## ERROR IN EARNED INCOME CREDIT AMOUNTS

While working on the BloombergBNA 2013 Projected Tax Rates, we were analyzing the Earned Income Credit and noticed something interesting.

Section 32(b)(3)(B)(i), added by the American Recovery and Reinvestment Act of 2009 (2009 ARRA), P.L. 111-5, §1002, and extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 TRA), P.L. 111-312, §103, provides marriage penalty relief by increasing the threshold phaseout amounts in §32(b)(2)(A) by \$5,000 for married taxpayers filing jointly for tax years beginning in 2009-2012.

Section 32(b)(3)(B)(ii) provides that the \$5,000 amount in §32(b)(3)(B)(i) is adjusted for inflation for any tax year beginning in 2010. Section 32(j) provides inflation-adjustment rules for the amounts in §32(b)(2).

So, to compute the threshold phaseout amounts for married taxpayers filing jointly for 2010, start with the \$5,280 and \$11,610 amounts in §32(b)(2)(A) and adjust them for inflation. Then, adjust the \$5,000 amount for inflation using 2008 as the base year pursuant to the special rule in §32(b)(3)(B)(ii). Next, add the two adjusted amounts. Finally, round the sum to the nearest multiple of \$10, per §32(j)(2)(A).

Therefore, the threshold phaseout amounts for married taxpayers filing jointly for 2010 are computed as follows:

No Qualifying Children

(\$5,280 × 1.416530421) + (\$5,000 × 1.001860131) = \$12,488.58 ≈ \$12,490

One or More Qualifying Children

(\$11,610 × 1.416530421) + (\$5,000 × 1.001860131) = \$21,455.22 ≈ \$21,460

These figures match what was published in Rev. Proc. 2009-50.

The threshold phaseout amounts for married taxpayers filing jointly for 2011 were published in Rev. Proc. 2011-12 as \$12,670 (no qualifying children) and \$21,770 (one or more qualifying children).

The threshold phaseout amounts for married taxpayers filing jointly for 2012 were published in Rev. Proc. 2011-52 as \$12,980 (no qualifying children) and \$22,300 (one or more qualifying children).

The problem is that §32(b)(3)(B)(ii) only permits the additional \$5,000 amount to be adjusted for inflation for tax years beginning in 2010, not for 2011 or 2012. But, when you do the math, it is apparent that the IRS adjusted the \$5,000 amount for inflation anyway.

The IRS computed the threshold phaseout amounts for 2011 as follows:

No Qualifying Children

(\$5,280 × 1.437453252) + (\$5,000 × 1.016658084) = \$12,673.04 ≈ \$12,670

One or More Qualifying Children

(\$11,610 × 1.437453252) + (\$5,000 × 1.016658084) = \$21,772.12 ≈ \$21,770

Likewise, the IRS computed the threshold phaseout amounts for 2012 as follows:

No Qualifying Children

(\$5,280 × 1.472331623) + (\$5,000 × 1.04132628) = \$12,980.54 ≈ \$12,980

One or More Qualifying Children

(\$11,610 × 1.472331623) + (\$5,000 × 1.04132628) = \$22,300.40 ≈ \$22,300

The threshold phaseout amounts for 2011 should have been computed as follows:

No Qualifying Children

(\$5,280 × 1.437453252) + \$5,000 = \$12,589.75 ≈ \$12,590

One or More Qualifying Children

(\$11,610 × 1.437453252) + \$5,000 = \$21,688.83 ≈ \$21,690

Similarly, the threshold phaseout amounts for 2012 should have been computed as follows:

No Qualifying Children

(\$5,280 × 1.472331623) + \$5,000 = \$12,773.91 ≈ \$12,770

One or More Qualifying Children

(\$11,610 × 1.472331623) + \$5,000 = \$22,093.77 ≈ \$22,090

The completed phaseout amounts for married taxpayers filing jointly for 2011 and 2012 are also incorrect, because they are based on the threshold phaseout amounts.

So, by adjusting the \$5,000 amount for inflation, the IRS allowed taxpayers a slightly more generous credit than was permitted by law for tax years beginning in 2011 and 2012.

Is there other authority that potentially allows an inflation adjustment to the \$5,000 amount for tax years beginning in 2011 and 2012?

One possibility that we explored starts with §32(b)(2)(B)(iii), which provides a \$3,000 increase for joint returns for tax years beginning after 2007. Section 32(j)(1)(B)(ii) adjusts the \$3,000 amount for inflation, using 2007 as the base year. For tax years beginning in 2009 through 2012, §32(b)(3)(B)(i) states that the dollar amount in effect under §32(b)(2)(B)(iii) is \$5,000.

