Earned Income Tax Credit (EITC)

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Earned Income Tax Credit (EITC)

What Is the Earned Income Tax Credit (EITC)?

The earned income tax credit (EITC) is a refundable tax credit that assists low-income Americans by decreasing the amount of tax owing on a dollar-for-dollar basis. If a taxpayer’s tax credit exceeds their tax due for the year, they may be entitled for a refund.

Due to the COVID-19 economic crisis and lockdown, many taxpayers’ incomes in 2020 were lower than their incomes in 2019. As a result, legislation implemented in 2020 permits taxpayers to base the EITC claimed on their 2020 tax returns on either their 2019 or 2020 earnings.

The measure relaxes several EITC criteria for 2021 tax returns and makes a larger EITC accessible to more childless people.

Key Takeaways

  • The earned income tax credit (EITC) is a refundable tax credit that is intended to augment low-income employees’ incomes and offset the impact of Social Security levies.
  • The EITC is only accessible to taxpayers with low or moderate wages, regardless of whether they have qualified dependents.
  • A taxpayer must have earned income during the tax year to be eligible for the EITC. However, investment income cannot have exceeded a certain threshold.
  • For the 2021 tax year, the American Rescue Plan Act (ARPA) amended a number of EITC requirements.

Understanding the Earned Income Tax Credit (EITC)

The earned income tax credit (EITC), sometimes known as the earned income credit (EIC), was designed as a “work bonus plan” to supplement low-income employees’ pay and assist offset the impact of Social Security levies. It is still regarded as an anti-poverty tax break.

The EITC is only accessible to taxpayers with low or moderate wages, regardless of whether they have qualified dependents. To be eligible for the credit in 2021, an individual taxpayer (or, if married, the person or their spouse, filing jointly) must be at least 19 years old and must have lived in the United States for more than half of the tax year.

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In general, qualified dependents for 2021 include dependent children under the age of 19, students under the age of 24, and dependents with a handicap. The credit percentage, earnings maximum, and credit amount vary depending on the filing status and number of dependents of the taxpayer. These criteria also affect the income phaseout range, which determines when the credit is reduced to zero. There is no credit permitted over the phaseout range limit.

Because the economic crisis caused many taxpayers’ 2021 incomes to be lower than their 2019 incomes, the EITC claimed on 2021 tax returns might be based on 2019 earnings if those earnings are greater.

To be eligible for the EITC, a taxpayer must have wages but cannot have investment income in excess of a certain amount, which for 2021 is set at $10,000. Age, relationship, and residence criteria apply to qualified dependents as well. On a dollar-for-dollar basis, the credit decreases the amount of tax owing. If a taxpayer’s EITC is larger than the amount of tax payable, the individual may be entitled for a refund.

Individual taxpayers may benefit from the EITC, which is one of the most significant tax benefits available. To be eligible for the EITC in 2021, the taxpayer must be a U.S. citizen or a resident alien for the full year and have a valid Social Security number before the due date of the tax return. The credit amount that may be claimed on a tax return is determined by the taxpayer’s yearly earned income for the tax year, filing status, and the number of qualifying dependents.

Example of the EITC

A refundable tax credit lowers a taxpayer’s obligation dollar for dollar and, if the liability is decreased to zero, resulting in a refund. For example, a person with a tax bill of $2,900 who is eligible for a $529 credit would owe $2,371 ($2,900 – $529 = $2,371). That lower sum is the total amount due to the Internal Revenue Service (IRS) for the year. If a taxpayer has a total tax due of $1,000 and a credit of $1,500, the individual is entitled to a $500 refund.

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Qualifying for the EITC

To be eligible for the EITC, a taxpayer’s earned income and adjusted gross income (AGI) must be less than specific thresholds. The income level, credit amount, and investment income limitations for a single or married taxpayer for the 2021 tax year vary based on the number of qualified dependents in the household, as indicated in the table below:

2021 Earned Income Tax Credit Qualifications
Children or Relatives ClaimedMaximum adjusted gross income (AGI) (Single, Head of Household, Widowed, or Married Filing Separately*)Maximum AGI (Married Filing Jointly)EITC Limit
$21,430$27,380$1,502
1$42,158$48,108$3,618
2$47,915$53,865$5,980
3$51,464$57,414$6,728

*Taxpayers claiming the EITC under married filing separately must fulfill the eligibility standards outlined in the American Rescue Plan Act (ARPA) of 2021.

According to the chart above, a single filer with no dependents earning less than $21,430 in 2021 is entitled for an EITC of up to $1,502 based on AGI. A married taxpayer and spouse filing jointly with two qualified dependent children, on the other hand, may claim up to a maximum EITC of $6,728 if the couple’s total earned income in 2021 is less than $53,865.

Furthermore, the IRS requires that investment income not exceed $10,000 in tax year 2021 in order to qualify for the EITC.

Beginning in 2021, taxpayers who are married filing separately will be eligible for this credit if they fulfill the ARPA’s eligibility standards. The tax legislation includes particular EITC requirements for clergy and military personnel stationed overseas, as well as specific procedures coordinating the credit with the tax laws of Puerto Rico, Guam, and American Samoa.

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Changes in the EITC for 2021 Tax Returns

As previously stated, the ARPA altered a number of EITC regulations for the 2021 tax year, including increasing the amount of—and eligibility conditions for—the EITC for taxpayers who do not have qualifying dependents.

As previously disclosed, income caps for 2021 rose owing to inflation, as did phaseout ranges and credit limits for all qualified taxpayers. For taxpayers with no qualifying dependents, the credit and phaseout rates increased from 7.65% to 15.3%; the maximum earned income amount for the credit and the phaseout amount increased to $9,820 and $11,610, respectively. In addition, in 2021, the bill decreased the age barrier for taxpayers without qualifying dependents to 19 and raised the investment income maximum from $3,650 to $10,000.

New guidelines that are more in line with current family law practice enable the EITC to be claimed on separate returns provided legal agreements and living conditions are followed. Furthermore, like the special economic crisis relief provision for 2020 returns, returns filed for the 2021 tax year are permitted to base the credit on the taxpayer’s income for 2019 or 2021.

What Is the Difference Between a Tax Credit and a Tax Deduction?

A tax credit reduces the amount of tax you owe dollar for dollar. A $1,000 tax credit, for example, implies you owe $1,000 less in taxes. A tax deduction, on the other hand, reduces your taxable income. If your taxable income falls by $1,000 and you fall into the 24% tax bracket, you will save $240 in taxes.

How Much Income Can You Earn in Investments and Still Take the EITC?

The maximum investment income for 2021 taxes has increased from $3,650 to $10,000.

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