A few years ago, I helped a recently divorced mom prepare her first tax return on her own.
She was anxious about dealing with taxes because her ex had always handled them for her and worried that she’d owe the IRS because she didn’t make much money.
Thanks to the Earned Income Tax Credit, not only did she not owe, but this single mom ended up getting a decent-sized refund she could put toward paying her bills.
That’s the power of the Earned Income Tax Credit. Read on to find out how this valuable tax credit works, and whether you can benefit from it too.
Understanding Earned Income Tax Credit
The U.S. federal income tax system is progressive, meaning the more money you make, the higher your tax rate. But Social Security and Medicare taxes aren’t progressive. As a result, low-income people end up paying a much larger percentage of their salary towards payroll taxes than high-income taxpayers do.
To help offset this and encourage people to work, Congress created the Earned Income Tax Credit (EITC) in 1975. Forty-five years later, this tax credit is still available and providing tax relief to low- and moderate-income workers, especially those with dependent children.
The EITC is a refundable credit, meaning it can reduce your tax liability to zero, and you’ll receive any remaining credit in the form of a tax refund.
The maximum credit depends on the number of “qualifying children” you claim on your return. The IRS has a four-part test to identify a qualifying child:
- Relationship. The child must be related to you in some way. They can be your son, daughter, stepchild, eligible foster child, adopted child, grandchild, brother, sister, half-brother, half-sister, stepbrother, stepsister, niece, or nephew.
- Age. The child must be under age 19 or a full-time student under the age of 24 at the end of the year. If you file a joint return, the qualifying child must be younger than either you or your spouse. However, if you have a dependent that is permanently and totally disabled, the age limitation doesn’t apply.
- Residency. The dependent must have lived with you in the U.S. (or with your spouse if you file a joint return) for more than half the year.
- Joint Return. Normally, you can’t claim someone as a qualifying child if they file a joint return with a spouse. However, there’s an exception for when the dependent was not required to file a tax return (because they did not earn enough income) but filed a joint return solely to claim a refund of taxes withheld.
For the 2019 tax year (returns filed in 2020), the maximum EITC credit is:
- $6,557 with three or more qualifying children
- $5,828 with two qualifying children
- $3,526 with one qualifying child
- $529 with no qualifying children
How to Qualify for Earned Income Tax Credit
The EITC can deliver significant tax savings for some taxpayers, but there are a lot of complicated eligibility rules for claiming it. Pay attention to these rules, because if you try to claim the EITC when you’re not eligible, the IRS can bar you from claiming it for up to 10 years.
Rule #1: Earned income below the limit
First, to qualify for the EITC, you need to have what the IRS refers to as “earned income.” Earned income includes wages, salaries, tips, commissions, or income from self-employment or farming. People whose only income comes from Social Security, welfare, pensions, or investment returns aren’t eligible.
And since the EITC is designed to benefit people with low income, it’s only available to taxpayers whose income falls below certain limits, based on filing status and the number of qualifying children listed on the return.
For the 2019 tax year, your earned income and your adjusted gross income (Line 8b of Form 1040), must each be less than:
- $50,162 ($55,952 married filing jointly) with three or more qualifying children
- $46,703 ($52,493 married filing jointly) with two qualifying children
- $41,094 ($46,884 married filing jointly) with one qualifying child
- $15,570 ($21,370 married filing jointly) with no qualifying children
Rule #2: Must have a Social Security number
You, your spouse, and any qualifying children listed on your tax return must have a valid Social Security number (SSN). You can’t claim the EITC using an Individual Taxpayer Identification Number – a number issued by the IRS to foreign nationals and other individuals who aren’t eligible for an SSN but are legally required to file a U.S. federal income tax return.
Rule #3: Not filing married filing separately
You can’t claim the EITC if you are married and file separately from your spouse. Any other filing status can qualify for the credit.
Rule #4: You must be a U.S. citizen or resident alien
You (and your spouse if married) must have been a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien and filing a joint return.
Rule #5: Limited investment income
Your investment income for the tax year must be less than $3,600. Investment income includes interest, dividends, capital gains, rents, and royalties.
Rule #6: Not claiming a foreign earned income exclusion
If you file Form 2555 to claim an exclusion of income earned in a foreign country from your gross income, you cannot claim the EITC.
Rule #7: Can’t be the qualifying child of another taxpayer
You can’t be eligible to be claimed as a dependent or qualifying child of another taxpayer and claim the EITC.
Rule #8: Additional rule for people without a qualifying child
If you don’t have a qualifying child, you (or your spouse, if married) must:
- Be at least 25 years old but younger than 65 by the end of the year, and
- Have resided in the U.S. for more than half the year.
There are some additional rules for members of the military, ministers, members of the clergy, people who receive disability benefits, and taxpayers impacted by disasters. You can learn more about those special EITC rules from the IRS.
If you need more help with the EITC eligibility rules, the IRS offers an EITC Assistant tool. After answering a few questions and providing some basic income information, you can find out if you’re eligible to claim the EITC, determine whether your child or children meet the tests for a qualifying child, and estimate your potential credit.
Similar Tax Credits and Deductions to Consider
Even if you don’t qualify for the Earned Income Credit, you may be able to take advantage of other tax credits and deductions to lower your tax bill. Here are a few to consider.
Child Tax Credit
If you have at least $2,500 of earned income and at least one dependent child, you may qualify for the Child Tax Credit. This credit is worth up to $2,000 for each dependent child under age 17 at the end of the tax year.
The credit phases out for taxpayers with higher incomes, but the income limits are much higher than those for the EITC. Single taxpayers with adjusted gross income (AGI) over $200,000 or married couples filing a joint return with AGI over $400,000 will see their credit reduced by 5% of their AGI. The credit phases out entirely if your AGI is over $240,000 (for single filers) or $440,000 (for married couples).
If your available Child Tax Credit exceeds your taxes owed, you can receive up to $1,400 of the balance as a refund. This refundable portion is also known as the Additional Child Tax Credit (ACTC).
Credit for Other Dependents
If you have a dependent that doesn’t meet the requirements to claim the Child Tax Credit, you may still be able to claim the Credit for Other Dependents. For instance, you can claim this credit for:
- A child who does not have an SSN but does have a Taxpayer Identification Number
- A child who is age 17-18 or age 19-24 and in school
- Other older dependents, such as an elderly parent
The maximum Credit for Other Dependents is $500, and it has the same phase-out threshold as the Child Tax Credit.
Child and Dependent Care Credit
If you paid a care provider to care for a child or other dependent while you worked or actively looked for work, you might qualify for the Child and Dependent Care Credit.
The credit is worth a percentage of your allowable care expenses. You can use up to $3,000 of expenses for one dependent or $6,000 of the costs of care of two or more dependents. The percentage ranges from 20% to 35% of your expenses, depending on your income. The higher your income, the lower your percentage. However, there is no upper limit on income for claiming the credit.
To qualify, you must have paid someone to care for:
- A child under age 13 at the end of the tax year whom you claim as a dependent on your return
- Your spouse, if they are unable to take care of themselves and lived with you for at least half the year
- Another person claimed as a dependent on your return, if that person can’t take care of themselves and lived with you for at least half the year
These are just a few tax deductions and credits available to individuals and families in 2019. If you might qualify for one or more of these tax breaks, take time to research the rules or talk to a tax professional. Claiming them can significantly lower your tax bill or even result in a generous refund.