Definition and Example of the Earned Income Tax Credit
The Earned Income Tax Credit (EITC) was created by the federal government in 1975 to help low-income taxpayers keep more of their hard-earned money in their pockets. This is a refundable tax credit, which means it is applied to any tax you might owe after you complete your return and calculate what's due. The IRS will send you a refund for the difference if there's any left over after it erases your tax debt. The Earned Income Tax Credit was intended to be just a temporary legislative provision, but it is still available today.
The amount of credit varies, depending on your income and how many dependents you have. The maximum Earned Income Tax Credit amounts for the 2021 tax year—the return you’d file in 2022—are as follows:
- $6,728 if you have three or more qualifying children
- $5,980 if you have two children
- $3,618 if you have one child
- $1,502 if you have no children
These credit amounts increase annually to keep pace with inflation. For instance, the maximum credit in tax year 2021 is $6,728, up from $6,660 in 2020, if you have three or more children.
How the Earned Income Tax Credit Works
The EITC is calculated by a percentage of income called the "credit rate." Taxpayers with the least income and largest families receive a greater credit as a result. The credit phases out entirely until it isn't available to those with incomes over certain limits based on filing status.
You must have earned income to qualify, but you can't have too much. Earned income includes all wages you earn from employment, as well as some disability payments.
Both your earned income and your adjusted gross income (AGI) must be less than a certain threshold to qualify for the EITC. Your AGI is your earned income minus certain adjustments for income that you don't have to pay taxes on, such as IRA contributions. Your AGI appears on line 11 of the 2021 Form 1040.
Your AGI must have been less than these amounts in 2021 if you use the single, head of household, or qualifying widower filing status:
- $51,464 if you have three or more qualifying children
- $47,915 if you have two children
- $42,158 if you have one child
- $21,430 if you have no children
Income limits increase for married taxpayers who file joint returns to the following amounts:
- $57,414 if you have three or more qualifying children
- $53,865 if you have two children
- $48,108 if you have one child
- $27,380 if you have no children
Investment income can't exceed $10,000 as of tax year 2021. This includes interest, dividends, capital gains, and royalties. It might be reported on a 1099-MISC or, for dividends, on Form 1099-DIV. The institutions where you hold investments or accounts should send you copies of these forms shortly after the first of the year.
Pros and Cons of the Earned Income Tax Credit
It provides tax relief to low-income workers.
It encourages taxpayers to work.
You’ll wait longer for your tax refund.
It’s a difficult credit to calculate.
- It provides tax relief to low-income workers: The eligibility requirements of the EITC are designed to give more money to those who need it most. The hope is that the EITC will also help reduce poverty and make the tax code more fair.
- It encourages taxpayers to work: You must have earned income to qualify for this tax credit. Studies have found that, since its inception, benefits from the EITC consistently encouraged workforce participation by single mothers.
- You’ll wait longer for your tax refund: The Protecting Americans from Tax Hikes (PATH) Act requires the IRS to hold refunds that claim this credit until at least February 15 each year. This allows the government some time to investigate the possibility of fraudulent claims, but it also means that many Americans will have to wait longer for their tax refunds.
- It’s a difficult credit to calculate: You might need to seek professional tax help to claim the EITC, because it’s among the most complicated tax credits to calculate—if not the most complicated. Common errors that people often make include claiming a child who does not qualify, filing as single when married, reporting incorrect expenses, and an inaccurately reported Social Security number.
On the bright side, the IRS offers the Free File program for lower-income taxpayers, and these software providers can assist you.
Requirements for the Earned Income Tax Credit
You must attach Schedule EIC for the appropriate tax year to your Form 1040 to claim a qualifying child or children for purposes of the EITC. Taxpayers must meet a few other rules to be eligible to claim this credit as well:
- You must have a valid Social Security number.
- You must be a U.S. citizen or a resident alien for the entire year.
- You (and your spouse if you're married) can't be claimed as a qualifying child by anyone else.
- You can't claim the foreign earned income exclusion, which relates to wages earned while living abroad.
Additional rules apply if you don't have a qualifying child:
- You and your spouse, if you file jointly, must be between the ages of 25 and 64.
- You must have lived in the U.S. for more than half of the year.
Finally, you can't claim the EITC if your filing status is married filing separately.
You might qualify to file as head of household if you and your spouse are separated, and your spouse didn't live with you at any time during the last six months of the tax year. This status would allow you to claim the EITC.
If the IRS disallows your claim for the EITC, you'll have to file Form 8862 with your next tax return to reclaim your eligibility.
Requirements for Qualifying Children
The rules for qualifying children for the EITC are slightly different from those for claiming dependents, in general. The rules for qualifying children for EITC purposes are based on four tests:
- The Relationship Test: The child must be related to you by birth, marriage, or adoption, or must live with you under a foster arrangement. The child can be your son, daughter, stepchild, grandchild, niece, nephew, brother, or sister, or an eligible foster child. Adopted children are treated the same as children by birth, and foster children must be placed in your care by an authorized placement agency.
- The Age Test: The child must be age 19 or younger at the end of the tax year, or a full-time student for at least five months of the year, aged 24 or younger. You can claim an individual for the EITC, regardless of age, if your dependent is permanently disabled. You (or your spouse if you're married and filing jointly) must be older than your dependent.
- The Residency Test: The child must live with you in the United States for more than half of the year (at least six months and one day).
- The Joint Return Test: A child you claim as a dependent for purposes of claiming the EITC cannot file a joint return with their spouse. One exception is if your dependent files a joint return solely to claim a refund, and they don't claim any deductions or tax credits on their own return.
The child must also have a valid Social Security number issued before the date of your tax return, including any extensions that you request. Complete Form SS-5 if your child needs a Social Security number, and submit the form to the Social Security Administration. You must provide two documents that prove your child's age, citizenship status, and identity, as well as an ID proving your own identity. If your request is approved, you should receive a Social Security card for the child within a couple of weeks.
Consider asking the IRS for an extension of time to file if the tax deadline is looming, and you don't yet have your child's Social Security number. Requesting an extension is a simple matter of filing Form 4868 on or before Tax Day, and it will give you until October 15 to file your return.
- The amount of the Earned Income Tax Credit is based on your income and how many dependent children you have. The amount increases as your income decreases and with each additional child.
- Taxpayers with high incomes aren’t eligible for the EITC.
- The EITC is refundable, so the IRS will send you a check for any balance left over if it eliminates your tax bill.
- Claiming the EITC can delay your refund until at least February 15.