This part of the chapter discusses rules A-1 through A-7. You must meet all seven rules to qualify for the earned income credit. If you do not meet all seven rules, you cannot get the credit and you do not need to read the rest of the chapter.

If you meet all seven rules in this part, then read either Part B or Part C (whichever applies) for more rules you must meet.

A-1. Earned Income

This credit is called the "earned income credit" because, to qualify, you must work and have earned income. If you are married and file a joint return, you meet this rule if at least one spouse works and has earned income.

Figuring your total earned income. You can figure your total earned income on the Earned Income Credit Worksheet (EIC Worksheet) in your tax return instructions for:

• Lines 59a and 59b (Form 1040),
• Lines 37a and 37b (Form 1040A), or
• Lines 8a and 8b (Form 1040EZ).

If you file Form 1040, complete lines 1 through 6 of the EIC worksheet to figure your total earned income. If you file Form 1040A or Form 1040EZ, complete lines 1 through 5.

If the total of your taxable and nontaxable earned income is $26,473 or more (if you have one qualifying child), $30,095 or more (if you have more than one qualifying child), or $10,030 or more (if you do not have a qualifying child), print "No" directly to the right of line 59a (Form 1040) or line 37a (Form 1040A), or to the right of the word "below" on line 8b (Form 1040EZ).

What Counts as Earned Income?

Earned income includes all the income you get from working--even if it is not taxable. Enter any nontaxable earned income on line 4 of the EIC Worksheet. If you claim the earned income credit, also enter that nontaxable earned income on line 59b (Form 1040), line 37b (Form 1040A), or line 8b (Form 1040EZ). (But see the "caution" under Special procedures for a minister or a member of a religious order, under What Counts as Earnings from Self-Employment, later.)

If you are married but filing as head of household (see rule A-3), and live in a state that has community property laws, your earned income for the credit does not include any amount earned by your spouse that is treated as belonging to you under those laws. That amount is not earned income for the credit even though you must include it in your gross income on your income tax return.

For some examples of items that are included or not included in earned income, see Table 37-2, Examples of Earned Income for the Earned Income Credit. Some of the items listed are discussed in more detail later. Earnings from self-employment are discussed separately.

Special note for household employees. If you were a household employee who did not receive a Form W-2 because your employer paid you less than $1,100 in 1998, be sure to include the amount you were paid on line 7 (Form 1040 or 1040A) or line 1 (Form 1040EZ). Print "HSH" and the amount not reported on Form W-2 on the dotted line next to line 7 (Form 1040), or in the space to the left of line 7 (Form 1040A), or in the space to the right of the words "W-2 form(s)" on line 1 (Form 1040EZ).

U.S. military pay. Combat zone excluded pay, basic quarters and subsistence allowances, and the value of in-kind quarters and subsistence are all earned income that is not taxed but must be used when you figure the earned income credit. These amounts will be on your W-2 in box 13 under code "Q." See Publication 3, Armed Forces' Tax Guide, for more detailed information.

Disability benefits. If you retired on disability, benefits you receive under your employer's disability retirement plan are considered earned income until you reach minimum retirement age. Minimum retirement age generally is the earliest age at which you could have received a pension or annuity if you were not disabled. You must report your taxable disability payments on line 7 of either Form 1040 or Form 1040A until you reach minimum retirement age.

Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension and are not considered earned income. Report taxable pension payments on Form 1040, lines 16a and 16b (or Form 1040A, lines 11a and 11b).

Salary reductions under cafeteria plans. If your employer offers a benefit plan that allows you to choose among two or more benefits consisting of cash and benefits that are not taxed, you are probably participating in a cafeteria plan. If you choose a benefit that is not taxed (such as accident and health insurance), the amount of the salary reduction (because you did not choose cash) is earned income when figuring this credit.

