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Copyright Appleseed 2010

All rights reserved


Please contact Jeremy Cook for permission to reproduce.
202.347.7960 or jcook@appleseednetwork.org
INTRODUCTION

The New York State Earned Income Credit (the “EIC”)1 is considered one
of New York State’s most capable tools for helping low-income working
New Yorkers and their families make ends meet. Federal, state and local
earned income tax credits are refundable credits that return tax dollars to
qualifying families and individuals. The amount varies depending on
income, marital and parental status, but working families earning less than
$44,000 per year may be eligible for up to $7,354 from earned income tax
credits alone. To qualify, applicants must be between ages 25 and 64 (if
childless), have a valid Social Security number, report earned income and
file a tax return to the appropriate authority. (Source: http://www.otda.
state.ny.us/main/reform/#eitc).

In New York City, total EIC claims exceeded $1.6 billion in 2007. (Source:
NYC Department of Consumer Affairs Press Release, January 23, 2008).
Many of these low-income individuals and working families, however,
face significant difficulties in claiming the EIC because they hold jobs
that classify them, for tax purposes, as self employed,2 and/or for which
they receive cash wages. These self-employed low-income cash earners
(hereinafter referred to simply as “cash earners”) are a large and growing
population.3 As some of the lowest paid workers in our communities—
childcare providers, taxi drivers, hairdressers, day laborers—they stand to
benefit the most from the EIC. Yet, in addition to the ubiquitous challenges
faced by many low-income workers in navigating the tax system (including
lack of access to good tax preparation services and financial literacy issues),
cash earners must also confront income documentation requirements that
are ambiguously defined, poorly explained, and sometimes incompatible
with the everyday practices of cash earners and those who pay them. Cash
earners who do not comply with these requirements, however, considerably
increase the likelihood that their EIC claim will be denied, or that their tax
return will be audited.

New York City estimates that more than 150,000 City residents never claim
their federal, state and city earned income tax credits, totaling more than
$160 million. (Source: NYC Department of Consumer Affairs Press Release,
April 8, 2009). Thus, in spite of the considerable publicity given to the
EIC as an anti-poverty measure, the process for claiming the EIC and the
rules under which EIC claims are adjudicated need to be changed to ensure
that the EIC actually benefits cash earners. This policy brief addresses the
most significant obstacles that cash earners face when claiming the EIC
and suggests concrete changes that could remedy this problem. These
obstacles, rarely encountered in isolation but rather tending to compound
each other, include the following:

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I. DOCUMENTATION PROBLEMS

Several of the most significant obstacles for cash earners claiming the
EIC have to do with some aspect of income documentation. The New
York State Department of Taxation and Finance (the “NYSDTF”) requires
that EIC claimants be able to present income documentation sufficient
to substantiate the earned income required to claim the credit. Because
the credit is available only to those who earn income, some form of
documentation requirement is understandable and desirable. But, as
simple as it is in principle, this requirement, as currently administered
by the tax authorities, trips up cash earners in ways that are unrelated to
whether or not they deserve the EIC.

A. Tax forms and instructions do not state that income


documentation is required.

As currently drafted, the tax forms, instructions, and website do not


conspicuously state that EIC claimants must provide documentation
verifying their income; they merely direct claimants to state their income
on a form. Though the requirement is not clearly stated, EIC claimants
who do not submit such documentation may have their claims denied, or
be asked to submit such documentation later.

It seems that, because most workers, who are not cash earners, have their
income substantiated by other standard documentation, such as a W-2,
the generalized tax instructions assume the existence of independently
generated statements of income.4 Cash earners are in a different situation
than most taxpayers in that their income is not independently documented
and submitted to the IRS. These general instructions are therefore
unhelpful to cash earners.

B. Forms and instructions do not state how to document income.

The tax forms, instructions, and web pages pertaining to the EIC offer
no useful guidelines about what sort of documentation is considered
sufficient to verify a person’s income. Thus, even if cash earners claiming
the EIC understand that they must document their earned income, they
still learn nothing about how they should do so. Though documenting
one’s income may not be particularly onerous for workers receiving a
W-2 or the like, cash earners need more guidance as to what records are
sufficient to claim the EIC.

