Earned Income Tax Credit (EITC) Explained: How It Works, Types, and Examples
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Summary:
The earned income tax credit (EITC) is a valuable financial resource that assists low and moderate-income workers in the United States. This refundable tax credit operates on a dollar-for-dollar basis, meaning it reduces the amount of tax owed. If the tax credit exceeds the tax liability for the year, taxpayers may be eligible for refunds. In 2020, recognizing the impact of the COVID-19 pandemic on incomes, legislation allowed taxpayers to base their EITC claims on either their 2019 or 2020 earnings.
What is the earned income tax credit (EITC)?
The earned income tax credit (EITC) is a refundable tax credit that helps certain U.S. taxpayers with low earnings by reducing the amount of tax owed on a dollar-for-dollar basis. Taxpayers may be eligible for refunds if their tax credit exceeds their tax liability for the year.
Legislation enacted in 2020 recognized that many taxpayers’ incomes that year were lower than their incomes in 2019 due to the COVID-19 economic crisis and lockdown; this law allows taxpayers to base the EITC claimed on their 2020 tax returns on either their 2019 or 2020 earnings.
Understanding the earned income tax credit (EITC)
The earned income tax credit (EITC), also called the earned income credit (EIC), was conceived as a “work bonus plan” to supplement the wages of low-income workers and help offset the effect of Social Security taxes. It continues to be viewed as an anti-poverty tax benefit.
The EITC is available only to taxpayers with low or moderate earnings, whether or not they have qualifying dependents. To claim the credit for 2022, an individual taxpayer (or if the taxpayer is married, the individual or their spouse, filing jointly) with no qualifying dependents must be at least 19 years old and must live in the United States for more than half of the tax year.
The credit percentage, earnings cap, and credit amount vary according to a taxpayer’s filing status and number of dependents. Qualifying dependents, which can include dependent children who are under age 19, students under age 24, or dependents with a disability. These factors also determine the income phaseout range over which the credit diminishes to zero. No credit is allowed above the ceiling for the phaseout range.
To be eligible for the EITC, a taxpayer must have earnings but cannot have investment income in excess of a specified level. For 2022, the maximum level of investment income was set at $10,300, increasing to $11,000 in 2023. Age, relationship, and residency requirements also apply with respect to qualifying dependents.
The credit reduces the amount of tax owed on a dollar-for-dollar basis. If the amount of the EITC is greater than the amount of tax owed by a taxpayer, then the taxpayer may be eligible for a refund.
The EITC is one of the most important tax credits available to individual taxpayers. The taxpayer must be a U.S. citizen or a resident alien for the entire year and have a valid Social Security number by the tax return’s due date. The amount of credit that can be claimed on a tax return depends on the taxpayer’s annual earned income for the tax year, filing status, and number of qualified dependents.
Example of the EITC
A refundable tax credit reduces the value of a taxpayer’s liability, dollar for dollar, and results in a refund if the liability is reduced below zero. For example, an individual who has a tax bill of $2,900 and can claim a $529 credit will owe $2,371 ($2,900 – $529 = $2,371).
That lower amount is the total that the taxpayer must pay to the Internal Revenue Service (IRS) for the year. If a taxpayer has a total tax liability of $1,000 and a credit of $1,500, then the taxpayer should be entitled to a refund of $500.
Qualifying for the EITC
To qualify for the EITC, a taxpayer’s earned income and adjusted gross income (AGI) must be below certain income limits. The limits on the income level, credit amount, and investment income for a single or married taxpayer vary, depending on the number of qualifying dependents in the household.
For the 2022 tax year, those limits were as follows. Note that in order to receive the credit, you must have earned less than $10,300 from investments.
2022 earned income tax credit qualifications
- Children or relatives claimed: Maximum adjusted gross income (AGI) (Single, Head of Household, Widowed, or Married Filing Separately*) – $16,480; Maximum AGI (Married Filing Jointly) – $22,610; EITC limit – $560
- 1 Child or relative claimed: Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately*) – $43,492; Maximum AGI (Married Filing Jointly) – $49,622; EITC limit – $3,733
- 2 Children or relatives claimed: Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately*) – $49,399; Maximum AGI (Married Filing Jointly) – $55,529; EITC limit – $6,164
- 3 Children or relatives claimed: Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately*) – $53,057; Maximum AGI (Married Filing Jointly) – $59,187; EITC limit – $6,935
These limits are changed for tax year 2023, as shown below. In addition, the threshold for investment income also increased to $11,000.