Earnings while an inmate. Amounts paid to inmates in penal institutions for their work are not earned income when figuring the earned income credit. These amounts include amounts received through a work release program or while in a halfway house. If the total on line 7 (Form 1040 or Form 1040A) or line 1 (Form 1040EZ) includes this income, do not enter that total on line 1 of the EIC Worksheet. Instead, subtract that income from the total and enter the result on line 1 of the EIC worksheet. Also, print "PRI" and the amount subtracted on the dotted line next to line 7 (Form 1040), or in the space to the left of line 7 (Form 1040A), or in the space to the right of the words "W-2 form(s)" on line 1 (Form 1040EZ).

Native Americans. Income received by Native Americans that is exempt from federal income tax under the Internal Revenue Code or because of a treaty, agreement, Act of Congress, or other federal law is earned income for the credit if it is compensation for services performed as an employee. However, nontaxable income received for performing services as a self-employed individual is not earned income when figuring the earned income credit.

What Counts as Earnings from Self-Employment?

Your earnings from self-employment are earned income for the credit. You may have earnings from self-employment if:

• You own your business,
• You are a minister or member of a religious order, or
• You reported income and expenses on Schedule C or C-EZ (Form 1040) as a statutory employee.

Enter your earnings (or loss) from self-employment on line 5 of the EIC Worksheet. Figure the amount to enter on line 5 by completing the separate worksheet for that line in the Form 1040 instructions for lines 59a and 59b.

Statutory employee's earnings. If you reported income and expenses on Schedule C or C-EZ (Form 1040) as a statutory employee, your earnings from self-employment are the amount on line 1 of either schedule. Enter that amount on line 3 of the separate worksheet for line 5 of the EIC Worksheet.

Other earnings. Your earnings from self-employment in a business you own, or from your services as a minister or member of a religious order, are earned income for the credit. You must include these earnings in earned income even if your net earnings are less than $400. (But if you are a minister or member of a religious order, see Approved Form 4361 or Approved Form 4029, later.)

If you have a loss from self-employment, you must subtract the loss from your other earned income.

If your net earnings from self-employment are $400 or more, be sure to correctly fill out Schedule SE (Form 1040) and pay the proper amount of self-employment tax. If you do not, you may not get all the earned income credit you are entitled to.

Schedule SE. If you are filing Schedule SE (Form 1040), your earnings from self-employment are the amount you get after you subtract one-half of your self-employment tax (Form 1040, line 27) from your net profit (Schedule SE, line 3 of either Section A or Section B, whichever applies). You figure this amount on lines 1a through 1e of the separate worksheet for line 5 of the EIC Worksheet.

Using the optional methods on Schedule SE to figure your net earnings from self-employment may qualify you for the earned income credit or give you a larger credit if your net earnings (determined without using the optional methods) are less than $1,600. If you use the optional methods, you increase your earnings from self-employment by adding the amount from line 4b of Section B, Schedule SE, to your net profit. See Publication 533 and the instructions for Schedule SE for details.

If you do not have to file Schedule SE. If you do not have to file Schedule SE (for example, because your net earnings from self-employment are less than $400), your earnings (or loss) from self-employment are the net profit or loss from your self-employment activities. Enter this amount on line 2a or 2b of the worksheet for line 5 of the EIC Worksheet. (But if you are a minister or member of a religious order, see Approved Form 4361 or Form 4029, later.)

Special procedures for a minister or member of a religious order. If you file Schedule SE and the amount on line 2 of that schedule includes an amount that was also reported on Form 1040, line 7, follow these special procedures.

1. If you claim the credit, print "Clergy" directly to the right of line 59a, Form 1040. Also show the amount included on both lines (for example, "Clergy $800").
2. Determine how much of the income reported on Form 1040, line 7, was also reported on Schedule SE, line 2.
3. Subtract that income from the amount on Form 1040, line 7. Enter only the result on line 1 of the EIC Worksheet.
4. Complete the worksheet for line 5 in the Form 1040 instructions for lines 59a and 59b.

