Article Highlights: Purpose of the Earned Income Tax Credit Qualifications Earned Income Qualified Child Credit Phaseout Computing the Credit Investment Income Limit Combat Pay Election Fraud Safeguards Any discussion of the earned income tax credit (EITC) needs to begin with a discussion of why Congress created it in the first place. It has a twofold purpose: first, as an incentive for people to work and get off public assistance, and second, to provide financial assistance for low-income taxpayers and their families based upon their income from working, which the tax code refers to as “earned income.” When originally created back in 1979, it even allowed taxpayers to obtain the credit in advance through their employer’s payroll payments, based on projecting the credit they would be entitled to on their tax return for the year. This was referred to as advanced EITC. However, because of the many problems associated with the advanced payment credit, it was repealed for years after 2010. The EITC is a refundable credit, meaning if any unused credit remains after offsetting all of a taxpayer’s tax liability, that remainder is refunded to the taxpayer. This refundable feature has made the EITC a giant target for fraud, which is discussed later in this article. In addition to the other requirements discussed below, the EITC is not allowed to married couples filing separately, nor can the taxpayer claiming the credit be a dependent of another taxpayer. In addition, the taxpayer must have been a U.S. citizen or resident alien all year and have a Social Security Number (SSN). Any children used to qualify the taxpayer for the credit are also required to have a SSN. Furthermore, because this credit is meant for lower-income individuals, if a taxpayer is working overseas and is able to exclude foreign earned income, he or she is barred from claiming the EITC. Taxable Earned Income – As previously mentioned, the EITC is based, in part, on the amount of a taxpayer’s (or in the case of a married couple, both a filer’s and a spouse’s) taxable earned income. For example, taxable earned income includes: Wages, salaries, and tips; Union strike benefits; Long-term disability benefits prior to minimum retirement age; and Earnings from self-employment. Taxable earned income does not include any form of earned income that is excluded from income, such as a clergyperson’s housing allowance, excluded military combat pay (but see the election for combat pay later), tax-deferred retirement contributions, or excludable dependent care benefits. Qualified Children – The EITC is also based upon the number of the taxpayer’s qualified children who lived with the taxpayer in the United States for more than half of the year for which the credit is being claimed. Generally, for EITC purposes, a qualified child must be younger than the taxpayer and be under the age of 19 or a full-time student under the age of 24 who had the same principal place of abode as the taxpayer for more than half of the tax year and is not married and filing a joint return (exceptions may apply). For the EITC, “child” is defined as the taxpayer’s: Son, daughter, adopted child, stepchild, eligible foster child, or a descendant of any of them (for example, a grandchild); or Brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them (for example, a niece or nephew). Exceptions to the residency requirement include temporary absences from the home, such as for school, vacations, illness, and military service. Computing the Credit and Phaseout – The amount of the EITC increases as the earned income increases until it reaches the maximum credit amount, and then it phases out as the taxpayer’s modified adjusted gross income (MAGI) increases above the phaseout threshold. The following table illustrates how the credit is determined and the maximum amount of the credit for 2019. Number of Qualifying Children Credit Percentage Earned Income Maximum Credit None 7.65 $6,920 $529 One 34.00 $10,370 $3,526 Two 40.00 $14,570 $5,828 Three or more 45.00 $14,570 $6,55 If a taxpayer has no qualifying children, the taxpayer must be age 25 or older but under the age of 65 before the end of the year. This is to prevent children and retired individuals from claiming the credit. As can be seen from the table above, the credit for a taxpayer who doesn’t have a qualifying child is significantly less than for someone with one or more children. Example #1: Ted and Jane have two qualifying children, and their only income is Ted’s wages (earned income) of $31,738. From the table above, based on two children, we determine their EITC before the phase-out as being the lesser of $12,695 (40% of $31,738) or $5,828 (the maximum for taxpayers with two qualifying children). Thus, in this case, the EITC before phaseout is $5,828. Phaseout – The tax law limits the EITC to lower-income taxpayers by phasing out (reducing) the credit as a taxpayer’s MAGI increases above a threshold, with the credit fully phased out when the MAGI reaches the complete phaseout amount shown in the table below. Number of Qualifying Children Phaseout Percentage Phaseout Threshold Complete Phaseout None 7.65 Joint Filers: $14,450Others: $8,650 $21,370$15,570 One 15.98 Joint Filers: $24,820Others: $19,030 $46,884$41,094 Two 21.06 Joint Filers: $24,820Others: $19,030 $52,493$46,703 Three or more 21.06 JointFilers:$24,820Others: $19,030 $55,952$50,162