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Discussion About EITC or Earned Income Credit

The EITC or EIC, also known as the Earned Income Tax Credit is what working people with low up to moderate income acquire as a benefit. However, there are qualifications to get this. They must meet specific requirements and also file their tax return. EITC also deducts the amount of tax that the taxpayers owe and can give them a refund.

The amount of the benefit from the EITC depends on the taxpayer’s income as well as the total number of children. For the individual to claim one or more EITC per qualifying child, there must be requirements like a relationship, shared residency and age, and these three must be met. Taxpayers with no child and earn income below the standard that is stated by the IRS receive a small amount of EITC benefit. The US tax forms 1040A, 1040 and 1040EX are used to claim EITC for those who do not have qualifying children as their dependents. Taxpayers with qualifying children can claim their credit by filling up forms 1040 and 1040A.

EIC phases slowly and has a medium-length plateau. After this, it phases slower than before because it constantly phases in. For example, if the credit phases at 21% for taxpayers that have more than one qualifying child, it has 16% of taxpayers who have one qualifying child. Therefore, taxpayers must always choose one more dollar of their actual wages or salary and increase this by fifty-dollar increments. It is also preferred to allot extra fifty-dollar increment per wages and salary by considering just the EITC. However, if the EITC is combined with other tested programs such as Temporary Assistance for Needy Families or Medicaid, the Marginal Tax Rate exceeds 100% in some circumstances. It depends on the state of residence of the tax payer. Under these circumstances, net income rises faster than the increase in the taxpayer’s wage due to the phasing in of the EITC.

History of the EITC

The EITC was enacted in 1975. It was created with the intention that it expanded by the tax legislation on certain occasions, which included the publicized Tax Reform Act of 1986. It was then expanded in the years 1990, 1993, 2001 and finally 2009, even though the act raised taxes in general (specifically 1990 and 1993) and lowered the taxes in 2001. It also eliminated the other credits and deductions in 1986. Nowadays, EITC is one of the largest anti-poverty tools that Americans turn to. However, it is important to note that most income measures that also includes the poverty rate, do not account this credit.

A qualifying child, when defined, can be the taxpayer’s son, daughter, adopted child, stepchild or foster child or even any descendent. It can also be the taxpayer’s sister, brother, half-brother, half-sister, stepsister, stepbrother or other descendants like nephew, niece, great nephew, great niece. A qualifying child can also be an adopted child provided that he or she has been placed lawfully in the home of the taxpayer.

When the taxpayer is claiming for the EIC from a qualifying child, he or she must be older than the latter. The only exception for this is if the qualifying child is classified as totally and permanently disabled for that specific income tax year. A qualifying child can be as old as 18. A qualifying child is also a full-time student who can be as old as 24. A qualifying child with no age limitation are individuals who are disabled. Taxpayers who are parents claim their child or children as their dependents unless they are also waiving the credit for that year to another family member who is an extended relative with a higher AGI. It is also important to note that there is no support test for Extra Income Credit. There is just the six month plus one day shared residency test.

When Are Refunds Expected?

If the taxpayer claims the EITC as well as the ACTC (which is additional tax credit) on the tax return that they filed, the IRS must hold onto the refund of the taxpayer – even if the portion does not have anything to do with the ACTC or the EITC.

Qualifications for Earned Income Credit

To qualify for the EITC, the taxpayer must have income because he has worked or he is running his firm or business and can meet the standard rules.

How to Claim EITC

Taxpayers must have filed a tax return before they can claim EITC. They need to submit the required documents and be on the lookout for the common errors that are made on filling up the forms. They should also be aware of the consequences when they file an EITC return, and an error was discovered. They should also be knowledgeable on how they can get help preparing for their return as well as what they should do just in case the EITC was denied. Most importantly, they need to know how they can claim the credit for previous tax years.

Why did I receive a letter from IRS regarding EITC?

IRS sends letters out regarding EITC because they are suggesting the taxpayer to claim their EITC because, upon careful review of their taxes, they qualify for this. They also ask the taxpayers to follow up on the additional information and send these to the IRS so that their claim can be verified. IRS also calls to gather more information about the claim.

Who claims the credit and how to get the EITC

The taxpayer or his or her spouse (if a joint return was filed) and others listed as the dependents must all have SSNs that are valid and required for their employment and issued before the due date of the return. This is one of the requirements to claim the credit and also qualify for an ETIC. The taxpayers must also have enough earned income by working for a company or a business or running or owning his own.

If married, the IRS should not be filed separately. The taxpayer must also be a US citizen or a resident alien.  It is very important that the taxpayer is not a qualified dependent (whether qualified child or qualified relative) of another taxpayer.  He or she must also have met the earned income, investment income limits and AGI for the specific tax year.