If you received a housing allowance or were provided housing, do not include the allowance or rental value of the parsonage as nontaxable earned income on line 4 of the EIC Worksheet (or on line 59b, Form 1040) if it is required to be included on Schedule SE, line 2.

Approved Form 4361 or Form 4029. This section is for persons who have an approved:

• Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners, or
• Form 4029, Application for Exemption from Social Security and Medicare Taxes and Waiver of Benefits.

Each approved form exempts certain income from the self-employment tax. Each form is discussed in this section in terms of what is or is not earned income for purposes of the earned income credit.

Form 4361. If you have an approved Form 4361, amounts you received for performing ministerial duties as an employee are earned income. This includes wages, salaries, tips, and other employee compensation. Other employee compensation includes nontaxable compensation such as housing allowances or the rental value of a parsonage that you receive as part of your pay for services as an employee.

Amounts you received in the exercise of ministerial duties, but not as an employee, are not earned income. Examples include fees for performing marriages and honoraria for delivering speeches.

Any compensation you received from an undertaking unrelated to the ministry is earned income. This is so, whether you received the amounts as an employee or as a self-employed individual.

Form 4029. If you have an approved Form 4029, all wages, salaries, tips, and other employee compensation are earned income. Amounts you received as a self-employed individual are not earned income. Also, losses from Schedule C, C-EZ, or F cannot be subtracted from wages on line 7 of Form 1040.

Table 37-2. Examples of earned income

A-2. Investment Income Limit

You cannot claim the earned income credit if your investment income is more than $2,300. For most people, investment income is the total of the following amounts.

• Taxable interest (line 8a of Form 1040 or 1040A).
• Tax-exempt interest (line 8b of Form 1040 or 1040A).
• Dividend income (line 9 of Form 1040 or 1040A).
• Capital gain net income (line 13 of Form 1040, if more than zero).

However, if you are reporting income from the rental of personal property on Form 1040, line 21, or are filing Schedule E (Form 1040), or are reporting a gain on Form 4797, get Publication 596 for more information.

A-3. Married Person's Filing Status

If you are married, you usually must file a joint return to claim the earned income credit. Your filing status cannot be "Married Filing Separately."

Exception for head of household. You do not have to file a joint return if you can file as head of household. To file as head of household:

1. Your spouse must not have lived in your home at any time during the last 6 months of the year,
2. You must have paid more than half the cost to keep up your home for the entire year, and
3. Your home must have been, for more than half of the year, the main home of your child, adopted child, stepchild, or eligible foster child for whom you can claim an exemption.

You will meet (3) even if you cannot claim an exemption for your child because:

• You gave that right to the other parent by filling out Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, or similar written statement, or
• You gave that right to the other parent in a pre-1985 agreement (decree of divorce or separate maintenance or written agreement).

For more information about filing as head of household, see the instructions for Form 1040 or Form 1040A.

If a child who qualifies you for head of household status also meets the requirements of a qualifying child, you may be able to take the credit under the rules in Parts A and B.

Example 1. You are married and lived apart from your spouse all year. You earned $8,000 and your 19-year-old son lived with you all year. You provided more than half the cost of keeping up your home. Your son had a part-time job and earned $2,000. He was not a full-time student or permanently and totally disabled. You qualify for the "head of household" filing status and claim your son as a dependent. You can get the earned income credit only if you meet all the rules in Parts A and C. You cannot use the rules in Part B because your son is not a qualifying child.

Example 2. The facts are the same as in Example 1, except your son is 18. In this case, your son is your dependent and a qualifying child. You qualify for the credit if you meet the rules in Parts A and B.

A-4. Social Security Number (SSN)

To claim the earned income credit, you must have a valid SSN for you, your spouse (if filing a joint return), and your qualifying child.

An SSN is a number issued by the Social Security Administration to a U.S. citizen or to a person who has permission from the Immigration and Naturalization Service to work in the United States. You cannot get the earned income credit if the SSN was issued solely for use in applying for or receiving federally funded benefits. If your social security card says "Not valid for employment" you cannot get the earned income credit.

