Chapter 5: Earned Income Credit
Chapter Description
Upon completion of this chapter, students will have a working knowledge of the Earned Income
... [Show More] Credit. Students will be able to identify earned income as it relates to the earned income credit. An understanding of the requirements for qualifying children and how taxpayers may qualify for this credit without having a qualifying child will be obtained. Students will become adept at completing Schedule EIC and able to transfer the information over to Form 1040. Due diligence will also be examined.
The following content is based on 2022 tax law for 2021 tax returns; however, discussions of prior year tax law will be addressed as applicable.
NOTE: There are a variety of temporary changes impacting the Earned Income Credit for the 2021 tax year. These changes will be highlighted throughout the chapter.
1) Examine the most common tax credit, the Earned Income Credit (EIC).
2) Define earned income as it relates to the Earned Income Credit.
3) Identify the eligibility rules for the Earned Income Credit which apply to everyone.
4) Summarize the additional eligibility rules which apply to taxpayers with a qualifying child.
5) Describe how taxpayers without children may qualify for Earned Income Credit.
6) Determine how to complete Schedule EIC and where to put the information from the appropriate worksheet on Form 1040.
7) Discuss circumstances when the IRS would disallow the Earned Income Credit.
8) Examine IRS due diligence requirements.
9) Recognize when special rules apply to a taxpayer claiming Earned Income Credit.
• Adopted Child
• Due Diligence
• Earned Income Credit (EIC)
• Foster Child
• Grandchild
• Married Child
• Permanently and Totally Disabled Child
• Qualifying Child of More than One Person
• Student
What is a Credit?
A tax credit reduces the taxpayer’s current tax liability dollar for dollar. There are two categories of credits.
Nonrefundable credits may reduce the taxpayer’s tax liability to zero. If the credit is more than the tax liability, the excess is not refunded. Most credits are nonrefundable. A nonrefundable credit may reduce the tax due to zero but will not produce payments to the taxpayer. The most common nonrefundable credits include the foreign tax credit, credit for child and dependent care expenses,
education credits, retirement savings contributions credit, credit for other dependents, and credit for the elderly and disabled.
See the example below for tax treatment for a nonrefundable credit.
Example: Total Tax $481
Foreign Tax Credit - 500
Tax Due/Refund $ 0
Refundable credits are treated as tax payments. The credit amount is added to federal income tax withheld. If the total of these credits is more than the tax liability, the excess will be refunded. There are a number of refundable credits, including:
• Earned Income Credit (Schedule EIC)
• Additional child tax credit (Form 8812) Note: The Child Tax Credit may be fully refundable to certain taxpayers in 2021.
• Excess Social Security and tier 1 RRTA tax withheld
• Credit for federal tax paid on fuels (Form 4136)
• Credit for taxes paid by regulated investment companies (Form 2439)
• Credit for prior year minimum tax (Form 8801)
• Health coverage tax credit (Form 8885)
• Claim of right credit
As shown in the following example, if the taxpayer had a refundable credit, the results would be different. The excess amount of credit would be refunded to the taxpayer.
Example: Total Tax $481
Earned Income Credit - 500
Refund $ 19
Partially refundable credits include certain tax credits that fit into both categories (nonrefundable and refundable). This type of credit is considered partially refundable because only a portion of the tax credit can be refunded to the taxpayer. An example of a partially refundable credit is the American Opportunity credit (Form 8863). Up to 40% of the $2,500 credit is refundable.
This chapter covers the Earned Income Credit. The other credits will be discussed in a later chapter.
What is the Earned Income Credit?
The Earned Income Credit (EIC, also known as EITC, Earned Income Tax Credit) is a refundable credit available to taxpayers with and without children. EIC is a tax benefit available for taxpayers who worked and had earned income under a specified amount that is adjusted annually.
In order for a taxpayer to receive EIC, he or she must qualify by meeting certain rules (discussed later in this chapter), and he or she must file a return even if he or she does not owe federal taxes, doesn’t meet the filing requirements for his filing status, and does not have federal income taxes withheld from his or her pay.
According to the IRS, 25 million taxpayers received the EIC in tax year 2020, and the average EIC was $2,411. 1
The following table, “Earned Income Credit in a Nutshell,” from Publication 596 is a well-known resource used by taxpayers to determine whether they are eligible to claim the EIC.
Earned Income Credit in a Nutshell
2
Earned Income Tax Credit (EITC) Limitations
The American Rescue Plan Act (ARPA) temporarily expanded the EITC in 2021. Specifically, ARPA implemented the following changes to the EITC:
• Age Requirement: ARPA reduced the applicable minimum age for the credit from 25 years old to 19 years old, unless the individual was a specified student or qualified former foster youth or qualified homeless youth. Under these scenarios, the applicable minimum age for purposes of the EITC is 24 years old. ARPA also eliminated the maximum age limit of 65, meaning there is no maximum age limit for purposes of claiming the EITC. The age requirement changes are applicable for the 2021 tax year only.
• Increase in the Childless EITC Amount: As discussed below, EITC temporarily increased the childless EITC amount for the 2021 tax year. Notably, it raised the credit percentage and phaseout percentage from 7.65% to 15.3% and raised the income at which the maximum childless EITC is reached to $9,820. As a result of these changes, the maximum “childless”
1 https://www.eitc.irs.gov/eitc-central/statistics-for-tax-returns-with-eitc/statistics-for-tax-returns-with-the-earned-income
2 Publication 596, page 2 [Show Less]