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Those cash earners who recognize that they are considered “self-employed”
for tax purposes may find some guidance in the IRS tax instruction forms
pertaining to recordkeeping by the self-employed.5 These guidelines,
though better than nothing, are not specific to EIC claims, may be too
general to provide practical advice for cash earners, and, most importantly,
are not specifically endorsed by the NYSDTF.

C. The legal standard for sufficient income documentation is


ambiguous.

Cash earners claiming the EIC are generally not in a position to contest
income documentation requirements in tax court. Most are probably not
aware that the legal standard for income documentation is itself unclear.
But an examination of the appeals of adverse EIC determinations illustrates
that the documentation problems encountered by cash earners go much
deeper than simply the drafting of forms and instructions. Complicating
matters even further (yet perhaps explaining the lack of specific guidance
about documentation in the forms and instructions), there is little stated
law about what constitutes sufficient documentation of income for the
purposes of claiming the EIC.

New York Division of Tax Appeals (“DTA”) decisions adjudicating


whether a taxpayer’s income documentation is sufficient to claim
the EIC generally do not state a precise legal standard for sufficiency.
Several generally refer to “books and records from which income and
expenses could be determined.” Such decisions may occasionally note
specific documentation requested of the taxpayer by the NYSDTF in
correspondence, for example, by citing the requirements described in a
“Statement of Refund Adjustment” issued by the NYSDTF to a petitioning
taxpayer in explanation for why her EIC claim was disallowed.6 Some
decisions state a requirement that documentation be “contemporaneous”
with income. Others require that documentation be consistent with other
records, including those held by individuals from whom the taxpayer
received income. In practice, DTA decisions vary considerably in what
sort of documentation is deemed sufficient to substantiate a person’s
income.7 This lack of transparency about documentation requirements
may be further complicated by differing norms across cash earners’
professions.

Three other issues, arising from the adjudication of documentation-related


EIC disputes, further aggravate this lack of a coherently articulated legal
standard:

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1. Tax appeal decisions have no precedential value.

Even if DTA decisions consistently articulated clear, specific cash


income documentation requirements, they would still be of limited
value to taxpayers contesting adverse assessments of their cash income
documentation. DTA decisions are statutorily barred from being
considered as precedent in other proceedings, including subsequent
appeals before the DTA itself.8 Therefore, even if a particular method
of documenting cash income—a tax driver’s handwritten ledger, for
example—had been deemed sufficient to claim the EIC in one case, other
cash earning taxi drivers could not be assured that using the same method
would be permitted in their cases.

2. Tax appeal judges have unconstrained discretion to determine


the sufficiency of income documentation.

There is no binding law that constrains the discretion of the tax


administrative law judges as to what substantiation is sufficient. Given
the lack of clearly defined standards and the inapplicability of previous
DTA determinations, DTA judges rule on the sufficiency of cash income
documentation on a case-by-case basis. Wide latitude of judicial discretion
permits administrative law judges the flexibility to accept varied forms of
cash income documentation. But discretion and flexibility can guarantee
neither uniformity nor predictability, and leave cash earners without
guidance—not even so much as a conservative safe harbor. Though most
published DTA decisions deny petitioners’ claimed income under the EIC,
the fact that these denials rest on an exercise of judicial discretion alone
aggravates the problem of the non-transparent standard.

3. The burden of proof falls on the petitioning taxpayer.

Finally, the procedure for contesting adverse NYSDTF determinations


may itself be an obstacle to cash earners’ income verification. Under Tax
Law § 689(e), a taxpayer whose requested tax refund has been adjusted by
the NYSDTF bears the burden of proof to show by clear and convincing
evidence that the adjustment is erroneous.9 For taxpayers documenting
cash income, this presents a twofold problem: Not only are cash earners’
tax filings more likely to be adjusted by the NYSDTF than those of non-
cash earners, but if they are adjusted, documentation of cash income may
be less likely to constitute clear and convincing evidence sufficient to
overturn the adjustment.

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D. Documenting income is difficult for cash earners.

