What is considered investment income for the Earned Income Tax Credit and why am I high risk for audit?

[KDS114]

Three questions. Please know upfront, I am a tax novice and I will take no offense whatsoever if you dummy-down and simplify your answer. 

I thought I had finished my taxes, but now see TurboTax is telling me I am at a high risk for audit so I want to clarify some things. I've NEVER been considered a high risk before. (I'm using Turbo Tax Home & Business.)

First question: I am self-employed and have unwittingly qualified for the Earned Income Tax Credit (which I didn't even know existed until I started researching things while working on my taxes). I re-examined the EITC qualifications. What is considered "investment income" in regards to the EITC stipulation that it must be under $3650? I took $3800 out of my Roth IRA in 2020; although I'm under 59 1/2 the money was part of funds I had contributed over five years ago. It is listed as a "J" on my 1099-R. Should I really still qualify for the EITC since it's over $3650? My Roth and traditional IRAs made more than $3650 last year, but I didn't take any of that money out and was not sent any other tax forms aside from the 1099-R. Is either scenario considered investment income?

Second question: One of the audit risks shown is that I only had only "one" income - my business - and it was at a loss. However, I had both LLC income and a W2. In 2020 my LLC's nominal income was actually considered a loss after entering my expenses, such as mileage, 20% of my cell phone bill and a couple other very small expenses. I also had a W2 for on-call work which was under $3000. (One of the risks listed: My expenses were more than my income, but that's not true if it included my W2 income.) Is the "one business" risk a TurboTax glitch? My W2 income shows in my 1040. Do I check other places in my forms to make sure I did things correctly? 

Third question: I only saw one place to enter mileage. I entered mileage for both my LLC work and for my W2 on-call work all together. (I don't think W2 work would be considered a "commute" since it had me driving all over the place and only on a as-needed basis.) I was not reimbursed for any of these miles. Is that okay that these miles are all lumped together since I think it appears as a business loss on my Schedule C?

I'll throw in, I did receive PUA benefits last year, but from what I've read those don't count toward my EITC qualification. 

MANY thanks in advance for your help! 

[AnnetteB6 · Accepted solution]

Rest assured that TurboTax will take all of your income into account (and the type of income you are reporting) when determining if you qualify for the Earned Income Tax Credit.  Investment income for the purpose of the EITC includes taxable and non-taxable interest income, dividends, pensions and annuities, net income from rents and royalties, net capital gains, and net passive income.  Receiving a distribution from your Roth IRA that consists of your contributions does not disqualify you for the EITC.

As for the higher audit risk, as long as you have documentation to back up any deductions you are claiming or documentation showing your income, you should not be worried.  The higher audit risk just indicates that taxpayers with Schedule C businesses showing a loss may be more likely to be chosen to have their return examined.  That certainly does not mean that it will happen though.

For the mileage deduction, you should not be lumping the mileage from your W-2 work with the mileage from your self-employed work.  The self-employed mileage is the only mileage that can be reported on the Schedule C.  After you make the adjustment to remove the W-2 mileage, you may see a change in your audit risk.  

Employee (W-2) business expenses such as mileage you drove as part of your job are no longer deductible on your Federal return for tax years 2018 through 2025.  If it was deductible it would be entered on Form 2106 and not part of Schedule C.  

[KDS114]

Thank you very much for the fast and helpful reply. Two follow-up questions, if I may:

Despite the fact I am a seasonal, on-call worker with no benefits, if I am given a W2 that means I cannot make any deduction for miles, right? (In 2020, just in January and February it was 2,000 miles.)

And when TurboTax stated I only had "one" income in my summary, I shouldn't be worried since it is indeed listed on my 1040, correct?

Again, I am most grateful for your help!

[Critter-3]

That "higher risk of audit" is just to scare you into buying audit protection services as an add on fee ... ignore the upsell.   

[Opus 17]

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@KDS114 wrote:

Thank you very much for the fast and helpful reply. Two follow-up questions, if I may:

Despite the fact I am a seasonal, on-call worker with no benefits, if I am given a W2 that means I cannot make any deduction for miles, right? (In 2020, just in January and February it was 2,000 miles.)

And when TurboTax stated I only had "one" income in my summary, I shouldn't be worried since it is indeed listed on my 1040, correct?

Again, I am most grateful for your help!

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Mileage for a W-2 job would be listed on form 2106 and is an itemized deduction on schedule A; a personal deduction like charity donations, not a business deduction.  You would access that deduction on the "Deductions and Credits" page on the personal side under "job-related expenses", and not the Schedule C on the business side.  Your schedule C should only list income and expenses for that particular job, if you have mileage for more than one job, you have to allocate it accordingly. 

Then separately, the 2018 tax reform eliminated this deduction for 2018-2025.  You can still enter job-related mileage (the program step was not removed) as it may give you a state tax deduction in some states.  

Your employer can reimburse you for miles tax-free if you provide adequate records (called an "accountable plan"), they can reimburse at the IRS mileage rate or a lower rate and the reimbursement is tax-free to you.  You might want to negotiate about that next time you renew your contract or have a conversation about compensation.  But it's not a federal deduction for 2018-2025.  

[KDS114]

@Opus 17 Thank you! Your explanation was clear and helpful. I entered the miles under personal as you said. However, I'm seeing my state refund hasn't changed at all. Arizona has a standard deduction so I'm guessing that's why? TurboTax didn't tell me either way. Since I appear to be a high risk for audit, am I better off just removing the miles under personal? Again, I greatly appreciate the help!

[Opus 17]

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@KDS114 wrote:

@Opus 17 Thank you! Your explanation was clear and helpful. I entered the miles under personal as you said. However, I'm seeing my state refund hasn't changed at all. Arizona has a standard deduction so I'm guessing that's why? TurboTax didn't tell me either way. Since I appear to be a high risk for audit, am I better off just removing the miles under personal? Again, I greatly appreciate the help!

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I would not put much stock in the "audit meter".  If you are taking the AZ standard deduction, then listing mileage in the program couldn't raise your audit risk since that information would not be passed on to the state anyway.  The most reason for not benefitting from listing itemized deductions is that your itemized deductions are less than the standard deduction, although I can't see your specific return.