If an SSN on your income tax return for you, your spouse, or qualifying child, is missing or incorrect, you may not get the credit.

Other taxpayer identification numbers. You cannot get the credit if, instead of an SSN, you, your spouse, or your qualifying child has:

• An individual taxpayer identification number (ITIN), which is issued to a noncitizen who cannot get an SSN, or
• An adoption taxpayer identification number (ATIN), which is issued for a child to adopting parents who cannot get an SSN for the child being adopted until the adoption is final.

Getting an SSN. If you, your spouse, or your child does not have an SSN, apply for one by filing Form SS-5 with the Social Security Administration.

Qualifying child's SSN. Enter the SSN for your qualifying child on Schedule EIC, line 4. If your qualifying child is your dependent, also enter the SSN on line 6c of Form 1040 or Form 1040A.

Birth and death of your child. If your child was born and died in 1998 and did not have an SSN, attach a copy of the child's birth certificate and enter "Died" on line 4 of Schedule EIC.

Filing deadline approaching and still no SSN. If the filing deadline is approaching and you still do not have an SSN, you have two choices.

1. Request an automatic 4-month extension (Form 4868). This extension does not give you extra time to pay any tax owed. You should pay any amount you expect to owe to avoid interest or penalty charges. (See the instructions for Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return.)
2. File the return on time without claiming the earned income credit. After receiving the SSN, file an amended return (Form 1040X) claiming the credit, and attach a filled-in Schedule EIC (if you have a qualifying child).

A-5. Qualifying Child of Another Person

If you (or your spouse if filing a joint return) are a qualifying child of another person, you cannot claim the earned income credit.

Are you a qualifying child? Basically, you are a qualifying child of another person (your parent, guardian, foster parent, etc.) if:

• You are that person's son, daughter, adopted child, stepchild, grandchild, or eligible foster child,
• At the end of the year you were under age 19, under age 24 and a full-time student, or any age and permanently and totally disabled, and
• You lived with that person in the United States for more than half of the year (all year if you were an eligible foster child). For the earned income credit, U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States during that duty period.

See rule B-2, Qualifying Child, if you need further information.

Example 1. You lived with your mother all year. You are age 26 and permanently and totally disabled. Your only income was from a community center where you went twice a week to answer telephones. You earned $1,500 for the year.

You are a qualifying child of your mother. She can claim the credit if she meets all the rules in Parts A and B. Because you are a qualifying child of your mother, you cannot claim the earned income credit even if you meet all the other rules in Parts A and C. This is so even if your mother cannot claim the credit because her income is too high.

Example 2. You and your daughter lived with your mother all year. You are 22 years old and attended a trade school full time. You had a part-time job and earned $5,700. You had no other income.

Your daughter is your qualifying child, but both you and your daughter are qualifying children of your mother. Your mother can claim the earned income credit if she meets all the rules in Parts A and B. Because you are your mother's qualifying child, you cannot claim the earned income credit even if you meet all the other rules in Parts A and B. This is so even if your mother cannot claim the credit because her income is too high.

If you (or your spouse if filing a joint return) were a qualifying child of another person in 1998, print "No" directly to the right of line 59a (Form 1040) or 37a (Form 1040A), or to the right of the word "below" on line 8b (Form 1040EZ).

A-6. Foreign Earned Income

You cannot claim the earned income credit if you file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion. You file these forms to exclude income earned in foreign countries from your gross income, or to deduct or exclude a foreign housing amount. U. S. possessions are not foreign countries. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, for more detailed information.

A-7. Nonresident Alien

You cannot claim the earned income credit if you are a nonresident alien for any part of the year, unless:

1. You are married to a U.S. citizen or a resident alien, and
2. You choose to be treated as a resident for all of 1998.

For more information on making this choice, get Publication 519, U.S. Tax Guide for Aliens.

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