So, someone reading §32(b)(2)(B)(iii) and (3)(B)(i) together could interpret those provisions to mean that \$5,000 is substituted in place of \$3,000, and then the substituted \$5,000 amount is adjusted for inflation pursuant to the rule in §32(j)(1)(B)(ii). In other words, the inflation adjustment rule in §32(b)(3)(ii) would only apply to tax years beginning in 2010; the rule in §32(j)(1)(B)(ii) would apply to the other years (2009, 2011, and 2012) that the additional \$5,000 amount is in force.

However, there are two problems with this interpretation. First, the \$5,000 amount was not adjusted for inflation for tax years beginning in 2009. The math confirms this, and the IRS also expressly stated that there was no inflation adjustment for the \$5,000 amount in 2009 in Rev. Proc. 2009-21: "For taxable years beginning in 2009, under §32(b)(3)(B)(i) the amount added to the threshold phaseout amounts and the completed phaseout amounts for married taxpayers filing a joint return is \$5,000. For taxable years beginning in 2010, the \$5,000 amount under §32(b)(3)(B)(i) is adjusted for inflation."

The second problem with this interpretation is that the inflation adjustment formula in §32(j)(1)(B)(ii) uses 2007 as the base year. If you do the math and apply this formula to the \$5,000 amount, the results do not match what was published by the IRS.

Using 2007 as the base year, the threshold phaseout amounts for married taxpayers filing joint returns for 2011 would be computed as follows:

No Qualifying Children

(\$5,280 × 1.437453252) + (\$5,000 × 1.0599922) = \$12,889.71 ≈ \$12,890

One or More Qualifying Children

(\$11,610 × 1.437453252) + (\$5,000 × 1.0599922) = \$21,988.79 ≈ \$21,990

Similarly, the threshold phaseout amounts for 2012 would be calculated as follows:

No Qualifying Children

(\$5,280 × 1.472331623) + (\$5,000 × 1.0599922) = \$13,073.87 ≈ \$13,070

One or More Qualifying Children

(\$11,610 × 1.472331623) + (\$5,000 × 1.0599922) = \$22,393.73 ≈ \$22,390

As illustrated in the computations at the beginning of this article, the \$5,000 amount was adjusted for inflation for 2011 and 2012 using 2008 as the base year, not 2007. Therefore, it is clear that the IRS does not interpret the \$5,000 amount as being simply a substitution for the \$3,000 amount in §32(b)(2)(B)(iii), subject to the inflation-adjustment rule in §32(j)(1)(B)(ii).

It will be interesting to see if the IRS continues to adjust the \$5,000 amount for inflation for 2013 and beyond (assuming the additional \$5,000 amount is extended beyond 2012). It will also be interesting to see whether Congress takes action to address this error.

In all likelihood, this was simply an oversight by the drafters of the 2010 TRA. When originally enacted by the 2009 ARRA, the \$5,000 amount only applied to tax years beginning in 2009 and 2010. The 2010 TRA amended the language at the beginning of §32(b)(3) to apply the \$5,000 amount to tax years beginning in 2009, 2010, 2011, and 2012. But the 2010 TRA failed to make a conforming amendment to the inflation-adjustment provision in §32(b)(3)(B)(ii).

A retroactive technical correction to §32(b)(3)(B)(ii) would address this problem and also legitimize the phaseout amounts published by the IRS for 2011 and 2012.

Be sure to attend BloombergBNA's inaugural Tax Policy & Practice Summit on November 13-14, 2012, in Washington, DC.  One week after the November election, the Summit will focus on the impact of the election on tax policy and the future of tax reform.  Keynote speakers will include Thomas A Barthold (JCT Chief of Staff), William Wilkins (Chief Counsel), and Rep. David Camp (R-Mich.) (Chairman, House Ways and Means Committee--invited). Some of the session titles are Planning for & Shaping Corporate Tax Reform, Health Reform, IRS Administrative Developments on Transfer Pricing That Will Survive Tax Reform, and State and Local Business Tax Policy: a Post-Election Roundup.  For more information and to register, please visit our Summit microsite at the following link: http://www.bna.com/tax-policy-summit/

Finally, I also want to recognize the efforts of Tax Law Editors LisaPfenninger, Warren Joseph, Pete Burt, and John Fusco, who provided valuable assistance with this research.

Peter D. Mills, Managing Editor—U.S. Income Tax