How the Earned Income Tax Credit Works

By: Dave Roos  | 

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The Earned Income Tax Credit is a tax credit available to working American families with low incomes. Thomas Barwick/Getty Images

The next time you find yourself bemoaning your tax burden or the size of your refund (or lack thereof), ask yourself one question: Do I qualify for the Earned Income Tax Credit?

The Earned Income Tax Credit (EITC) is a tax credit available to working Americans with low incomes. It is specifically designed to keep individuals and families out of poverty while encouraging people to work. And it works! In 2018, the EITC was credited with lifting 5.6 million Americans above the poverty line including 3 million children [source: CBPP]. In 2020, about 25 million Americans received an EITC for a total of $62 billion [source: IRS]. But not everyone who qualifies for the EITC claims this important credit, potentially leaving thousands of dollars in free money on the table.

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To qualify for the EITC, you have to earn relatively little money for the size of your family. For the 2020 tax year, the maximum you can report in earned income is $56,844 if married and filing jointly or $43,998 if filing individually — and that's only if you have three or more children. The income limit decreases if you have fewer children or no children to support. If you are single with no children, you have to make less than $15,820 to receive the EITC [source: IRS].

The EITC was created by the Tax Reduction Act of 1975. From the beginning, it was designed to benefit low-income families with children by offering a fully refundable tax credit. What does it mean to be fully refundable? Like the Child Tax Credit, the EITC can reduce a taxpayer's tax liability to below zero, resulting in a refund [source: Tax Policy Center]. And if you owe no income tax at all — which is true for many low-earning households — then you get to keep the full amount of the EITC. Unlike other so-called "welfare" programs, the EITC encourages work by requiring some level of earned income. In fact, the amount of the credit increases with income to a certain level, after which it begins to decrease or "phase out." For example, if you're a married couple with three children, you'll receive the maximum tax credit if you earned between $15,000 and $25,000 in 2020. For every dollar you earned over $25,000, your tax credit will decrease [source: IRS].

As with any IRS program, the EITC comes with a long list of complicated rules, restrictions and rate tables. To clear up some of the confusion, we'll start by explaining exactly who qualifies for the EITC and who does not.

Who Qualifies for the Earned Income Tax Credit?

To qualify for the Earned Income Tax Credit (EITC), you need to meet some basic requirements. First of all, you need to have a Social Security number. You don't necessarily have to be a U.S. citizen, but you have to legally reside in the United States for at least half of the tax year. You also cannot be claimed as a dependent child by anyone else [source: IRS].

We'll talk in detail about income limits soon, but there are certain kinds of income that will automatically disqualify you for the EITC. Specifically, if you have foreign earned income that requires you to file form 2555 or 2555EZ, then you can't claim the tax credit. Also, if you report investment income that exceeded $3,650 in the tax year you're claiming the credit — regardless of filing status or number of children — you're ineligible [source: IRS]. Sources of investment income include interest and dividends, capital gains from the sale of stocks and bonds, and rental property.

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If you're claiming the EITC without children, there are additional requirements, namely that you (and your spouse if you're filing jointly) are U.S. citizens (not resident aliens), that your main home is within the United States for more than half the year, and that you're between the ages of 25 and 65 [source: IRS]. There is no such age restriction if you're claiming the EITC with children.

To claim the EITC with children, you need to make sure that your kids are qualifying children in the eyes of the Internal Revenue Service (IRS). The IRS understands that not all families fit the traditional mold, but it asks that qualifying children pass three basic tests: age, relationship and residency.

As for age, a qualifying child must be younger than 19, unless he or she is a full-time student for at least five months of the year, in which case the child must be younger then 24. The child must also be younger than both you and your spouse, if you're filing as a married couple. If the child is permanently disabled, then there is no age restriction [source: IRS].

For the relationship test, a qualifying child is basically any child that lives with you and is related to you. That list not only includes biological children, stepchildren, adopted and foster children, but also grandchildren, younger brothers and sisters, half siblings and step siblings, nieces and nephews, cousins, and any of their children [source: IRS].

To pass the residency test, the qualifying child must live with you in the United States for more than half of the tax year [source: IRS].

Since the Earned Income Tax Credit (EITC) is built into the tax code, you must file a tax return to qualify. Even if you owe no money in income tax, you need to file a tax return to claim the EITC. We'll explain more about claiming the EITC later in the article.

Income is the most important qualifying factor for receiving an EITC. Next we'll look at the different income limits for married filers, single filers and families of various sizes.

Income Limits for the Earned Income Tax Credit

As its name indicates, the Earned Income Tax Credit (EITC) is largely based on the amount of income you earn in a tax year. Earned income, as defined by the IRS, includes all wages, salary and tips from a job, self-employment or your own business. Earned income also includes other taxable forms of income, like Social Security benefits, unemployment benefits, union strike benefits and long-term disability benefits if you are under age 65. Earned income does not include non-taxable income like alimony, child support or unemployment benefits [source: IRS].

The EITC is designed to help low-income working families stay above the poverty line. For that reason, there is a limit to how much money you can make and still qualify for the credit. For the 2020 tax year, the income limit starts at $15,820 for single, head of household or qualifying widow(er) filers with no children and increases for married couple and families with one or more children. The very highest income limit is $56,844 for a married couple with three or more children.

