SERVICE ANNOUNCES FORMULA FOR DETERMINING ALLOCABLE PORTION OF EARNED INCOME CREDIT.

Rev. Rul. 87-52

ISSUE

If a married couple filed a joint return on which they claimed the earned income credit under section 32 of the Internal Revenue Code and on which they claimed an overpayment, then, for purposes of computing the amount that may be credited against one spouse's unpaid separate tax liability from a prior year, how is the earned income credit taken into account in determining that spouse's contribution to the overpayment?

FACTS

A and B are married and filed a joint Form 1040A, U.S. Individual Income Tax Return, for calendar year 1985. The following information was reported on the return:

      Wages (A):                    $5,500

LAW AND ANALYSIS

Section 6402(a) of the Internal Revenue Code provides that in the case of any overpayment, the Secretary may within the applicable period of limitations credit the amount of the overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall refund the balance to such person.

Rev. Rul. 74-611, 1974-2 C.B. 399, provides that when a husband and wife file a joint return, each spouse has a separate interest in the jointly reported income and a separate interest in any overpayment.

Rev. Rul. 80-7, 1980-1 C.B. 296, as amplified by Rev. Rul. 85-70, 1985-1 C.B. 361, contains a method of computation ("separate tax formula") that allocates to each spouse that spouse's share of the tax liability shown on a joint return. The ruling provides that if spouses file a joint return showing an overpayment, the amount that may be credited to one's spouse's separate liability is the amount of that spouse's interest in the overpayment. This amount is computed by subtracting that spouse's share of the joint liability, determined in accordance with the separate tax formula, from that spouse's contribution toward payment of the joint liability. Each spouse's share of the joint liability is determined based on the total tax liability of that spouse before application of the earned income credit. The amount credited cannot exceed the amount of the joint overpayment.

Rev. Rul. 80-7 provides that each spouse's contribution to the overpayment includes an attributable portion of the earned income credit under the predecessor of section 32 of the Code.

Under section 32(c)(2) of the Code, the term "earned income" means generally --

(i) wages, salaries, tips, and other employee compensation, plus

(ii) net earnings from self-employment (within the meaning of section 1402(a) and the regulations thereunder).

Section 32(c)(2)(B)(i) of the Code provides that earned income is computed without regard to community property laws.

Under section 32(a) of the Code, eligible individual taxpayers are allowed a credit against tax equal to a portion of their earned income. For taxable years beginning after December 31, 1986, subject to a limitation in section 32(b), this credit is equal to 14 percent of the taxpayer's earned income up to a ceiling amount of earned income that is adjusted annually for inflation.

For 1985, the year at issue here, subject to the limitation in section 32(b) of the Code, the amount of the credit allowed was 11 percent of the taxpayer's income up to $5,000.

Section 32(b) of the Code imposes a limitation on the amount of the allowable credit. If a taxpayer's adjusted gross income exceeds a phaseout point, the maximum credit allowable to that taxpayer decreases as adjusted gross income increases. For taxable years beginning after December 31, 1986, a taxpayer's earned income credit may not exceed the maximum credit allowable to any taxpayer decreased by 10% of any amount by which adjusted gross income of the taxpayer at issue exceeds a phaseout point. That point is adjusted annually for inflation. (Between 1987 and 1988, there is an additional increase in the phaseout point.)

For 1985, the taxable year in issue here, the earned income credit of a taxpayer was limited to the excess of $550 (the maximum credit of any taxpayer under section 32(a)) over 12-2/9 percent of the amount by which adjusted gross income of the taxpayer at issue exceeded $6,500 (the phaseout point for 1985).

The effect of the limitation in section 32(b) of the Code is to gradually decrease the amount of credit allowable as adjusted gross income increases beyond the phaseout point until it phases out completely. For example, for the year in question, 1985, if all of the taxpayer's adjusted gross income was earned income, the amount of the credit increased gradually as earned income approached the $5,000 level and remained at $550 until the $6,500 phaseout point was reached. As adjusted gross income increased beyond $6,500, the credit decreased until it phased out completely when adjusted gross income reached $11,000. Thus, for a couple filing a joint return, the amount of earned income credit allowable may be less than the aggregate credits that would be allowable if each spouse's income were to be considered separately. Accordingly, for purposes of determining each spouse's contribution toward an overpayment, the credit cannot be allocated on a dollar-for-dollar basis. The allocated amount is arrived at by using the Earned Income Credit Tables to determine the hypothetical separate earned income credit that would have been available to each spouse if that spouse had filed a separate return (and if the earned income credit were available on a separate return) and then using the following formula:

Spouse's contribution to earned income credit =

HOLDING

The amount of the earned income allocable to each spouse's contribution to the overpayment shown on the joint return is determined as follows:

                      $500

Rev. Rul. 80-7 is clarified and amplified. Rev. Rul. 85-70 is amplified.