If these requirements are all met, then the taxpayer is qualified for EITC. The next step is to file the tax returns with the IRS even if the taxpayer owes no tax or not required to file in the first place.

If IRS denied the taxpayer an EITC last year and he or she is qualified in the current income tax year, the taxpayer must attach the completed Form 8862 or what is also known as the Information to Claim Earned Income Credit After Disallowance to claim EITC. Taxpayers need not file Form 8862 if the IRS has decided to reduce or not allow the taxpayer to receive an EITC  due to intentional disregard or recklessness concerning EITC rules.

Earned income also includes wages and taxable income that the taxpayer obtains from working for a company or running or owning his firm or business.

Taxable earned income covers the following:

  • Salaries, wages, tips
  • Benefits from union strikes
  • Disability benefits that the taxpayer receives before reaching the minimum age for retirement
  • Net earnings from self-employment

Combat Pay

Taxpayers can choose to include their nontaxable combat pay in their earned income that is taxable to get the EITC. They either have to include it or not include it at all. If they choose to do this, then they have to check if they can include this whenever the taxable increases the refund or deducts the amount of tax that is owed. If the spouse of the taxpayer is also eligible for nontaxable combat pay, then both of them can opt for one that is best. The amount of the nontaxable combat pay is shown on the Form W2 in box 12 with the code Q.

How is credit calculated?

After the taxpayer determines that he or she does qualify for EITC, there are two choices to calculate the credit:

  1. Let the IRS do the work. Follow the instructions stated on Line 64 on Form 1040. It is found on Line 38a on the Form 1040 as well as on Line8a on Form 1040EZ.
  2. They can calculate the credit themselves. They must use the EIC Worksheet and follow the instructions stated in the booklet for Forms 1040, 1040A and 1040EZ as well as the EIC Table. They can also use online tools such as the EITC Assistant Tool which is available in both the English and Spanish language.

If taxpayers are prohibited to claim their EITC for years and the year after that due to an error from reckless or intentional disregard of the rules for EITC, then the taxpayer is prohibited to claim EITC for two years. If the error was because of fraud, they could not claim EITC for the next decade. The date that IRS denies the EITC of the taxpayer and the date on which the taxpayer files the return affects the next time frame of 2 to 10 years, then they will be barred from ever claiming their EITC.

Other Requirements for EITC

  • The investment income cannot be more than what is stated in the income tax year.
  • The taxpayer must be a US citizen or a resident alien. If he or she is married and is filing jointly and one is a citizen, and one is not, then the taxpaying couple must regard the non-resident partner as a resident who then concludes that their entire income would be subject to taxes. Only then will they be able to qualify for EIC.
  • Files with or without children that are qualified should have lived in the 50 states or District of Columbia for more than six months and one day. The Northern Mariana Islands, American Samoa and Puerto Rico are not included. However, a taxpayer who is on an extended military duty is still considered to have met the requirement of the duration of his stay even if he or she is serving time away.
  • Taxpayers who do not have a qualifying child must be 25 to 64 years old. Married couples without a qualifying child must only have one spouse within that age range. A single individual with a qualifying child has no age requirement, aside from the fact that he is not the qualifying child or dependent of another taxpayer. A married couple with one qualifying child is classified as claimable by a qualifying relative, and the couple must also have earned income before once can qualify for an EIC.
  • All taxpayers and qualifying children must have valid social security numbers. This includes the SSN cards that have “Valid for work only with DHS authorization” and “Valid for work only with INS authorization.”
  • For Single, Qualifying Widows, Qualifying Widowers, Heads of Households and Married but Filing Jointly taxpayers, they must have valid filing status for the EIC. It still depends on the total income of both the husband and the wife. Married couples who file jointly can have a better advantage depending on the phase out. A legally married couple can also file jointly despite that act that they have lived apart for the entire income tax year and even if they do not have any expenses or revenues that they share throughout the income tax year. As long as both the husband and wife agree to file together, then they can do so.

Finally, another important note to look at is that it phases out by the adjusted gross income or the greater of the total earned income. For example, a married couple whose overall income amounts to $21,500 but has $3,100 investment income is eligible for the maximum credit, depending on the number of their qualifying child. That investment income cannot get any greater than $3,100. They also receive zero EIC. There are some incomes that range beyond this, depending on the increase of dollar investment as well as the result of the losses after dollars that have been taxed.

Where is Your Tax Home?

