Claiming Earned Income Credit? File Carefully

For Matthew Kern, the earned income tax credit has tangible meaning. The $600 he’ll get this year covers about six months of child care bills.

To Laura D., the credit is salvation. The Tucson mother of two has been scraping by on about $11,000 a year from her job as a typist and falling behind on everything from rent to credit card payments. Now the federal government promises to send her more than $2,400--about 20% of her annual income--thanks to the much-maligned, widely misunderstood and revamped earned income credit.

The credit is a special break for the working poor--parents who earn less than $25,296 a year and others earning less than $9,000 annually.

The credit can be worth as much as $2,528 in 1994. It provides an incentive for low-income families to work rather than collect welfare, says Amy Abraham, acting director of policy at Children Now in Oakland.

Starting this year, however, claiming the credit is widely believed to be an audit trigger--something likely to single out your return for extra IRS scrutiny. If you err in claiming the credit--or simply report something incorrectly--your refund could be held up for months, tax officials say.

The bottom line: Taxpayers need to know the rules and follow them precisely, because the earned income credit is simply too valuable to pass up.

What are the rules? Do you qualify for the credit? How can you claim it? A question-and-answer guide:

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Q. What is the earned income credit?

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A. It is a tax credit that essentially rebates all or part of the Social Security taxes that both you and your employer pay on your wages. It is payable only to wage earners; those whose income is derived from investment earnings or welfare benefits cannot qualify.

After you determine how much income tax you owe, you subtract the earned income credit amount that corresponds to your income and number of dependents. (There’s a table in the 1040 booklet where you look up the credit amount.) If the credit is greater than the amount of tax you owe, you are entitled to a refund.

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Q. Will claiming it affect my eventual Social Security benefits?

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A. No. While the theory behind the credit was to refund Social Security taxes, which weigh heavily on low-income workers, the Social Security Administration does not keep track of who claims it. Your Social Security benefits will be based on your wages, not the amount of tax you have paid, says Scott Rose, a Social Security spokesman in San Francisco.

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Q. Who is eligible to claim the credit?

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A. An individual without children can claim the credit if total income--taxable and non-taxable--is less than $9,000 annually. Parents who make up to $25,296 annually and have custody of their children may claim it, as long as the taxpayer cannot be claimed as someone else’s dependent.

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Q. How could a parent be claimed as someone else’s dependent?

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A. A teen-age mother who moved back in with her parents, for example, would not eligible for the earned income tax credit, because both the mother and the child could be claimed as dependents of the grandparents.

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Q. Does that family get nothing just because the teen mom is living with her parents?

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A. Not necessarily. The income test must be applied to the highest-earning person in the household, says Nancy Anderson, director of special tax projects at H & R Block in Kansas City, Mo. So if the teen mother earned $10,000 and her mother, with whom she lived, earned $20,000, the earned income credit would be calculated based on the $20,000 income.

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Q. How much do you get?

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A. The amount varies with income and circumstances, but here are a few examples:

* A wage earner with total income of $6,000: Without children, this individual’s credit is $228; with one qualified child, the credit would be $1,585; with two or more children the credit would amount to $1,808.

* A wage earner with $8,999 in total income: With no children, $2; with one child, $2,038; with two children, $2,528.

* A wage earner with $20,000 in income: Without children this individual does not qualify for the credit; with one child the credit is $596; with two children it’s $932.

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Q. What does “qualified child” mean?

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A. The child must be related to the taxpayer as either a natural or adopted son or daughter, grandchild, stepchild or foster child. You must share the same principal residence in the United States for more than half the year. A foster child must have lived with you for the entire tax year. To qualify, a child must be under the age of 19 or a full-time student under 24 or permanently and totally disabled.

In addition, you must include the child’s Social Security number on the EIC form, along with other identifying information, such as the child’s name and year of birth.

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Q. What if I don’t have a Social Security number for my child?

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A. Get one. Technically, if the child was born in 1994, you don’t need a Social Security number until you file your 1995 return, but many experts believe that missing Social Security numbers--no matter what the reason--will cause your return to be kicked out of the system and processed by hand. That spells certain delay and may trigger an audit. Neither is loads of fun. To get a number, call the Social Security Administration at (800) 772-1213 to request a form. Bring it to your nearest Social Security office with an original copy of the child’s birth certificate and several other forms of identification.

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Q. My cash income would allow me to qualify for the credit, but I get subsidized housing. Somebody told me that I’ve got to include the value of the housing in my total income, which would make my income too high to claim the credit. Is that true?

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A. Yes. You must include all income, both taxable and non-taxable, to determine whether you qualify for the earned income credit. The value of subsidized housing, contributions to tax-favored retirement programs such as 401(k)s and certain valuable employee benefits would all fall into this category.

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Q. What do I have to do to claim the credit?

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A. File a tax return and fill out a Schedule EIC.

Many people who qualify for this credit don’t need to file tax returns because their income falls below the filing threshold. Singles don’t need to file until their income exceeds $6,250, for example. Heads of household need to file only if income exceeds $8,050. But, unless you file a form 1040, 1040A or 1040EZ, you can’t claim the credit.

If you have trouble filling out the necessary forms, call the Internal Revenue Service at (800) TAX-1040. They can direct you to the nearest Volunteer Income Tax Assistance center, where tax accountants and other trained volunteers will help you complete the forms at no charge.