earned income credit

[Maggie]

Taxpayer had $3000 of Series EE bond interest which was excluded from income because it was used to pay for college education. IRS rejected her EIC claim saying her investment income was above $2,950 (2008). Investment income aside from EE bond interest was $150 (and this is reflected on line 8a). Instructions for EIC investment income worksheet say to pick up interest from line 8a and 8b. The series EE bond interest does not show up on line 8a or 8b because it is excluded on the 8815. Is there some reason that the $3000 SHOULD have been included in the investment income calculation for EIC? Purely by following the instructions, the IRS is incorrect in denying the claim.
Thanks

[Burke]

Good question. The investment income was earned; it was just excluded from TAX due to the purpose for which it was used. I admit I have not had one of these where both EE exclusion and EITC applied.

[appelman]

EIC and educational use of bond proceeds

I agree with Maggie's conclusion. I suggest you give the Practitioner Priority Line a buzz. If they disagree, get them to quote chapter and verse.

Evan Appelman, EA

[ChEAr$]

I agree with Maggie's conclusion. I suggest you give the Practitioner Priority Line a buzz. If they disagree, get them to quote chapter and verse.

Evan Appelman, EA

I don't think this is a matter for our practitioners' priority line to handle, since it's
a matter of tax law and research. There "priority" is to help account issues.

[Koss]

Not eligible for EIC

The text of the Internal Revenue Code disallows the Earned Income Credit for taxpayers with excessive investment income. The definition of investment income, in this context, includes all interest and dividend income, whether taxable or tax-exempt. The language of the code does not provide for special treatment of Series EE interest that is excluded on Form 8815. This interest appears to be just another type of tax-exempt interest. Unfortunately, that means that it still disqualifies the taxpayer from claiming EIC.

Here's the relevant text of IRC 32(i):

Denial of credit for individuals having excessive investment income
(1) In general
No credit shall be allowed under subsection (a) for the taxable year if the aggregate amount of disqualified income of the taxpayer for the taxable year exceeds $2,950.
(2) Disqualified income
For purposes of paragraph (1), the term “disqualified income” means—
(A) interest or dividends to the extent includible in gross income for the taxable year,
(B) interest received or accrued during the taxable year which is exempt from tax imposed by this chapter,
(C) the excess (if any) of—
(i) gross income from rents or royalties not derived in the ordinary course of a trade or business, over
(ii) the sum of—
(I) the deductions (other than interest) which are clearly and directly allocable to such gross income, plus
(II) interest deductions properly allocable to such gross income.

[Emphasis supplied]

I have reviewed the worksheet provided in IRS Publication 596 (2008), and it does not instruct the reader to include interest that was excluded on Form 8815.

The worksheet is defective.



Unfortunately, the courts have conclusively ruled that when IRS instructions conflict with the law, the law itself prevails.

The tax pro's job at this point may be to try to get the IRS to waive any interest and penalties--yes, I said interest and penalties--on the grounds that the error on the return was due to erroneous written advice from the IRS. Also, the tax pro should make sure that the taxpayer is not denied EIC in future years because of this honest mistake.

What software was used to prepare the return in question? Or was this a DIY job?

One final observation:

In the instructions for Form 1040, for the Tax Year 2008, page 46 has a sort of flowchart for determining eligibility for EIC. Step 2 addresses investment income. Here, too, the instructions direct the reader to calculate investment income by adding lines 8a, 8b, 9a, and 13 (from Form 1040). The instructions then ask the reader, "Is your investment income more than $2950?" If the answer is yes, the reader is then asked "Are you filing Form 4797?" If the answer to that question is no, then the result is that the person cannot claim EIC.

Here again, the worksheet used to calculate investment income is defective, because it does not account for interest reported on Form 8815. This strengthens the argument that the error is based on incorrect written advice from the IRS.

Nevertheless, even though the worksheet is wrong, the questions actually produce the correct conclusion. For the taxpayer in question, when the instructions ask, "Is your investment income more than $2950?", the answer, unfortunately, is yes, even though some of her investment income does not appear in the worksheet.

BMK

[luke]

Awesome

answer KOSS! That was worth the price of admission to this forum (again!)

[appelman]

Sorry, but I don't think it is that all cut and dried.

Sorry, but I don't think it is that all cut and dried. "Tax-exempt interest" refers specifically to the interest reported on line 8b. It is not obvious that it includes interest explicitly EXCLUDED from income on Form 8815. And inasmuch as Maggie is presumably interested in challenging a determination made for her client, the Practitioner Priority Line is, in fact, the easiest place to start. They can direct her to whomever made the determination. I obviously can't guarantee that she can get them to reconsider, but I think it's worth a shot. And if Koss's interpretation is valid, then they really need to correct Pub. 596, and especially Worksheet 1. I would also think that this would have come up often enough that if the intent really was to include interest excluded on 8815, they would have said so somewhere in the Pub.

Evan Appelman, EA

[Gene V]

Sorry, but I don't think it is that all cut and dried. "Tax-exempt interest" refers specifically to the interest reported on line 8b. It is not obvious that it includes interest explicitly EXCLUDED from income on Form 8815. And inasmuch as Maggie is presumably interested in challenging a determination made for her client, the Practitioner Priority Line is, in fact, the easiest place to start. They can direct her to whomever made the determination. I obviously can't guarantee that she can get them to reconsider, but I think it's worth a shot. And if Koss's interpretation is valid, then they really need to correct Pub. 596, and especially Worksheet 1. I would also think that this would have come up often enough that if the intent really was to include interest excluded on 8815, they would have said so somewhere in the Pub.

Evan Appelman, EA

I agree with Appelman,

Koss-you asked--What software was used to prepare the return in question? Or was this a DIY job?
Have you tried this on your software?

[dyne]

I entered the data in my 2008 and 2009 Drake Tax Software and it ALLOWED the EIC. If the
education expense is removed, the EIC is NOT allowed.This issue has been
discussed on this message board and one other and the general consensious
is that the EIC is NOT allowable. We should override our computer software
if necessary. Since U. S. Government bond interest is only taxed when bonds
are cashed, a taxpayer can avoid this problem by not cashing in enough bonds
in one year to reach the investment income threshold which might disqualify the EIC.

[appelman]

I'd go with Drake.

I'd go with Drake. I think someone at the IRS was just adding ujp the 1099's.

Evan Appelman, EA

[robinbert]

Question about the EITC worksheet on irs.gov

I have a client whose daughter turned 19 in Dec 2009. However, she was a full-time High School student until June 1, 2009. By my understanding of reading in Pub 596, there is an "or" when you answer the question about the age of the child and the student age 24. A competitor has told the client that the child does not qualify due to age 19 - however, I am reading this as under age 24 AND a full time student. What do you think?

Robin

[Jesse]

Robin, I'm in agreement with you that the child does meet the definition of full time student. So as long as all other requirements are met too, this would be a qualifying child for EIC.

[Maggie]

Thank you

Thanks so much for the great responses. All are much appreciated.

[Maggie]

software used

By the way, I am using the intuit proseries program. I did a separate return removing the 8815, and the EIC was denied.