If your job requires you to travel from time to time, some of the expenses that you incur while traveling away from home may be entitled to tax deductions. In this sense, however, home does not necessarily refer to the place where you live but the place where you work. This is what the Internal Revenue Service (IRS) refers to as your tax home.

Determining where your tax home is is the first and most fundamental thing that you need to do if you want to determine if you are really traveling away from home.

Basically, your tax home refers to the general area of your workplace, regardless of where you actually live. So, if you work in New York, your tax home is New York.

Do not be confused if the place where you work is different from the place where you lay your head at night, because your tax home designation has nothing to do with where you live. In fact, you may travel miles from your permanent residence to your workplace every day, but your workplace will still and always be your tax home.

 Why You Need to Determine Your Tax Home

Often, when you attend a cocktail party and are asked where your home is, your answer is your current place of residence. However, that is not necessarily the case if the one asking you is from the IRS.  While their tax home is the same as their personal home for some taxpayers, the story is different for those who frequently travel for work or business. Don’t think that your tax home doesn’t deserve a thought, because it does matter especially for taxpayers like you.

According to the IRS, your travel can be considered deductible if your work or business requires you to be away from home longer than your normal work hours. Given that, it is clear that the key criterion in determining if your travel expenses are deductible is if your travel takes you away from your tax home.

Differentiating your tax home from your personal home is crucial because only those expenses incur while you are away from your tax home are considered by the law as deductible.

Your Tax Home, As Per the IRS

 IRS’ definition of tax home is plain and simple—Your tax home is your regular place of business or post of duty, regardless of where you maintain your family home.

Basically, your tax home covers the general area or the entire city where your business or workplace is located. If your office is somewhere in Cortlandt Street in New York, then your tax home is New York. If you travel to Louisville every week for your business but return to your permanent residence in Nashville on weekends, your tax home is still Louisville even if you call Nashville home.

 Why Your Workplace Must Be Your Tax Home

There is a reason the IRS requires every taxpayer to know their tax home, and there is a reason the tax home designation exists in the IRS law. The purpose of the tax home designation is for the deduction of travel expenses associated with work or business. This explains why in the eyes of the tax-collecting agency, your workplace is your home and not your apartment.

Imagine living miles outside Louisville but working in the city. If there is no tax home designation, then you must also be counting your house in Nashville out as your tax home. If that is the case, then theoretically, you can declare each and every expense you spend in Nashville as a business or work-related expense. The IRS is wise enough not to fall for such tricks.

When You Have More Than One Regular Place of Business

 Some taxpayers find it hard to determine their tax home because they have multiple places of business. Should that be your case, then your tax home must be your main place of business or the place where you conduct majority of your business. So, if you have offices in Nashville, Louisville and Franklin, then you must declare the place where you do most of your work as your tax home. In this case, the IRS expects you to consider the following in determining your tax home:

  • How much is the total time that you normally spend in each workplace?
  • How much work do you usually accomplish in each workplace?
  • How much money do you make in each workplace? Is the income you earn from conducting business there significant or insignificant?

Of the above mentioned criteria, the first one is the most important since the IRS states that the place where you conduct most of your business should be your tax home. Logically, the workplace where you spend most of your time is the same place where you conduct majority of your business.

Take this as an example. You reside in Birmingham since you have a seasonal job there for nine months each year. Annually, you earn around $50,000 from your seasonal job there. For the rest of the year which is equivalent to three months, you work in Atlanta where you earn $20,000. In that case, you may consider Birmingham as your main place of business since you spend most of your time there and you earn most of your significant income there.

When You Do Not Have a Regular or Main Place of Business

 Taxpayers who have more than one regular place of business and those who do not have a regular or main place of business usually have the same dilemma in determining their tax home. According to the IRS, for taxpayers whose nature of work causes them to not have a regular or main place of business, their tax home must be the location of their residence or where they regularly live.

Say you are a freelance web designer and do not have a regular office where you conduct business. Since your job requires you to visit offices of your clients to discuss business with them, and since you do not really have a workplace of your own, then your tax home is your house.

Freelance workers and travel bloggers are perfect examples of taxpayers who do not have a regular workplace, since they do not have a fixed place where they conduct business. In this case, you do most of the work at home so your tax home may be your actual home or your personal residence.

Take a look at these factors which the IRS considers in determining your tax home if you do not have a regular place of business:

  • You at least perform part of your business in the area of your personal residence and use it for lodging while conducting business.
  • There are living expenses in your personal residence that you are compelled to duplicate because your job or business needs you to travel away from home.
  • You do not abandon the area of both your place of lodging and personal residence are located, members of your family live with you in that residence, and you use that home for lodging most of the time.

