Earned income credit questions every tax pro must get right

The earned income tax credit (EIC) can provide taxpayers with a lower tax bill or even a welcome refund. However, determining whether the taxpayer qualifies for the credit can be confusing.

Income can make the difference

Qualifying for the EIC often comes down to how income is treated. These questions address two situations that can affect whether the credit is available.

Box 12 of Form W-2, Wage and Tax Statement, shows Medicaid waiver payments exempt from income; are they eligible as earned income for EIC purposes?

The IRS, following the Tax Court’s decision in Feigh v. Commissioner, has clarified that even if Medicaid waiver payments are excluded from gross income under Notice 2014-7, taxpayers may still elect to include these payments as earned income for EIC purposes. When figuring the EIC, the taxpayer uses the earned income worksheet instructions so the excluded Medicaid waiver payments are treated as earned income for EIC purposes while remaining excluded from gross income.

Grandparents earn $50,000 and mom earns only $25,000. Grandparents pay all expenses for the home where they all live. Can mom allow grandparents to claim the grandchild for EIC purposes?

If the child is also the grandparents’ qualifying child for EIC purposes and the parent does not claim the child, the grandparents may claim the child only if their AGI is higher than the parent’s AGI. The rule is based on the qualifying child and tiebreaker rules.

Schedule K-1

Does income from Schedule K-1 (Form 1065) qualify as earned or self-employment (SE) income for EIC purposes?

Generally, yes. But remember that not all Schedule K-1 (Form 1065) income is earned income for EIC purposes. The relevant item is generally the partner’s net earnings from self-employment, which is reported on Schedule K-1 (Form 1065), Box 14, Code A. Other K-1 items may or may not be earned income depending on their character.

What about income passed through to shareholders on a Schedule K-1 (Form 1120-S), would that qualify as earned or self-employment income for EIC purposes?

No, S corporation Schedule K-1, Box 1 income does not qualify, as it is not counted as earned or self-employment income. Wages paid to shareholder-employees would count.

If income from a partnership flows as rental income to Form 1040, U.S. Individual Income Tax Return, does that qualify as earned income for the EIC?

Generally, no. Rental real estate income reported on Schedule E is not earned income unless it is included in net earnings from self-employment; real estate professional status alone does not make it earned income. Rental income may count as investment income for EIC limitation purposes, depending on the facts.

What about the kids?

For unmarried parents who live together all year and provide equal support, who can claim the EIC? Do you have to default to the parent with the higher AGI, or can parents agree to who will claim head of household (HOH) with the dependent and the other claims single?

If the child is a qualifying child of both parents and only one parent claims the child, the parents may choose which parent does so. That parent may claim the child-related tax benefits for which they are eligible, including the EIC, HOH filing status and child tax credit. The benefits cannot be split between the parents based on the same child. HOH status also requires the claimant to pay more than half the cost of keeping up the home.

I have unmarried clients now, and they both tell me they share the child exactly 50/50. Is there a rule for who can claim the child for EIC purposes?

If there are 365 days in a year, one of them likely has the child more than 50% of the year, unless it is a leap year with 366 days. They are likely not counting accurately enough. If both parents claim the child and the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent with the higher AGI.

Does a child living with an otherwise eligible parent for six months and one day qualify the parent for the EIC?

Yes, if the child lived with the otherwise eligible parent for more than half the year, that parent meets the EIC residency test for the child. Publication 596, Earned Income Credit, contains more detailed definitions of nights and rules for vacations, camp and other temporary absences.

Review requirements before filing

Help your clients determine whether they qualify for the EIC by reviewing not only their income but their household situation too. Understanding where a child lived, who may treat the child as a qualifying child and whether the taxpayer meets each benefit’s separate requirements can mean the difference between a balance due and a refund.