What Is the Earned Income Tax Credit?

The federal earned income tax credit aims to help low- and lower-middle-income working families raise living standards by reducing their taxes up to $6,728.

By Karen Lynch | American Express Credit Intel Freelance Contributor

6 Min Read | February 1, 2022 in Money

 

At-A-Glance

Earned income tax credits are issued to help low- and lower-middle-income families boost their standard of living.

Federal and state credits depend on your level of earnings, marital status, and number of children.

As of 2021, law changes have permanently expanded the earned income tax credit.

Earned income tax credits aim to reduce poverty – particularly in working families. The federal earned income tax credit, also known as the EITC or earned income credit, helped some 25 million American workers and their families get a tax break or refund in 2020, for example.1 Meanwhile, many states and some cities also provide earned income tax credits.

 

Who Can Qualify for an Earned Income Credit?

You only qualify for the credit if you work to earn an income. That’s the “earned” part of its name. Then, your income level, marital status, and number of “qualifying” children are the three biggest factors in determining whether you get a tax credit and for how much. Although you don’t have to have a child to be entitled to a credit, you are less likely to qualify if you don’t. And if you qualify, you will get a much smaller credit without children.

 

Check out the accompanying table to see how the IRS breaks down potential earned income tax credits for 2021, based on those three major factors.

Earned Income Tax Credit Phases for 2021

Tax Filing Status Maximum Adjusted Gross Income to Get Any Credit Max Credit Amount
Single, Head of Household, Widowed, no children $21,430 $1,502
Single, etc., 1 child $42,158 $3,618
Single, etc., 2 children $47,915 $5,980
Single, etc., 3 children $51,464 $6,728
Married, no children $27,380 $1,502
Married, 1 child $48,108 $3,618
Married, 2 children $53,865 $5,980
Married, 3 children $57,414 $6,728

Source: "Earned Income and Earned Income Tax Credit (EITC) Tables," IRS

 

The next logical question, then, is what’s a qualifying child? The IRS has certain relationship, age, and residency requirements. For instance, the child must be a son, daughter, adopted child, stepchild, foster child, or a descendent of any of these.2 Online tools can help determine whether your child qualifies.3

 

You might also ask, what’s income? For the purposes of an earned income tax credit, it’s money you earn in a given year either working for someone or running your own business. To get more specific, this tax credit relies on your adjusted gross income, or AGI, which is based on your earned income. For more on AGI, read “What Is Adjusted Gross Income?” 

 

If you’re also an investor, your investment income must be $10,000 or less as of 2021 – a notable increase from years past. 

 

How Does the Earned Income Tax Credit Work?

You have to file for the credit to receive it. Obvious, right? Yet the IRS says about 20% of eligible people don’t claim the federal credit. That’s in part because many low-income workers’ earnings are so low that they owe no federal tax,4 and also because workers move in and out of eligibility for the earned income tax credit based on changes in marital, parental, and financial status. But earned income credits are refundable, meaning that you can receive money even if you owe no taxes, as long as you file for them. If the credit you are allowed exceeds the taxes you’ve paid during the year – such as those withheld from your paycheck – the IRS will send you the balance.

 

And tax credits are generally worth more than tax deductions. Tax credits directly reduce the amount of tax you owe, while deductions only lower your taxable income. If you were in a 25% tax bracket, for instance, a $1,000 credit would lower your tax bill by $1,000, whereas a $1,000 tax deduction would only drop it by $250.

 

In calculating federal earned income tax credits, children make a big difference. For example, in the above chart for 2021, the maximum credit amount for a childless individual or couple is $1,502, while a household with one child could receive up to $3,618 and a household with three children could get as much as $6,728.

 

Earned Income Tax Credit Changes for 2021 and Beyond

Law changes in 2021 aim to expand the availability of the earned income tax credit.5 As mentioned above, the amount of investment income someone can receive and still be eligible for the EITC has increased from $3,650 to $10,000. Married but separated spouses who do not file a joint return may also now qualify for the EITC, as long as a few key stipulations are met. Specifically, they must live with their qualifying child for more than half the year and either:

  • Do not live in the same dwelling as the other spouse for at least the last six months of the tax year for which the EITC is being claimed, or
  • Are legally separated according to their state law and do not live in the same household as their spouse at the end of the tax year for which the EITC is being claimed.

In the past, you could not claim the EITC if your filing status was married filing separately.

 

States Offer Earned Income Credits

If you qualify for a federal credit, you might also be entitled to a state earned income tax credit in 31 states, Puerto Rico, Guam, and Washington, DC.6 State requirements often mirror federal requirements, with some exceptions. There are online tools you can use to learn more about your state.

 

Many states calculate their earned income tax credit benefits as a straight percent of the federal credit – from 3% in Montana to 83.33% in South Carolina as of 2021.7 Other states, like California, establish their own income limits and phase out calculations. Some local governments, such as New York City, also offer earned income tax credits.8

 

Qualifying for the federal earned income tax credit might also indicate that you qualify for child tax credits and others. Check out “What Is the Child Tax Credit?” and “What Is the Childcare Tax Credit?” It’s worth your time, since the IRS allows you to combine these credits.  

 

Also helpful: Calculators and free tax preparation help9 are available online and in person, from the IRS and some state governments. Some tax software packages also include the earned income tax credit.

 

Earned Income Credit Policy

In general, all tax credits for individuals represent the government’s attempt to encourage certain behaviors in Americans, to achieve specific goals. The earned income tax credit is designed to reward people who enter and stay in the workforce, with the aim of both improving their family’s standard of living and contributing to the nation’s economic growth. Some congressmembers are looking to expand the population that qualifies. For example, the Build Back Better Act aims to permanently allow childless workers to receive the greater EITC benefits temporarily established by the American Rescue Plan.10 If passed, it could benefit around 17 million low-wage, childless workers.

 

Details of the earned income tax credit change from year to year, but the credit itself has demonstrated staying power. The federal credit has been in place since 1975, and Rhode Island was the first state to enact an earned income tax credit, in 1986.11

 

The Takeaway

Earned income tax credits can range from a few hundred dollars to more than $6,500, and aim to help working families get tax breaks or refunds. Your eligibility depends on your income level, marital status, and number of children. Even if your earnings are so low that you pay little or no income taxes, you might be entitled to this credit – making it akin to a grant. Online tools and free tax preparation advice are available to help you figure it out.

Karen Lynch

Karen Lynch is a journalist who has covered global business, technology, finance, and related public policy issues for more than 30 years.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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