Rule 6. You Must Have 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. If you are an employee, earned income includes all the taxable income you get from your employer. Worksheet 2 on page 20 will help you figure the amount of your earned income. If you are self-employed or a statutory employee, you will figure your earned income on EIC Worksheet B on page 25.

Earned Income

Earned income includes:

1. Wages, salaries, and tips,
2. Net earnings from self-employment, and
3. Gross income received as a statutory employee.

Wages, salaries, and tips.   Wages, salaries, and tips you receive for working are reported to you on Form W-2, box 1. You should report these on line 1 (Form 1040EZ) or line 7 (Forms 1040A and 1040).

Net earnings from self-employment.   You may have net earnings from self-employment if:

• You own your business, or
• You are a minister or member of a religious order.

Statutory employee.   You are a statutory employee if you receive a Form W-2 on which the Statutory employee box (box 13) is checked. You report your income and expenses as a statutory employee on Schedule C or C-EZ (Form 1040).

Strike benefits.   Strike benefits paid by a union to its members are earned income.

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 social security taxes. Each form is discussed in this section in terms of what is or is not earned income for purposes of the EIC.

Form 4361.   Even if you have an approved Form 4361, amounts you received for performing ministerial duties as an employee count as earned income. This includes wages, salaries, tips, and other taxable employee compensation. Amounts you received for performing ministerial duties, but not as an employee, do not count as earned income. Examples include fees for performing marriages and honoraria for delivering speeches.

Form 4029.   Even if you have an approved Form 4029, all wages, salaries, tips, and other taxable employee compensation count as earned income. However, amounts you received as a self-employed individual do not count as earned income. Also, in figuring earned income, do not subtract losses on Schedule C, C-EZ, or F from wages on line 7 of Form 1040.

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 12a and 12b.

Disability insurance payments.   Payments you received from a disability insurance policy that you paid the premiums for are not earned income. It does not matter whether you have reached minimum retirement age. If this policy is through your employer, the amount may be shown in box 12 of your Form W-2 with code J.

Income That Is Not Earned Income

Examples of items that are NOT earned income include interest and dividends, pensions and annuities, social security and railroad retirement benefits (including disability benefits), alimony and child support, welfare benefits, workers' compensation benefits, unemployment compensation (insurance), nontaxable foster care payments, and veterans' benefits, including VA rehabilitation payments. Do NOT include any of these items in your earned income.

Earnings while an inmate.   Amounts received for work performed while an inmate in a penal institution are not earned income when figuring the earned income credit. This includes amounts received through a work release program or while in a halfway house.

Workfare payments.   Nontaxable workfare payments are not earned income for the EIC. These are cash payments certain people receive from a state or local agency that administers public assistance programs funded under the federal Temporary Assistance for Needy Families (TANF) program in return for certain work activities such as (1) work experience activities (including remodeling or repairing public housing) if sufficient private sector employment is not available, or (2) community service program activities.

Community property.   If you are married, but qualify to file as head of household under special rules for married taxpayers living apart (see Rule 2), and live in a state that has community property laws, your earned income for the EIC 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 EIC, even though you must include it in your gross income on your income tax return. Your earned income includes the entire amount you earned, even if part of it is treated as belonging to your spouse under your state's community property laws.

Rules If You Have a Qualifying Child

If you have met all the rules in chapter 1, use this chapter to see if you have a qualifying child. This chapter discusses Rules 7 through 9. You must meet all three of those rules, in addition to the rules in chapters 1 and 4, to qualify for the earned income credit with a qualifying child.

Note. You must file Form 1040 or Form 1040A to claim the EIC with a qualifying child. (You cannot file Form 1040EZ.) You must also complete Schedule EIC and attach it to your return. If you meet all the rules in chapter 1 and this chapter, read chapter 4 to find out what to do next.

No qualifying child.   If you do not meet Rule 7, you do not have a qualifying child. Read chapter 3 to find out if you can get the earned income credit without a qualifying child.

Rule 7. Your Child Must Meet the Relationship, Age, and Residency Tests

Your child is a qualifying child if your child meets three tests. The three tests are:

1. Relationship,
2. Age, and
3. Residency.

The three tests are illustrated in Figure 2 on page 11. The paragraphs that follow contain more information about each test.

Relationship Test

Your child must be either your son, daughter, adopted child, stepchild, grandchild, or eligible foster child. Your brother, sister, stepbrother, or stepsister (or the child or grandchild of your brother, sister, stepbrother, or stepsister) may also be a qualifying child if you care for this individual as you would your own child. The following definitions clarify the relationship test.

Adopted child.   Your adopted child includes a child placed with you for adoption by an authorized placement agency, even if the adoption is not final.

An authorized placement agency includes any person or court authorized by state law to place children for legal adoption.

Grandchild.   For the EIC, this means any descendant of a son, daughter, stepchild, or adopted child. For example, a grandchild includes your great-grandchild, great-great-grandchild, etc.

