns $6,200 at a campus job. Maya lives on her Social Security payments. Who can take Adam for the EIC?
Solution to Example 6
Although Gary is a qualifying child of Maya, since Maya does not need to file a tax return, Gary may take Adam for the EIC. Maya cannot take Adam or Gary, as she has no earned income.
Example 7
Gary is 21 and lives with his mother, Maya, and his son, Adam. Gary is a full-time student and earns $6,200 at a campus job. Maya lives on her Social Security payments, and has a part-time job that pays $2,300 over the year. She files a tax return to claim the money taken from her paychecks. Who can take Adam for the EIC?
Solution to Example 7
If Maya’s return solely consists of getting back the taxes taken from her paycheck, Gary may take Adam for the EIC. However, if Maya takes Gary for the EIC, then Gary cannot also claim Adam for the EIC. Maya cannot take Adam for the EIC as she makes less than Gary.
Part C. Rules if You Do Not Have a Qualifying Child
Rule 11. Taxpayer Must Be at Least Age 25 but Under Age 65.
Example 8
Lilly, age 21, and Connor, age 25, are married. Do they qualify for the EIC?
Solution to Example 8
Yes, since one spouse, Connor, is 25.
Part C. Rules if You Do Not Have a Qualifying Child
Rule 12. Taxpayer Cannot Be a Dependent of Someone Else.
Example 9
Caitlin, age 21, is a full-time student and makes $2,100 at a campus job. Her parents claim her as a dependent. Does she qualify for the EIC?
Solution to Example 9
No, but her parents could take her for the EIC.
Part C. Rules if You Do Not Have a Qualifying Child
Rule 13. Taxpayer Cannot Be a Qualifying Child of Someone Else
Rule 14. Taxpayer Must Have Lived in the U.S. More Than Half
the Year
Part D. Figuring and Claiming the EIC
Rule 15. Earned Income Limitations
Common Misconceptions
• A child must be a dependent to qualify for the EIC.
• A single taxpayer must have Head of Household status to qualify for the EIC.
Example 10
Matt Matticks, age 48, comes into your office with his daughter Sondra Matticks, age 25, whose baby, Skee, was born on July 28, 2013. Sondra is unmarried and lived with Matt all year, earning $9,245 during 2013. Matt is unmarried, having divorced Sondra’s mother 10 years ago, and made $22,425 as a bookkeeper. Who qualifies for EIC?
Solution to Example 10
Skee is a qualifying child for both Matt and Sondra because Skee meets the relationship, age, joint return, and residency requirements. Sondra is not a qualifying child for Matt as she does not meet the age test. Sondra has first claim to the EIC, but she can allow Matt to take the EIC instead since his AGI is greater than hers.
Example 10, Variant 1
Sondra earns $29,945, not $9,245.
Solution to Example 10, Variant 1
In this case, Skee is still a qualifying child for both Matt and Sondra because Skee meets the relationship, age, joint return, and residency requirements. Sondra is not a qualifying child for Matt as she does not meet the age test. Sondra can claim the EIC, but she cannot allow Matt to take the EIC as her AGI is greater than his.
Example 10, Variant 2
Sondra has two other children, ages 2
and 4.
Solution to Example 10, Variant 2 In this case, nothing changes. All three
children are qualifying children for both Matt and Sondra because they meet the relationship, age, joint return, and residency requirements. Sondra is not a qualifying child for Matt as she does not meet the age test. Sondra has first claim to the EIC, but she can allow Matt to take the EIC instead since his AGI is greater than hers.
Example 10, Variant 3
Sondra is 17, not 25.
Solution to Example 10, Variant 3
In this case, Skee is still a qualifying child for both Matt and Sondra because Skee meets the relationship, age, joint return, and residency requirements. Sondra is now a qualifying child for Matt as she meets the relationship, age, joint return, and residency requirements. Only Matt can claim the EIC, and he can claim it for both Sondra and Skee.
Example 10, Variant 4
Sondra is 17, and Sondra’s mother gets to claim dependency for Sondra as part of the divorce agreement.
