Ask the tax adviser
By George Saenz • Bankrate.com

Calculating earned income credit

Dear Tax Talk:
How do you file 401(k) payments being taken out of your wages each week for retirement on your tax return if you're also filing the earned income credit? Last year I subtracted my 401(k) payments from my earned income and put it also in the box marked nontaxable earned income, type 401(k). Was that right?
Dinnie

Dear Dinnie:
Subtracting the 401(k) payments from the earned income credit is not right, but I believe the Internal Revenue Service would have fixed this mistake and adjusted your refund.

If the IRS did not, then you may want to correct your return for this mistake.

In order to qualify for the EIC, you must have one or more qualifying children and have earned between $12,460 and $30,580; or not have any qualifying children, be at least 25 years old but not more than 65 and have earned between $5,670 and $10,380.

There are several more rules that you may want to read through if you believe you qualify. You can only qualify for the EIC if you have earned income such as from salary and wages or self-employment.

In determining what is earned for the EIC, you have to adjust taxable wages on form W-2 for nontaxable amounts such as the 401(k) contributions. Your 401(k) deductions are reported by your employer on your Form W-2 in box 13 and should have a code letter "D" next to the amount. This adjustment is only for the EIC and not for purposes of determining taxable wages reported on your Form 1040. The 401(k) contributions can increase or decrease the EIC, but are added to your earned income, not subtracted. Your EIC will increase by adjusting for your 401(k) deductions if you are in the lower part of earned income range.

You'll be happy to know that for 1999 you do not have to do any of the computations for the credit. If you do feel the need to figure the credit, although I highly recommend against it, you can find 7 pages of graphics and narrative describing the voluminous rules of the earned income credit starting on page 38 of the Form 1040 instructions. There are also three pages of tables if you can manage to get the right number for the credit.

Child exemptions for divorced parents

Dear Tax Talk:
My question is based on the exemption for a dependent child. Well, see, I am divorced with two kids, age 4 and 5. The father of the kids gives them $250 to $300 every other month. He wants to claim for one child as a dependent. I don't know if I can give him one exemption, or will it be a problem if I claim both?
Mabel

Dear Mabel:
It will be a problem if both you and your ex claim the same child. If you are the custodial parent and the divorce decree does not state that he gets the exemption, then you are entitled to claim both children. If you want him to have the dependency exemption for one or both children for one or more years, then you can release the deduction to him by not claiming the children on your return. You must provide him with IRS Form 8332, which he attaches to his return.

You may want to release the credit to him if your income is less than his and he gets a better benefit by claiming the children. Alternatively, if your income is too high to get a benefit by claiming the children, you can release the exemptions to him. Compute your tax returns with and without the children to see who benefits more. If you release the exemptions to him, then he may pay additional support without tax consequences.

-- Posted Feb. 18, 2000

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