Child not a dependent.   Your child does not have to be your dependent to be a qualifying child, unless he or she is married.

Married child.   If your child was married at the end of the year, he or she does not meet the relationship test unless either of these two situations applies to you:

1. You can claim the child's exemption, or
2. The reason you cannot claim the child's exemption is that you gave that right to your child's other parent:
   1. When you completed Form 8332 or a similar written statement, or
   2. In a pre-1985 agreement (such as a separation agreement or divorce decree).

Figure 2. Tests for Qualifying Child

Conditions for Qualifying Child

Eligible foster child.   For the EIC, a person is your eligible foster child if both of the following are true.

1. The child is placed with you by an authorized placement agency. (An authorized placement agency includes a state or local government agency or court. It also includes a tax-exempt organization licensed by a state.)
2. You cared for that child as you would your own child.

Example.   Debbie, who is 12 years old, was placed in your care two years ago by an authorized agency responsible for placing children in foster homes. You care for her as you would your own child. Debbie is your eligible foster child.

Age Test

Your child must be:

1. Under age 19 at the end of 2002,
2. A full-time student under age 24 at the end of 2002, or
3. Permanently and totally disabled at any time during 2002, regardless of age.

The following example and definitions clarify the age test.

Example.   Your son turned 19 on December 10. Unless he was disabled or a full-time student, he is not a qualifying child because, at the end of the year, he was not under age 19.

Full-time student.   A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.

Student defined.    To qualify as a student, your child must be, during some part of each of any 5 calendar months during the calendar year:

1. A full-time student at a school that has a regular teaching staff, course of study, and regular student body, or
2. A student taking a full-time, on-farm training course given by a school described in (1), or a state, county, or local government.

The 5 calendar months need not be consecutive.

School defined.   A school can be an elementary school, junior or senior high school, college, university, or technical, trade, or mechanical school. However, on-the-job training courses, correspondence schools, and night schools do not count as schools for the EIC. (But see Night school, later.)

Vocational high school students.    Students who work in co-op jobs in private industry as a part of a school's regular course of classroom and practical training are considered full-time students.

Night school.   Your child is not a full-time student if he or she attends school only at night. However, full-time attendance at a school may include some attendance at night as part of a full-time course of study.

Permanently and totally disabled.   Your child is permanently and totally disabled if both of the following apply.

1. He or she cannot engage in any substantial gainful activity because of a physical or mental condition.
2. A doctor determines the condition has lasted or can be expected to last continuously for at least a year or can lead to death.

Residency Test

Your child must have lived with you in the United States for more than half of 2002. The following definitions clarify the residency test.

United States.   This means one of the 50 states and the District of Columbia. It does not include U.S. possessions, such as Guam and Puerto Rico.

Homeless shelter.   Your home can be any location where you regularly live. You do not need a traditional home. For example, if your child lived with you for more than half the year in one or more homeless shelters, your child meets the residency test.

Military personnel stationed outside the United States.   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 for purposes of the EIC.

Extended active duty.   Extended active duty means you are called or ordered to duty for an indefinite period or for a period of more than 90 days. Once you begin serving your extended active duty, you are still considered to have been on extended active duty even if you do not serve more than 90 days.

Birth or death of child.   A child who was born or died in 2002 is treated as having lived with you for all of 2002 if your home was the child's home the entire time he or she was alive in 2002.

Temporary absences.   Count time that you or your child is away from home on a temporary absence due to a special circumstance as time lived at home. Examples of a special circumstance include:

• Illness,
• School attendance,
• Detention in a juvenile facility,
• Business,
• Vacation, and
• Military service.

Kidnapped child.   A kidnapped child is treated as living with you for more than half of the year if the child lived with you for more than half the part of the year before the date of the kidnapping. The child must be presumed by law enforcement authorities to have been kidnapped by someone who is not a member of your family or the child's family. This treatment applies for all years until the child is returned. However, the last year this treatment can apply is the earlier of:

1. The year there is a determination that the child is dead, or
2. The year the child would have reached age 18.

If your qualifying child has been kidnapped and meets these requirements, enter KC, instead of a number, on line 6 of Schedule EIC.

Social security number.

Your qualifying child must have a valid social security number (SSN), unless the child was born and died in 2002. You cannot claim the EIC on the basis of a qualifying child if:

1. Your qualifying child's SSN is missing from your tax return or is incorrect,
2. Your qualifying child's social security card says Not valid for employment and was issued for use in getting a federally funded benefit, or
3. Instead of an SSN, your qualifying child has:
   1. An individual taxpayer identification number (ITIN), which is issued to a noncitizen who cannot get an SSN, or
   2. An adoption taxpayer identification number (ATIN), which is issued to adopting parents who cannot get an SSN for the child being adopted until the adoption is final.

If you have two qualifying children and only one has a valid SSN, you can claim the EIC only on the basis of that child. For more information about SSNs, see Rule 1.

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