Earned Income Credit

The earned income credit (aka EIC, earned income tax credit, EITC) (IRC §32), enacted in 1975, is a refundable tax credit to lighten the burden of the regressive payroll taxes, which consists of the Social Security tax and the Medicare tax, on the poor. Hence, the credit can only be applied to earned income that is subject to employment taxes. So, for instance, it cannot be used to offset the taxes on unemployment compensation. The base amount of the credit depends on the number of qualifying children for which the taxpayer can claim as dependents, but the actual amount of the credit depends on the taxpayer's income. To claim the credit, investment income cannot exceed a limit that is adjusted annually for inflation.

The earned income credit is sometimes considered a negative income tax, because, being a refundable tax credit, it is paid to people even if they do not have a tax liability.

In previous years, many taxpayers took the EIC as an advance payment of earned income credit by reducing the tax taken out of their wages. However, this provision, which had been available for many years, was eliminated by the Education Jobs and Medicaid Assistance Act of 2010. IRC §3507, which authorized advanced payments, has been repealed. Hence, after 2010, the earned income credit can only be claimed with the tax return.

Eligibility

The earned income credit is available to single and married people with children. Taxpayers without children can also claim the credit if they are older than 24 and younger than 65 and no one else can claim them as a dependent. However, the earned income credit is larger for people with children and the phaseout limit is much higher.

Married persons filing separately may not claim the EIC. However, if a spouse lived apart from the other spouse for the last half of the tax year, then she may be able to claim the credit as head of household. Nonresident aliens cannot claim the credit, unless they are married and an election is made by the couple to subject their worldwide income to United States tax.

The amount of the earned income credit that can be claimed by the taxpayer depends on income and the number of qualifying children. A qualifying child must satisfy these tests:

A child who is married by the end of the tax year, and who files a joint return, cannot be claimed as a qualifying child, unless the return is filed only to claim a refund.

Tie-Breaking Rules

If more than 1 taxpayer can potentially claim a certain child, then tie-breaking rules apply:

Earned Income, Disqualifying Income

The amount of the credit is limited by earned income, which includes:

Earned income does not include interest, dividends, alimony, welfare benefits, veterans' benefits, pensions and annuities, workers compensation, unemployment compensation, nontaxable employee compensation, excludable dependent care benefits, or excludable education assistance.

The earned income credit is not available if disqualifying income exceeds the investment income limit, which is adjusted for inflation annually. For 2013, the limit is $3,300. Disqualifying income includes:

Presumably, a taxpayer with large amounts of unearned income does not need the EIC. The EIC cannot be claimed by a taxpayer who claims the foreign income exclusion, regardless of the amount.

How the Earned Income Credit Is Calculated

The earned income credit calculation is rather complicated, but most people can simply consult the EITC tax table in the instructions to Form 1040. If the taxpayer has qualifying children, then Schedule EIC should be filed with Form 1040 or Form 1040A, listing the qualifying children and their social security numbers. To calculate the EIC, taxpayers are classified into groups based on filing status and the number of qualifying children: 0, 1, 2, 3 or more.

The EIC calculation is based on the following numbers, which is stipulated by IRC §32, some of which are adjusted for inflation:

To summarize:

Diagram showing how the earned income tax credit (EITC) varies with taxpayer income.
Qualifying
Children
Maximum
EIC
Maximum AGI
(Married Filing Jointly)
2014: Investment Income ≤ $3,350
0$496$14,590 ($20,020)
1$3,305$38,511 ($43,941)
2$5,460$43,756 ($49,186)
3 or more$6,143$46,997 ($52,427)
2013: Investment Income ≤ $3,300
0$487$14,340 ($19,680)
1$3,250$37,870 ($43,210)
2$5,372$43,038 ($48,378)
3 or more$6,044$46,227 ($51,567)
2012: Investment Income ≤ $3,200
0$475$13,980 ($19,190)
1$3,169$36,920 ($42,130)
2$5,236$41,952 ($47,162)
3 or more$5,891$45,060 ($50,270)
2011: Investment Income ≤ $3,150
0$464$13,660 ($18,740)
1$3,094$36,052 ($41,132)
2$5,112$40,964 ($46,044)
3 or more$5,751$43,998 ($49,078)
Source: Preview of EITC Income Limits, Maximum Credit Amounts and Tax Law Updates

The maximum credit allowable phases out at much lower adjusted gross income (AGI) levels.

For taxpayers who are married filing jointly, the EIC begins to phase out with income greater than $21,800, for 1 or more qualifying children. However, the phaseout endpoint depends on the number of children. For all other taxpayers, the phaseout income begins at $16,700 for 1 or more qualifying children.

When there are no qualifying children, then the phaseout begins with an AGI of at least $7600 ($12,700 for married filing jointly) and the upper boundary for the phaseout interval is $13,660 ($18,740 for married filing jointly).

EIC Related Penalties

The IRS assesses penalties against taxpayers who fraudulently claim the EIC or flagrantly violates the rules. If the IRS sends a deficiency letter denying the EIC for a taxpayer, then the credit cannot be claimed in future years unless she files Form 8862. The taxpayer can claim the credit if the IRS re-certifies eligibility, in which case, Form 8862 does not have to be filed again unless the IRS denies the EIC again.

Future credits for a taxpayer are denied for 2 years if the taxpayer disregarded the rules in claiming the EIC. Fraud increases the period to 10 years.

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