In addition to the documentation requirement difficulties noted thus far,


cash earners may face more fundamental difficulties in documenting their
income:

1. More initiative is required of cash earners than other workers.

Documenting cash wages, particularly cash wages that vary greatly from
week to week and season to season, requires that cash earners be more
organized and more precise in their accounting than other workers ever
have to be. Workers who are paid by check and receive a W-2 every year
do not need to keep precise, coherent, standardized records; they are kept
for them, and often automatically supplied to the tax authorities. Cash
earners, by contrast, must develop and adhere to a system of documenting
their income, which, besides satisfying the ambiguously defined
requirements noted above, must be practical enough so that cash earners
can actually use it.

2. Different types of work have different recordkeeping norms.

Cash earners work in a wide range of professions, each of which may


have different norms for recording earnings. Taxi drivers, for example,
typically record their earnings differently than day laborers. Recording
practices that are normal for some professions, such as a handwritten
ledger documenting taxi fares collected, may be inconsistent with the
income documenting expectations of the tax authorities.

II. CASH EARNERS ALSO CONFRONT THE


CHALLENGES THAT AFFECT OTHER WORKERS
CLAIMING THE EIC.

In addition to the difficulties specifically caused by receiving cash wages,


cash earners who are eligible for the EIC must overcome all the other barriers
and disadvantages that low-income taxpayers face in general. These
impediments include the complexity of the tax code, fear of consequences
unrelated to tax administration, and socioeconomic characteristics
disproportionately represented among low-income persons.

A. The process to claim the EIC is complicated and confusing.

Complex eligibility rules that include sliding scale earnings limits,10


a unique definition of qualifying children,11 and distinctions between

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different types of income, make claiming the EIC a complicated and
confusing process for any claimant, cash earner or otherwise.12 Though
instructional publications issued by state tax authorities and taxpayer
assistance organizations certainly help individuals become aware of and
determine their eligibility for the EIC, these materials are generally less
effective in explaining in adequate detail how one applies for the EIC.13 In
terms of explaining how one applies for the EIC, as noted above, the tax
form instructions do not state clearly that submitting documentation of
earned income is required.

Given the complexity of the claim process, it is perhaps not surprising that
74% of New Yorkers claiming the federal earned income credit use a paid
preparer to navigate the filing rules.14 Using a paid preparer, however,
comes with its own set of risks for low-income workers unfamiliar with
the tax system, including deception by companies offering high interest
refund anticipation loans. Because refund anticipation loans are secured
by the eventual tax refund, the consumer ultimately bears the risk that
the refund will be smaller than expected or nonexistent. Since the risk of
adjustment is not theirs, the companies selling such loans have an incentive
to overstate EIC claims and understate documentation requirements.
EIC claimants’ finances are squeezed further when refunds are adjusted
downward.

B. Many low-income taxpayers fear collateral consequences.

Cash earners, like other low-income workers, may be reluctant to claim


the EIC because they are afraid it will interfere with other social service
benefits upon which they depend. This fear is largely a misperception,
and efforts are being made to remedy it.15 Still, such fears may make
individuals less likely to claim the EIC.

Likewise, cash earners, like other low-income workers, may be reluctant to


claim the EIC because they are afraid that it will somehow alert immigration
authorities to the presence of undocumented workers in their households.
Given the aggressiveness with which alleged immigration violations are
currently pursued, this fear should be taken seriously.

C. Low-income taxpayers in general face significant hurdles that


result from socioeconomic and related conditions.

Though this brief is primarily intended to address the obstacles faced by


cash earners claiming the EIC, it is worth reiterating that cash earners,
being a subset of low-income workers in general, must deal with the
institutional problems that disproportionately affect low-income taxpayers
as a whole, including:

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• Limited access to quality low- or no-cost tax preparation
services;
• Inability to afford legal counsel for tax law assistance;
• Lack of access to computers and online resources for information
and correspondence with tax authorities;16
• Limited understanding of how the tax system works
(withholding, credits, refund, etc.);
• Difficulty with the English language; and
• Susceptibility to predatory lenders offering refund anticipation
loans.
Were these hindrances not enough, there is evidence that low-income
taxpayers may be more likely to be audited than higher income
taxpayers.

