EIC issue

[Mark Goldberg]

My client, Barbara, is H of H and eligible for a $4,000 EIC (two children). She owns her home. The deed has her ex significant other's name on it. However the mortgage is only in her name. In 2004 he needed money so she refinanced and pulled out $40,000 which went to him. Every month he gives her a check for $400, the amount her mortgage went up after the refi. Barbara has $700 of interest income. She also has a zero income tax as her deductions are greater than her income. They have no agreement as to how long he will pay the $400 or whether he is paying interest. When I asked for her mortgage interest she gave me $12,000 which represents 100% of the interest. When I questioned her on her deductions she told me about the $400. My fear here is if the IRS looks at her return and they decide that he is paying her interest every month equal to what she is paying the bank she will have more than $2700 of interest and be disqualified from EIC. One thought I had is to remove the interest from her Schedule A on the $400 a month he pays to her and say that he is paying it so it is his. Using the logic of the court case with the two brothers. Brother A lived in the house and paid the loan but only brother B's name was on the loan. It was this way becasue Brother A could not get a loan. The court allowed brother A to deduct. Any thoughts?

[Ken]

intrest

I think that would be best for both of them Mark. He is paying the intrest, just let him deduct that amount.

[Koss]

Interest Income?

If she is eligible for $4000 in EIC, then her income is probably low enough that her tax liability will be zero, or near zero, even if she doesn't itemize deductions.

So generally I agree with the earlier response that it is probably in your client's best interest to take the position that her ex is actually paying the interest, and for your client to simply take the standard deduction.

With that being said, it is early enough in the year for them to address this issue for 2006. She must be on good terms with him, since she decided to lend him forty grand...

Here's how you solve this for next year:

Going forward, he should either make his check for $400 out to the lender, or...

He should sign a promissory note with a zero interest rate. That way, every payment of $400 that he makes would, by definition, be principal and not interest income to her.

Will that give him some sort of imputed income due to a below-market loan? I don't know and I don't care, as long as he's not the client.

What makes you think the IRS would even find out about the $400 per month in "interest income," if that is indeed what it is?

I never tell a client to "cheat" just because I think "the IRS won't catch it." That's extremely unethical and in serious cases it amounts to facilitating the filing of a fraudulent return. But I'm curious why you think the IRS would ever become aware of this source of alleged interest income. He hasn't issued a 1099-INT. And on her type of tax return, it would be pretty unusual, and I would even say invasive, for the IRS to ask for complete banking records.

Are you worried that an examination of her Schedule A would involve allowing the IRS to look at her checkbook? Most Schedule A deductions could be substantiated without presenting the checkbook itself.

Burton

[Mark Goldberg]

Burton

I realize that the chance of the IRS looking at this issue is slim to none but if they did and they decided my client was receiving interest income her $4,000 EIC disappears and you know she is going to blame me. Also, my fear is this could be construed as EIC fraud and then she would loss EIC for multiple years. All because she never asked how to structure this properly..