2023 earned income tax credit qualifications
- Children or relatives claimed: Maximum adjusted gross income (AGI) (Single, Head of Household, Widowed, or Married Filing Separately*) – $17,640; Maximum AGI (Married Filing Jointly) – $24,210; EITC limit – $600
- 1 Child or relative claimed: Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately*) – $46,560; Maximum AGI (Married Filing Jointly) – $53,120; EITC limit – $3,995
- 2 Children or relatives claimed: Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately*) – $52,918; Maximum AGI (Married Filing Separately) – $59,478; EITC limit – $6,604
- 3 Children or relatives claimed: Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately*) – $56,838; Maximum AGI (Married Filing Jointly) – $63,698; EITC limit – $7,430
Taxpayers who claim the EITC under married filing separately must meet the eligibility requirements under the special rule in the American Rescue Plan Act (ARPA) of 2021.
As shown in the table above, a single filer with no dependents who earned less than $16,480 in 2022 is eligible for an EITC of up to $560, depending on AGI. In contrast, a married taxpayer and spouse filing jointly, having two children who are qualifying dependents, can claim up to a maximum EITC of $6,164 if the total of the couple’s earned income in 2022 was less than $55,529.
Taxpayers who are married filing separately can qualify for this credit provided that they meet the eligibility requirements under the ARPA. The tax law provides special EITC rules for clergy and members of the military stationed abroad, and specific rules coordinating the credit with the tax laws applicable in Puerto Rico, Guam, and American Samoa.
What is the difference between a tax credit and a tax deduction?
It’s essential to understand the distinction between a tax credit and a tax deduction. A tax credit reduces your tax liability dollar for dollar, meaning a $1,000 tax credit reduces your taxes owed by $1,000. In contrast, a tax deduction lowers your taxable income. For instance, if your taxable income decreases by $1,000 and you’re in the 24% tax bracket, you would save $240 in taxes.
How much income can you earn in investments and still take the EITC?
For the 2022 tax year, the maximum investment income limit to qualify for the EITC increased from $10,000 to $10,300. In 2023, this limit rises to $11,000.
How do you qualify for the earned income tax credit?
In order to qualify for the earned income tax credit, a taxpayer must be a U.S. citizen or resident alien for the entire tax year, with a social security card that was issued before they file their tax return. In addition, they must have worked and had an earned income that was lower than the EITC income threshold for the tax year. Investment income must also be below a certain limit, and the taxpayer cannot claim foreign earned income that year. Members of the military, clergy, and dependents with disabilities also have special rules.
Frequently asked questions
What is a refundable tax credit?
A refundable tax credit reduces the taxpayer’s liability dollar for dollar and can lead to a refund if the credit exceeds the tax owed.
Can I claim the EITC if I have no dependents?
Yes, you can claim the EITC even if you have no qualifying dependents, but specific criteria must be met.
How does the EITC impact my tax liability?
The EITC reduces your tax liability on a dollar-for-dollar basis, potentially leading to a refund if the credit exceeds your tax owed.
Is the EITC available to all taxpayers?
The EITC is available to low and moderate-income taxpayers, but eligibility criteria, such as income and dependents, apply.
What is the maximum investment income limit to qualify for the EITC?
For the 2023 tax year, the maximum investment income limit to qualify for the EITC is $11,000.
Key takeaways
- The earned income tax credit (EITC) is a valuable financial resource that assists low and moderate-income workers in the United States.
- The EITC is a refundable tax credit, reducing tax liability dollar for dollar and potentially resulting in a refund.
- Eligibility for the EITC is based on factors such as earned income, filing status, and the number of qualifying dependents.
- The EITC rules can change from year to year, so it’s essential to stay updated on the latest requirements.
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