III. DELIVERING THE EIC MORE EFFICIENTLY


COULD SAVE MONEY NOW ALLOCATED TO
OTHER SERVICES.

A robust and efficiently administered EIC has the potential to reduce state
spending on certain social services by transferring money directly to the
neediest workers in our communities. Given New York State’s perennial
budgetary challenges, there will be some opposition to any reform that
improves the efficiency of the EIC based on a concern for the state’s
bottom line. This concern is misguided and counterproductive. Reforms
that facilitate the delivery of the EIC do not necessarily correspond to an
equivalent tightening of the budget. Although less tax revenue is possible,
a portion of the state’s budget is currently allocated to services that low-
income cash earners would avoid if they had the financial stability that the
EIC affords. For example, households with more financial resources will
have fewer needs for emergency social services.

RECOMMENDATIONS

In response to the concerns discussed above, we propose the following


measures to improve the effectiveness of the EIC in reducing poverty
among cash earners. The following is not intended to be an exhaustive
list, but rather, a summary of those measures we believe to be both
relatively easy to implement and likely to yield immediate and noticeable
improvement.

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I. CLEAR AND SPECIFIC LEGAL STANDARD FOR
MINIMUM DOCUMENTATION

NYSDTF should formulate, articulate and adhere to a legal standard that


states clearly and specifically the minimum documentation that is required
to support an EIC claim filed by a cash earner. If audited, the claimant’s
compliance with this standard by providing appropriate documentation
should place the burden of proof of noncompliance with the tax authorities.
The standard should have the following characteristics:

A. The standard should accommodate normal practices for


income documentation among cash wage earners.

To effectively improve cash earning workers’ success in claiming the EIC,


the legal standard for minimum documentation should reflect an awareness
that cash earners typically do not receive W-2 forms from their employers,
may not deposit their wages in a bank account, and may document their
income in ways that are different from self-employed individuals who are
not cash earners. It should be formulated so as to provide as much clarity
as possible about what documents are sufficient, yet be flexible enough to
accommodate diverse practices for income documentation.

B. The standard should define the time frame in which records


must be kept.

The legal standard for minimum documentation should not contain an


artificial requirement that records of earned income by cash earners be
kept contemporaneously. Many of the tax appeal decisions surveyed for
this policy brief base their decision against the claimant on the fact that
records were not kept contemporaneously with income. Records are
certainly more credible if they are recorded at or near the time of income,
but there must be some indication of how quickly earnings must be
recorded. Ideally, the standard would permit records of cash earnings that
are otherwise credible to be compiled explicitly for tax filing purposes,
including records compiled with the assistance of a tax preparer.

C. A good faith effort to meet the documentation standard should


be sufficient.

Cash earners who demonstrate a good faith effort to comply with the
legal standard for minimum documentation should be presumed to have
complied with the standard. A good faith compliance rule must take into
account that many low income cash earners do not have the resources or
the education to account for their income in the same manner as other self-
employed taxpayers.

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II. CLEARER INSTRUCTIONS AND GUIDANCE
FOR THE AFFECTED POPULATION

As discussed above, one of the greatest challenges cash earners face is the
lack of clear and available instructions for how to document one’s income
for the purposes of making an EIC claim, as well as guidance regarding
one’s rights and responsibilities in an audit or disallowance of an EIC claim.
NYSTDF should prepare documents addressing these issues (perhaps
with the assistance of advocates for cash earners and/or tax preparers who
assist cash earners) and should make those documents easily available
to cash earners. Not only should the instructions reflect rules that bind
the tax authorities, but, when cash earners rely on this specific direction
from NYSDTF, their claims should be presumed compliant. Translations
of such documents would also be very helpful in reaching non-English-
speaking cash earners.

III. ELIMINATION OF ALL AUDITING TARGETS


RELATED TO EIC

To the extent that NYSDTF presently adheres to policies that set auditing targets
relating to any aspect of the EIC or employs audit selection practices that cause
EIC claimants to be disproportionately more likely to be targeted for an audit
than other individuals filing tax returns, such policies and practices should be
eliminated. Inequitable policies such as setting benchmarks for the number of
EIC claimants to target for an audit or using “data-mining” computer software
should not be employed. The NYSDTF should implement and adhere to
policies that ensure that individuals, cash earning and otherwise, who claim
the EIC are not placed at greater risk of audit than other taxpayers.