Solution to Example 10, Variant 4 Skee is still a qualifying child for both Matt
and Sondra because Skee meets the relationship, age, joint return, and residency requirements. Sondra is now a qualifying child for Matt as she meets the relationship, age, joint return, and residency requirements. Only Matt can claim the EIC, and he can claim it for both Sondra and Skee. So Sondra’s mother can take Sondra as a dependent, and Matt can claim the EIC for Sondra.
EIC Due Diligence
• EIC error rate is from 21% to 26%.
• 70% of EIC returns are prepared by paid preparers
• Congress enacted due diligence requirements in 1997
• Extra steps are required of paid preparers
Four Tiers of Enforcement
• Tier 1: Educate Preparers: Educational letters alerting both new and experienced preparers with high error probability
• Tier 2: In-person Visits: In-person educational visits by IRS agents and criminal investigators
Four Tiers of Enforcement
• Tier 3: Onsite Audits of EIC records: Onsite audits of preparer records, checklists, worksheets, etc.
• Tier 4: Civil Injunctions or Criminal Prosecutions: Civil injunctions can permanently or temporarily bar tax preparation
Common Errors
In general, more than 60% of EIC errors fall into one of the following three categories:• Claiming a child who doesn’t meet the age,
relationship, or residency requirement• Incorrect filing status• Under or over-reporting income
Claiming a child who doesn’t meet the age, relationship, or residency requirement
• Gather all the facts to determine child eligibility by asking simple and easy to understand questions.
• Probe the relationships and look for ambiguous answers.
• You also need to know special rules and exceptions including the AGI and tie-breaking rules.
Incorrect filing status
• You need to understand the differences in filing status between single, head of household, and married.
• Filing status rules are not the same as the eligibility rules for the EIC.
• You, not the client, must determine filing status.
Under or over-reporting income
• You need to look for questionable W-2 forms and unsubstantiated SE income and expenses.
• You also want to be wary of incomes in the “sweet spot,” where the EIC is maximized.
Requirements of Paid Preparers
This is spelled out in the Internal Revenue Code Section 6695(g)• Complete Form 8867, Paid Preparer’s Earned
Income Credit Checklist• Compute the credit using the EIC worksheet
or an equivalent• Keep records (3 years)• Know the law
For returns filed after December 31, 2011
• The due diligence penalty for an EIC return is $500
• Preparers must file Form 8867
• Individuals and firms who employ others to prepare returns could be subject to due diligence requirements and penalties
Best Practices
Know the Law
Get the Facts
Ensure Income is Reported Correctly
Document the Responses
Know the Law
• Don’t rely on software alone
• Explain the law to your clients
• Evaluate the information received from your clients
• Use resources when questions come up
Get the Facts
• Conduct a thorough interview
• Ask open-ended questions
• Phrase questions in terms your client understands
• Ask questions of each client, each child, every year
Ensure Income is Reported Correctly
• Reasonableness of known income
• Propriety of forms
• Propriety of Schedule C figures
• Situations that maximize EIC credit
• Collect all the facts
Document the Responses
• Use questionnaires
• Document additional questions you raised and the client responses
• Maintain all client records in a secure environment
IRS Resources
• Publication 17. Your Federal Income Tax. Earned Income Credit has its own chapter
• Publication 596. Earned Income Credit
• The IRS has a special web address for EIC returns and questions: www.EIC.irs.gov
• One tab on this website is “Tax Preparer Toolkit”: www.EIC.irs.gov/central/main/
Presentation developed by Raven Deerwater, EA, Ph.D
Raven Deerwater EA, Ph.D has a tax practice in Mendocino, California, specializing in individuals and families. A former math teacher and professor, Raven has written several articles EA Journal, including “The Do’s of Due Diligence” and “Benford’s Law & Enrolled Agents”. He was the 2012-2013 President of the California Society of Enrolled Agents (CSEA). He also serves on the Implementation Task Force for NAEA.
PO Box 1786 / Mendocino, CA 95460707-937-1099 / 707-937-1075 (FAX)
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