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The amount of your EITC increases as your earned income increases up to a certain level. For every dollar you earn above that peak level, the amount of your EITC decreases until you reach the income limit for your filing status and family size. For that reason, a married couple with three children that earned $40,000 in 2020 would receive 3,542 in EITC, while a similar family that earned $15,000 would receive $6,660 in EITC. The greater the need, the larger the credit.

Finally, let's find out exactly how to claim the EITC on your tax return.

How to Claim the Earned Income Tax Credit

Reading the instructions that accompany the IRS form 1040 is a mind-numbing experience. But before you despair, let's clear up the confusion over claiming the Earned Income Tax Credit on your income tax return.

As we mentioned earlier, you have to file an income tax return to qualify for the EITC, even if you don't make enough money to owe federal income tax. Line 27 of form 1040 is called "Earned Income Credit (EIC)." That's where you're supposed to enter the amount of your credit, but there are no instructions on the 1040 form itself. That information is found in the lengthy 1040 instruction booklet that you can download here from the Internal Revenue Service.

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Jump to page 40 of the 1040 instruction booklet to find information about the EITC. The booklet contains a six-step process for figuring out if you qualify for the credit, how to calculate earned income and how much you can claim in EITC. Step one contains a list of questions designed to weed out people who don't qualify, either because they earn too much money, don't have a Social Security number, have foreign earned income or are married but filing separately.

Step two uses information from your 1040 to figure out how much you earn in investment income. If that number is greater than $3,650, you don't qualify. Step three helps you determine if you have a "qualifying child" under the EITC rules. Step four is for those who are claiming the EITC without a qualifying child. The questions in this step check your income level, age, and U.S. residency status.

Step five is for those claiming the EITC with a qualifying child. This step helps you determine your earned income. If you are self-employed, the instructions tell you to jump to Worksheet B to determine your EITC. If you earned wage, salary and tip income as an employee of someone else, then you have a choice. You can have the IRS figure out your EITC or you can complete Worksheet A and do it yourself. If you want the IRS to do the math for you, simply write "EIC" on the dotted line next to line 27 on form 1040. If you're feeling lucky, proceed to Worksheet A.

Worksheet A helps you decide whether to use the earned income amount you calculated in step five or your adjusted gross income (AGI) entered on line 1 of your 1040. When you settle on a number to use, consult the Earned Income Credit Table (also in the instruction booklet) that corresponds to your income level, filing status and family size. That number is the figure you will enter on line 27 of the 1040. If you are self-employed, you will use Worksheet B to determine your earned income number and EITC amount.

One last thing: If you are claiming qualifying children for your EITC, you need to complete and attach Schedule EIC, a separate tax form from the 1040. Still confused? Perhaps this is why 22 percent of eligible taxpayers failed to claim their EITC in 2017 [source: IRS].

Originally Published: Mar 5, 2012

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Author's Note: How the Earned Income Tax Credit Works

As a faithful user of TurboTax, I've walked through the qualifying questions for the Earned Income Tax Credit a number of times, but never fully understood what it was I was qualifying (or not qualifying) for. As with any tax credit, I was disappointed to find out that I didn't qualify for any free money, year after year. But now that I understand what the EITC is and who it's for, I'm thankful that I never passed the EITC test. The EITC is rightfully reserved as an emergency credit for those who are truly struggling to stay above the poverty line, and I'm glad to learn that it works. The EITC is the most successful of all government anti-poverty programs. I'm glad I haven't needed it, but I'm also glad to know it's there if I ever do.

Related Articles

  • Forman, Jonathan Barry. Tax Policy Center. "Earned income tax credit." http://www.taxpolicycenter.org/taxtopics/encyclopedia/EITC.cfm
  • Internal Revenue Service. "About EITC" http://www.eitc.irs.gov/central/abouteitc/
  • Internal Revenue Service. "About EITC: Basic Qualifications" http://www.eitc.irs.gov/central/abouteitc/basicqualifications/
  • Internal Revenue Service. "Earned Income Tax Credit Q&A" http://www.irs.gov/pub/irs-pdf/p3211esp.pdf
  • Internal Revenue Service. Publication 596. "Earned Income Credit (EIC)." 2011 http://www.irs.gov/pub/irs-pdf/p596.pdf
  • Internal Revenue Service. "The Range of EITC for 2011" http://www.eitc.irs.gov/public/site_files/3056-EITC_2011_Graph_1100x850.jpg
  • Short, Kathleen. U.S. Census Bureau. "The Research Supplemental Poverty Measure 2010." November 2011 http://www.census.gov/prod/2011pubs/p60-241.pdf
  • Tax Policy Center. "Taxation and the family: What is the Earned Income Tax Credit?" http://www.taxpolicycenter.org/briefing-book/key-elements/family/eitc.cfm
  • Tax Policy Center. "Taxes and the poor: How do refundable and nonrefundable credits differ?" http://www.taxpolicycenter.org/briefing-book/key-elements/poor/credits.cfm