What Is the Earned Income Tax Credit & How Do You Claim It?

father and young son

In tough times the hardest hit is always the low-income earners in our society.  This past year has been one of the toughest times this nation has ever seen. It is important at this time to know all the tax credits available when filing your return to either reduce your tax debt or strengthen your refund. A tax credit is a dollar-for-dollar reduction of the income tax you owe. 

In previous articles, we have covered a few of these credits. I have mentioned this credit in previous articles, but today we will go into further detail about the Earned Income Tax Credit. If you make under $56,844 you may qualify for this and be able to save substantial money.

 

What Is the Earned Income Tax Credit?

The Earned Income Tax Credit (EIC) is a refundable tax credit for low- and moderate-income workers. This credit was first enacted in 1975 to provide financial assistance to working families with children. It was originally conceived as a “work bonus plan” to supplement the wages of low-income workers, help offset the effect of social security taxes, and to encourage workers to steer people off welfare programs. It continues to be viewed as an anti-poverty tax. 

The credit has evolved over the years and now helps taxpayers with or without children.  Since the credit is considered refundable, if your tax credit exceeds your tax liability, you may be eligible for a refund.

 

How Do You Qualify?

The main qualifier for this tax credit is you must be earning income. Earned income includes wages, tips. and net self-employment income. A taxpayer who only has income from unemployment, alimony, child support, or interest is not considered earned income for qualification for the EITC. There are 7 rules the IRS requires taxpayers to meet to qualify for the credit.

  1. You must meet the minimum income requirements. Your 2020 AGI must be below $56,844 if you have three or more qualifying children. $53,330 if you have two or more qualifying children. $47, 646 if you have one qualifying child and $21,710 if you do not have children.
  2. You must have a valid social security number.
  3. Your filing status must be single, married filing jointly, head of household, or qualifying widower. Taxpayers who file married filing separately can not qualify for the earned income credit.
  4. You must be a US Citizen or resident alien.
  5. If you earned foreign income and are required to file form 2555 you will not qualify.
  6. Your investment income must be $3650 or less. Investment income includes interest income, dividends, rents, or royalties.
  7.  You must have earned income to qualify.

What Is the Income Limit?

As mentioned earlier there is an income limit for the earned income credit. The income limit is based on the number of qualifying children that you have. The first important part of that would be to determine what a qualified child is.

Qualifying Child

A qualifying child is a child that meets the IRS requirements to be your dependent for tax purposes. Though it does not have to be your child, the qualifying child must be related to you. There are four tests a person must satisfy to qualify as a qualified child. 

Relationship

The taxpayer’s child or stepchild (whether by blood or adoption), foster child, sibling, stepsibling, or a descendant of one of these.

Residence

Has the same principal residence as the taxpayer for more than half the tax year. Exceptions apply in certain cases, for children of divorced or separated parents, kidnapped children, temporary absences, and children who were born or died during the year.

Age

Must be under the age of 19 at the end of the tax year, or under the age of 24 if is a full-time student for at least five months of the year.

Support

Did not provide more than one-half of his/her own support for the year.

The income limits to qualify for and how much you qualify for adjustments based on how many qualified dependents that you can claim. The EITC ranges from $1502 to $6728 depending on tax filing status, income, and the number of children. Below as seen on Nerd Wallet are the maximum earned income tax credit amounts, plus the max you can earn before losing the benefit all together.

 

2020 Earned Income Tax Credit

(for taxes due in April 2021)

Number of children Maximum earned income tax credit Max earnings, single or head of household filers Max earnings, joint filers
0 $538 $15,820 $21,710
1 $3,584 $41,756 $47,646
2 $5,920 $47,440 $53,330
3 or more $6,660 $50,954 $56,844

 

Taxpayers who are married filing separately can not qualify for the earned income credit. The rules are also different for military members and clergy or ministers. If you or your spouse get nontaxable pay as a member of the Armed Forces, you do not have to include it as earned income on your federal taxes. If you and your spouse do choose to include your nontaxable pay as earned income for the EIC, you may owe less tax and get a larger refund. 

A person who includes their nontaxable income as earned income must include all of it. If you are a clergy member or minister you must include the rental value of the home you live in, or the housing allowance if that was provided to you by the church. You must also include all income provided to you working as a minister if you are an employee.

 

Earned Income Tax Credit Fraud

With substantial amounts of money flowing through the EIC program, it has become a fertile ground for tax fraud. The IRS estimates that between 21-26% of EIC claims are fraudulent. Some of the errors are unintentionally caused by the complexity of the law but some of the claims are intentional disregard of the law. The fraud is so rampant that the IRS has added a clause that if found erroneously claiming the credit you are prohibited from claiming the credit for two years. 

There are many ways that people have defrauded this program. One common scam is that people with no earned income will report cash income right at the level to receive the greatest allowance from the program. 

Another common tactic used is if one person has children but does not have income, they will allow someone else who did not help support those children to use their children for the credit. In a lot of these circumstances, the parent of the children and the person filing with the children will split the money. 

And another common practice is when married couples split their qualifying children and both file as head of household to reap the benefits of the EITC. 

With these known practices of fraud, the IRS has tightened up on their review of returns filing for the EITC. The IRS uses both internal information and information from external sources such as other government agencies. The information of the return is matched with information already on file with the IRS and other government agencies. If the review shows questionable or incomplete information, the IRS holds the EIC portion of the taxpayer’s refund ad contacts the taxpayer to verify the information. 

The IRS also uses a screening process based on historical information to select returns for examination. The IRS can conduct these exams both pre and post the refund. Unfortunately, currently, the IRS does not have the resources to examine all questionable EIC returns. 

In this age of computers, a lot of offenders are caught. At this point not only will you have to pay back the refund and credits received but you will also be assessed interest, penalties, late payment penalties, and possibly under-reported fines. If you don’t pay this amount back they can garnish your wages or freeze your bank accounts.

 

How to Claim the Earned Income Tax Credit

To claim the EIC, you must complete your Form 1040 with a complete EIC schedule attached. The EIC schedule requires you to provide your qualifying child’s name, social security number, date of birth, age, relationship, and residency information. This information is especially important to have correct on the forms because this is verifying your rights to the credit. 

There are many tax software programs and apps available that can assist you with this. When trying to take advantage of all the different credits available to a taxpayer it would usually financially benefit somebody to hire a true tax professional such as an Enrolled Agent or CPA.

In conclusion, if you qualify for the EIC then definitely take advantage of it. It has been found to be an effective program in fighting poverty. If you do not qualify, I would highly recommend not trying to defraud the system that helps so many. Not only is it wrong and takes away from the ones who need it but if you are one of the ones that get caught the consequences are costly.

 

Ozzie Gomez is a Senior Tax Settlement Agent and the owner of Innovative Tax Relief which holds business licenses in Tax Resolution, Tax Audit Representation and Tax Preparation.  With almost 10 years of experience in the tax resolution industry, he has personally helped more than 4,000 individuals and businesses resolve their tax issues.

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