IV. “ONE-TIME PASS” FOR FIRST TIME EIC


CLAIMANTS

The NYSTDF should adopt a policy of granting a “one-time pass” to


EIC claimants whose first-ever EIC claim would otherwise be denied for
inadequate documentation. Under this “one-time pass” policy, the NYSDTF
would grant the claimant’s EIC claim but notify the claimant that, though
the claim has been granted, certain documentation requirements have not
been met and in subsequent years, any EIC claim will not be allowed absent
such documentation. The NYSDTF would make clear specifically what
documentation is necessary but missing, and instruct the claimant about what
documentation will be acceptable for the purposes of making an EIC claim in
subsequent years.

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In addition to evening the playing field for individuals who are more likely
to be disadvantaged, a “one-time pass” policy allows the NYSTDF to educate
the taxpayers who are most in need of direction without penalizing their
initial effort. In fact this policy might be most effective if it were coupled
with an opportunity for more thorough instruction. One possibility would
be that NYSTDF, in cooperation with tax preparers assisting low-income
populations, would offer short classes or multimedia materials that would
teach cash earners how to account for their income.

New York Appleseed and the Financial Clinic would like to thank White
& Case LLP for their generous support of this project, including primary
briefing authors Brendan Driscoll, Allison Harder and Richard Chen.
Thanks to Padraic Driscoll for the design and layout of this policy brief.

New York Appleseed is part of a network of 16 Appleseed public interest law


centers around the United States and in Mexico. Working with volunteers
in the private and public sectors, New York Appleseed expands economic
opportunity for low-income and vulnerable communities by advocating for
effective policy reform and catalyzing innovative cross-sector partnerships in
areas such as financial access, education, healthcare and affordable housing.
New York Appleseed thanks JPMorgan Chase Foundation and Western Union
Foundation for their support of our economic opportunity advocacy.

The Financial Clinic is a pioneer in financial development, defining the


field itself and guiding the thinking and policy behind solutions. We provide
innovative, results-oriented financial coaching and legal support for working
poor families caught in the wage gap—where they earn too much money for
public assistance and too little to be self-sufficient. Our mission is to improve
our customers’ financial security, and ultimately, their financial mobility.

For more information about All Work and No Pay, contact New York Appleseed
at 212.848.5468 or eic@appleseednetwork.org.

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1
This policy brief focuses on the New York State EIC, also referred to as the Earned Income Tax Credit, or “EITC.”
Because the New York State EIC is determined as a percentage of the federal EIC, this brief addresses the federal Credit
indirectly, but does not address the New York City Earned Income Tax Credit. To avoid doubt, the term “EIC” as used
herein refers to the New York State EIC unless otherwise specified.
2
In tax contexts, self-employed workers are occasionally also referred to as “independent contractors.”
3
Need statistic – Appleseed to supply?
4
The federal earned income credit documentation is similarly silent on the requirement. IRS Publication 596 (2007),
“Earned Income Credit (EIC),” is quite thorough in explaining who qualifies for the EIC. It is less clear in explaining
how one who qualifies should claim the credit, at least as far as documentation is concerned.
5
See IRS Publication 583 (1/2007), “Starting a Business and Keeping Records,” which offers the following guidelines:

Kinds of Records To Keep

Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping
system suited to your business that clearly shows your income and expenses.

The business you are in affects the type of records you need to keep for federal tax purposes. You should set up your
recordkeeping system using an accounting method that clearly shows your income for your tax year. See Accounting
Method, earlier. If you are in more than one business, you should keep a complete and separate set of records for
each business. A corporation should keep minutes of board of directors’ meetings.

Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily
made in your books (for example, accounting journals and ledgers). Your books must show your gross income, as
well as your deductions and credits. For most small businesses, the business checkbook (discussed later) is the main
source for entries in the business books. In addition, you must keep supporting documents, explained [in subsequent
sections].

