The earned income tax credit (EITC) has been around for years. But for some folks, it’s never been worth as much as it will be for 2021.
That’s thanks to liberalizations included in the American Rescue Plan Act of 2021 (ARPA). Some of the favorable changes are only for the 2021 tax year. Others are permanent.
EITC Basics
The EITC is targeted at low-income and moderate-income individual taxpayers. Perhaps most important, it’s a refundable credit.
That means you can collect it even if you don’t owe any federal income tax. In other words, it’s free money.
If you’re an eligible individual, your tentative EITC (the maximum you can hope for) equals the applicable credit percentage of your earned income for the year.
The tentative EITC is then reduced by the phaseout amount, if applicable, to arrive at your allowable EITC.
Eligible Individual Defined
In general, you are an eligible individual if you have at least one qualifying child for the tax year in question.
Earned Income Defined
The term earned income generally means
- wages, salaries, tips, and other taxable employee compensation, and
- any net earnings from self-employment reduced by the deduction for 50 percent of self-employment tax.
Qualifying Child Defined
The term qualifying child means your child; a descendant of your child (such as a grandchild); or your brother, sister, stepbrother, or stepsister (or a descendant of one of those persons).
To be your qualifying child, the individual must also have the same principal residence as you have for over half of the year in question. The individual must be younger than you and
- under age 19 at the end of the year, or
- a student who is under age 24 at the end of the year, or
- permanently and totally disabled at any time during the year.
Finally, the individual cannot have filed a joint Form 1040 for the year.
EITC Calculations in a Nutshell
Under the rules that apply for your 2020 Form 1040, tentative EITC equals
- 7.65 percent of the first $7,030 of earned income if you don’t have a qualifying child,
- 34 percent of the first $10,540 of earned income for one qualifying child,
- 40 percent of the first $14,800 of earned income for two qualifying children, or
- 45 percent of the first $14,800 of earned income for three or more qualifying children.
If the couple’s adjusted gross income exceeds $47,646, their EITC is completely phased out. Use the table in the Form 1040 instructions to find the exact allowable EITC amounts.
For 2021, the inflation-adjusted earned income amounts are $7,100, $10,640, $14,950, and $14,950, respectively.
Finally, if you have certain types of investment income over the applicable annual inflation-adjusted threshold, you’re completely ineligible for the EITC. For 2020, the investment income cap was $3,650.
Thanks to the ARPA, you can have up to $10,000 of disqualified income without losing out on the EITC for 2021. For 2022 and later years, the $10,000 limit will be adjusted for inflation.
Temporary Changes (for 2021 Only)
A. For 2021, you generally must be at least age 19 as of December 31, 2021 (versus age 25 under the regular rules), and there’s no upper age limit (versus an upper limit of age 64 under the regular rules.
B. If you are a qualified former foster youth or a qualified homeless youth (as defined), the minimum age is 18 for 2021.
Under the regular rules, the tentative EITC for 2021 if you have no qualifying children was scheduled to be only $543. Thanks to the ARPA, the tentative EITC for 2021 is upped to $1,502.
C. To calculate your EITC for 2021, you can use either your 2019 earned income or your 2021 earned income. Use whichever number gives you the bigger 2021 credit.
Permanent Changes (for 2021 and Beyond)
A. Under the pre-ARPA EITC rules, you would have been ineligible for the EITC in 2021 if you had more than $3,650 of disqualified income (basically, certain types of investment income as explained below). Thanks to the ARPA, you can have up to $10,000 of disqualified income without losing out on the EITC for 2021. For 2022 and later years, the $10,000 limit will be adjusted for inflation
B. For 2021 and beyond, the ARPA includes a permanent change that will allow more married-but-separated individuals to claim the EITC without having to file a joint Form 1040. The new general rule says you can claim the EITC on a married-filing-separate return or on a head-of-household return (when head-of-household filing status is permitted), as long as a qualifying child lives with you for more than six months during the year in question and you either:
- do not have the same principal residence as your spouse for the last six months of the year, or
- have a separation instrument in effect (a court decree or agreement other than an actual divorce decree) and do not live in the same household with your spouse as of the end of the year
C. Under the pre-ARPA rules, you cannot claim the EITC based on a qualifying child unless you include the child’s name, age, and taxpayer identification number (generally a Social Security number). Failure to provide child ID information also made you ineligible to claim the EITC under the rules for someone with no qualifying children. In other words, you were flat out of luck. But for 2021 and beyond, the ARPA permanently removes that rule. So, if you fail to provide child ID Information, you can claim the EITC under the rules for someone with no qualifying children. Fair enough.
Takeaways
The ARPA made favorable changes to the EITC rules. Some are temporary, for 2021 only. Others are permanent, for 2021 and beyond.
The most important changes are (for 2021 only) the liberalized rules for taxpayers with no qualifying children and (for 2021 and beyond) the permanent increase in the amount of investment income that you can have without becoming ineligible for the EITC.
While your income may be way too high to claim the EITC, you may have loved ones who are eligible. According to a report by the Treasury Inspector General for Tax Administration, about 5 million potentially eligible taxpayers fail to claim the EITC each year, resulting in about $7 billion in unclaimed credits each year. Don’t let a loved one fall into this category.
There’s no IRS form dedicated to the EITC. You must use the worksheets provided in Form 1040 instructions to calculate your allowable credit. Pack a lunch—it takes a while!
If you would like to discuss the EITC in more detail, please call me on my direct line at 509-543-7600 or send a request HERE.
April 2021
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