Last week’s column promised more details on the Earned Income Tax Credit (EITC). Below is our fulfillment of the promise.
There is mostly good news and some bad news in IRS publication 596 (Earned Income Credit). The good news starts on page 2: “The Earned Income Credit (EIC) is a tax credit for certain people who work and have earned less than $57,414. A tax credit usually means more money in your pocket. It reduces the amount of tax you The EIC can also refund you.
What we really love about the EIC is that it’s a strong incentive for people to get off the living room couch and get paid. In other words, the EIC rewards earned income…up to a point…which includes wages, salaries, and net self-employment income. Empirical research shows that most refunds generated by the EIC are spent quickly – another positive as it helps the economy. Our experience with the Notre Dame Tax Assistance Program adds anecdotal evidence that complements the research findings. In many situations, taxpayers reacted to the announcement of a refund with comments that the money would be used to replace a worn-out appliance, fix a leaky roof, or “right a wrong” by repaying a debt owed a friend, family member or a fierce collection agency.
The EIC is phased in – meaning the higher the earned income, the higher the EIC – then levels off before encountering phasing out rules that reduce the credit to $0. Check out the Earned Income Credit (EIC) chart in Publication 596 available on our favorite website this time of year – irs.gov.
The EITC can climb up to $6,728 in joint filing situations where the taxpayers have at least three children. For taxpayers without eligible children, the credit is capped at $1,502.
In a very unique twist, taxpayers are allowed to use their income earned in 2019 (not 2020 as reported last week) to determine EIC if the 2019 number provides a higher EIC than 2021. For example, a single filer or head of household with one qualifying child whose earned income of $10,000 in 2021 is less than the $19,000 recorded in 2019, reports an EIC of $3,618 based on 2019 income. That is $209 more than the IEC using $10,000. Another illustration – a married couple filing jointly with three (3) eligible children and the same earned income configuration (i.e. $10,000 in 2021 and $19,000 in 2019) finds the above provision generates an EIC of $6,728 (using the 2019 number) which is $2,217 plus $4,511 – the EIC table figure for earned income in 2021. Notes: Using earned income in 2019 is only allowed when it exceeds your earned income in 2021; report the information on line 27c of Form 1040.
The letter “R” plays a prominent role in the conclusion of our abbreviated coverage of the EITC. Namely, the credit is Refundable. In other words, the credit can generate a refund in itself. Strict age barriers have been addressed since the minimum age was raised from 25 to 19. Recklessness in reporting the EIC can have repercussions, especially if the IRS gives a “thumbs down” in the form of a deficiency notice. When this occurs, the taxpayer must use Form 8862 to demonstrate that they qualify for the credit. If the IRS (“after further review”) goes with a “thumbs up” (i.e., recertifies eligibility), the EIC may be reported and Form 8862 will become a “mirror memory” unless the IRS denies the EIC again in a loophole proceed.
As mentioned, the above is an abbreviated coverage of the EIC. The IRS provides much more information in Publication 596. The EIC is one of the most generous tax credits and also one of the most complex to calculate. If you are eligible for credit (see pages 2 and 32 of Publication 596, which provide eligibility checklists) and find it too difficult to calculate the EIC, ask the IRS to “do the math” (see page 22 of publication 596 for specifics).
Rick Klee was tax director at the University of Notre Dame from 1998 to August 2019. A retired CPA, Klee is a graduate of Notre Dame. You can contact him at firstname.lastname@example.org.
Ken Milani is a professor of accounting at Notre Dame where he served as the faculty coordinator for the Notre Dame Tax Assistance Program. Contact him at email@example.com. Email questions to either.