The NYSDTF webpage provides a link to the IRS webpages about self-employed workers.
6
See Matter of Gallego, N.Y. Div. of Tax Appeals, Small Claims, DTA No. 819528 (Nov. 24, 2004). In that case, the
petitioning taxpayer, a Queens jewelry vendor whose EIC claim was disallowed, was issued a Statement of Refund
Adjustment that noted the following documentation requirements:

In order to qualify for the Earned Income Tax Credit and/or Dependent Care Credit, a taxpayer must be able to
document that he received earned income during the tax year. In the case of business income, the taxpayer must
be able to provide records which support when the income was earned, to whom services were provided, and the
exact amount of compensation received from each transaction. Some examples of acceptable proof include: copies
of your receipt booklet, pages from any ledgers you maintain, bank statements, paid receipts, canceled checks and/
or invoices.
7
See list of cases and outcomes in the Appendix.
8
New York Chap. 60 Tax Law Art. 40, Sec. 2010.5
9
See Matter of Suburban Restoration Co., Inc. v. Tax Appeals Tribunal, 299 A.D.2d 751, 752 (Appellate Division, Third Dept.
2002).
10
The amount of the EIC is determined as a function of both income and the number of qualifying children in the
household.
11
For example, the definition of a qualifying child for purposes of the EIC is different than the Food Stamp program and
Temporary Assistance for Needy Families (“TANF”).
12
Although this policy brief focuses on the documentation requirement that prevents cash earners from successfully
claiming the EIC, several other documentary hurdles are evident. For a brief overview of the complexity of the EIC,
see National Taxpayer Advocate’s 2008 Annual Report to Congress, 8 (December 31, 2008) (available at http://www.irs.
gov/pub/irs-utl/08_tas_arc_intro_toc_msp.pdf). A more thorough examination appears in FY 2002 National Taxpayer
Advocate’s Annual Report to Congress, 47-51 (December 31, 2002) (available at http://www.irs.gov/pub/irs-utl/
arc2002_section_one.pdf).
13
See, e.g., Publication 310-NY (12/07) (“Information on New York’s Earned Income Credits”) and Form IT-215-I (2007)
(“Instructions for Form IT-215, Claim for Earned Income Credit”), neither of which mentions income documentation
requirements.
14
By comparison, 66% of all filers in New York use a paid tax preparer. These proportions are calculated from tax data
for 2006 available from The Brookings Institution on their website at http://www.brookings.edu/projects/EITC.aspx
(last visited July 22, 2009).
15
See, e.g., the New York City Department of Consumer Affairs flyer addressing this misconception, available at http://
www.nyc.gov/html/dca/downloads/pdf/wceca_eitc_flyer_2008.pdf.
16
Recent efforts to streamline the IRS and state tax agencies have aggravated this problem. See generally Janet R.
Spragens & Nancy Abramowitz, “Low-Income Taxpayers and the Modernized IRS: A View from the Trenches,” Tax
Notes, Vol. 17, No. 11 (June 13, 2005).
17
See Matter of Moreno, N.Y. Div. of Tax Appeals, Small Claims, DTA No. 820959 (Jun. 14, 2007), Matter of Moreno, N.Y. Div.
of Tax Appeals, Small Claims, DTA No. 820316 (Jun. 14, 2007), Matter of Defreitas, N.Y. Div. of Tax Appeals, Small Claims,
DTA No. 820364 (Apr. 6, 2006) and Matter of Valoy, N.Y. Div. of Tax Appeals, Small Claims, DTA No. 819191 (Feb. 19,
2004).
18
The decision did not specify what “documentation” was provided by petitioner.

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APPENDIX

NEW YORK STATE DIVISION OF TAX APPEALS


DECISIONS

The following cases adjudicate proof of earned income for the purposes of
claiming the EIC. These decisions are not binding precedent for any New
York judicial proceeding, but may be a useful resource in determining which
factors are relevant in documenting EIC income.

Also, note that these cases were only considered for their analysis of
income documentation, not other EIC-related issues such as verification of
dependents.

(Covers cases through 10/25/07. Current as of 5/27/08.)

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Copyright Appleseed 2010
All rights reserved
Please contact Jeremy Cook for permission to reproduce.
202.347.7960 or jcook@appleseednetwork.org

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