Remember that you need to meet all the three criteria so you can consider your personal residence as your tax home. If you meet all the three factors, then any travel expense that you may incur away from your personal home can be considered deductible since they meet the “away from home” requirement for business travel deductions.

Unfortunately though, if you only meet one of the three factors, then the IRS can consider you as not having a true tax home so you can write off none of your travel expenses.

For example, your family residence is located in Indianapolis. In that city, you work 15 weeks a year. For the rest of the year, you work for the same employer in Cincinnati, where you dine in expensive restaurants and sleep in a rented apartment. For you, it doesn’t really matter whether you are in Indianapolis or in Cincinnati because your salary is the same whether you are in one city or the other. However, since you conduct most of your business in Cincinnati, that city is considered your tax home. That means that even if your expenses there are bigger than when you are in Indianapolis, you cannot deduct any of your expenses for meals and lodging while you are there. When you return to your family home in Indianapolis, you are away from your tax home so you can deduct the cost of your round trip between Indianapolis and Cincinnati, as well as part of your family’s living expenses for meals and lodging while working in your personal home.

When You Do Not Have a Fixed Workplace and a Fixed Home Address

 In determining your tax home, there is something much worse than having more than one regular workplace or not having a regular workplace at all– Not having a regular place of business or post of duty and no personal residence at the same time.

While determining your tax home is not that easy if you have more than one regular workplace, it becomes easy when you finally determine which among your workplaces is your tax home. And while determining your tax home is not that easy when you do not have a regular workplace, it becomes easy when you have a personal residence which you can call your tax home.

However, things become a bit complicated when you do not have a regular place of business and you do not have a place where you regularly live at the same time. In that case, the IRS considers you as an itinerant.

The IRS law states that the tax home of an itinerant or a transient is wherever he works. If you belong to this category, then you are not entitled to travel expense deductions because no matter where you work, you are never considered to be traveling away from home.

Since as an itinerant, everywhere you work is your tax home, you are never really away from home, which means that you cannot write off any of your travel expenses.

An outside salesman is an example of an itinerant. Say you are an outside salesman whose sales territory covers different states. The main office of your employee is in Memphis but you do not work or conduct any business there. Your work assignments are relatively temporary and you have no idea about the locations of your future assignments. Your sister is renting out a room somewhere in Saint Louis so you stay there for a couple of weekends each year, but you do not conduct any business in that area. You do not pay for your accommodation there either. Since you do not satisfy any of the previously mentioned factors that will make your regular home your tax home, then you are considered an itinerant and therefore have no deductible travel expenses.

 When Traveling is Considered Traveling Away from Your Tax Home

 Regardless of which of the abovementioned categories you fall under, all the said criteria boil down to the fact that determining your tax home is critical in determining your tax liability when traveling. Once you have already identified your tax home, it will become easier for you to know which of your travel expenses you should write off and which you should not.

It is also worth mentioning that these tax home rules are the same whether you are an employee or a self-employed individual, although there are certain instances when the degree to which you can write off your business travel expenses may differ.

For instance, employees can only deduct work-related expenses that they have not reimbursed from their employers, while self-employed individuals can deduct the full amount of their travel expenses as long as they are incurred away from their tax homes. In any case, remember to keep well-organized records like receipts, checks and other documents to support your deduction claims.

A New Tax Strategy For College Expenses

There are a lot of families that make too much money for their beloved child to qualify for college aid that is need based. The only way they can save money on college expenses is to focus on college tax aid. This is a tax savings that will help parents lower the total college cost. Currently, the stock market is reaching all time highs. Parents are able to combine any investment gains using this strategy which could wipe out capital gains up to $25,000 during the years that their child is attending college. It is a great way to save for college as well as paying you dividends when you retire.

 Example of This Tax Strategy

You give your child an investment such as a mutual fund, EFT or appreciated stock. Your child can then use the personal exemption, American Opportunity Tax Credit and standard deduction to offset the $25,000 of long term capital gains for that year.

 Personal Exemption & Standard Deduction

Normally, parents claim the personal exemption ($3,900 for 2013) for their child in college because they provide more than 50% of the support during the year. If your child uses her own assets and income to provide more than 50% of their own support (approximately 50% of the college costs), than they can claim their own personal exemption instead of the parent claiming the exemption.

dependent child standard deduction is the amount of income the child earns from $300 up to $6,100. If your child claims their own personal exemption because he/she provide more than 50% of his/her own support, he/she can get the personal exemption automatically in addition to taking the full standard deduction ($6,100 in 2013) no matter how much income he/she has earned.

