Academic journal article Journal of Accountancy

The New Earned Income Credit

Academic journal article Journal of Accountancy

The New Earned Income Credit

Article excerpt

The earned income credit (EIC) is designed to help low income taxpayers, who generally have not used professional tax preparers. For this reason, many tax practitioners are unfamiliar with the credit. However, Congress has amended Internal Revenue Code section 32 effective for 1991 tax returns. Among the changes is the addition of a separate form for computing the EIC; eligibility rules also have become more complex. Given this added complexity, and the increasing popularity of electronic filing of individual tax returns among taxpayers seeking quick refunds, more low income taxpayers entitled to the EIC are likely to seek help from professional income tax preparers.

EIC computation errors are one major reason why an electronically filed tax return is held up in processing or the direct deposit of a taxpayer's refund is changed to a check. Changing to a check can cause serious problems for a bank that has made a refund anticipation loan to the taxpayer; the refund goes directly to the taxpayer instead of into his or her account at the bank that made the loan.

For 1991, a new two-page form, schedule EIC, leads the taxpayer or preparer through the EIC computation. This article reviews EIC eligibility rules and provides a step-by-step guide for completing schedule EIC and calculating the credit.

EARNED INCOME

Earned income, for EIC purposes, can be substantially different from adjusted gross income (AGI) because of the omission of nonearned income items such as dividends, interest and alimony, and inclusion of nontaxable earned income, such as military housing and subsistence allowances. The computation starts with wages, salaries, tips, etc., on line 7 of form 1040 or form 1040A, but a number of adjustments may need to be made.

Reimbursed employee business expenses. Most employees incurring business expenses account to their employers by submitting expense reports; employers by submitting expense reports; employees are then reimbursed for the exact amount. If the employee is given a set amount per day for meals and lodging, he or she may be later required to submit actual expenses, and only any excess reimbursement is added to his or her W-2 form. In these cases, no adjustment to the amount on line 7 of form 1040 is necessary.

However, if the W-2 forms are incorrect, or the employer includes the entire reimbursement expecting the employee to deduct his or her business expenses on schedule A, an adjustment to the employee's earned income is necessary. Only employee business expenses deductible on schedule A, which have been reimbursed and included on lin 7, are subject to the adjustment.

IRC section 401(k) or cafeteria plans. Any contribution to an employer-sponsored 401(k) or cafeteria plan should be included in earned income. These amounts will not appear on the W-2 form in box 10 but may appear elsewhere on the W-2.

Other adjustments. Certain scholarships for which no form W-2 is received may no be earned income. Union strike benefits and certain disability pensions are includable in earned income, although not taxable.

Military quarters and subsistence. Military personnel basic allowances for quarters (BAQ) or for subsistence (BAS) do not appear on the tax return because the amounts are not taxable. The fair market value of any housing, food and other allowances given to military personnel should be added when computing earned income. In some cases, the taxpayer may have to estimate the value of the apartment or other quarters or allowances being provided.

To be eligible for the EIC, the law requires the taxpayer maintain a home in the United States and have a qualifying child living in that home. Thus, military personnel living abroad are not eligible for the EIC if the child is also living abroad.

Self-employment. The computation of net earnings from self-employment may be different for purposes of computing earned income for the EIC from that for computing income subject to self-employment Social Security taxes. …

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