American Opportunity Tax Credit

Your child can claim the American Opportunity Tax Credit if you do not claim this tax credit or claim that child as a personal exemption on your personal tax return. The American Opportunity Tax Credit is worth a maximum of $2,500 for each of the 4 college years. The amount of the tax credit is 100% of qualified tuition, costs and fees that are paid in addition to 25% of the next $2,000 that was paid.

Kiddie Tax

An unearned income that is paid to children under 19 years old or if your child is attending college full time and is under 24 years old is subject to the Kiddie tax. In 2013, the first $1,000 of unearned income is tax free, the second $1,000 of unearned income is taxed at the child’s tax rate and any other income over $2,000 is federally taxed at the parents’ federal tax rate.

A college student can avoid the Kiddie tax by providing more than 50% of his/her own support using earned income such as salary or wages. Understand that the requirement for the Kiddie tax is different from the personal exemption support test.

Example of Tax Savings

You gift your child appreciated assets of $14,000 per year for each permitted donor in 2013 or $28,000 for parents filing jointly. Your child will need to sell some of the assets during the year to pay for his/her own support. Your child realizes $25,000 in long term capital gains. Your child will use the money from selling the assets to enroll in a state university that costs $46,000 every year.

Your child will get the personal exemption, standard deduction and use the American Opportunity Tax Credit in order to offset the $25,000 long term capital gains for the year.

The personal exemption and standard deduction will reduce the capital gains of $25,000. The remaining taxable income will be $15,000 that will be taxed, under the Kiddie tax, at 15% (which is the parents capital gains tax rate). The total tax will be $2,250. This will be completely eliminated when the American Opportunity Tax Credit of $2,500 is used.

Education Tax Deductions and Credits Can Help Save You Money

The cost of college is always increasing; however, there is some relief with education tax deductions and credits. Qualified education expenses may be deducted for your dependents, yourself or your spouse. These tax deductions and credits help more parents and students pay for college expenses.

 American Opportunity Tax Credit

 The American Opportunity Tax Credit helps taxpayers save money on the cost of post-secondary education. It is a tax credit for undergraduate college qualified expenses. This credit was extended until Dec. 31, 2017 when the 2012 American Taxpayer Relief Act was passed.

Tax credits are better than tax deductions because credits reduce the total amount of tax owed or it increases the total amount of your refund in the credit amount. This means that your tax liability will be reduced one dollar for each eligible credit. There is a $2,500 maximum per student for the American Opportunity Tax Credit. In order to qualify, you need to have paid a minimum of $4,000 during the year in qualified education expenses. If you do not incur a tax liability during the year, this credit is still partially refundable up to 40%.

What Expenses Qualify For The Education Tax Credits?

The American Opportunity Tax Credit is unlike other education related tax credits because in addition to tuition, it also includes expenses for supplies, equipment and course related books that are not always paid directly to the educational intuition. Computers qualify for the tax credit if the computer is needed as a condition of attendance or enrollment at the educational institution. These expenses for course materials must be needed for the course of study.

This credit is allowed to be claimed for expenses that are incurred for during the first 4 years of the post-secondary education. The expenses must be paid during the taxable year and relate to the academic period that begins during the same year or the academic period that begins during the first 3 months or the following taxable year.

There are several expenses that do not qualify for the education tax credits. These expenses include:

  • Transportation
  • Room and board
  • Medical expenses
  • Insurance
  • Student fees that are not required as a condition of attendance or enrollment
  • Expenses that are paid with tax-free assistance
  • Expenses that are used for another educational benefit, tax credit or tax deduction

Do I Qualify For The American Opportunity Tax Credit?

The education expenses must relate to the first 4 years of college after high school to qualify for this tax credit. Although graduate students do not qualify for the American Opportunity Tax Credit, there may be other tax deductions and credits that may be eligible for including the Tuition and Fees Deduction and the Lifetime Learning Credit. The American Opportunity Tax Credit is not available for single filers with a modified AGI (adjusted gross income) higher than $90,000 or people filing jointly with income higher than $180,000.

What is the Tuition and Fees Deduction?

 If you have paid a minimum of $4,000 in education tuition and fees, the tuition and fees deduction maximizes out at $4,000. This is a tax deduction and is not the same as a tax credit. Additionally, it is different than the American Opportunity Tax Credit because the deduction for upper income is phased out at a slightly lower income range. This deduction is not available for single filers with a modified AGI (adjusted gross income) higher than $80,000 or people filing jointly with income higher than $160,000.

It is important to understand that you cannot use the American Opportunity Tax Credit and the Tuition and Fees Deduction in the same year. You need to choose between taking the Tuition and Fees Deduction or claiming the American Opportunity Tax Credit.