Welcome to WCS Money Tutorials.
Today’s topic is How to Increase Your Earned Income Tax Credit.
The earned income tax credit, enacted in 1975, is a refundable tax credit to lighten the burden
of regressive payroll taxes, which consists of the Social Security tax and the Medicare tax,
on the poor. The credit is especially generous for people with children,
and since it is refundable, the excess credit over your tax liability will be refunded to you.
The purpose of this video is to show you how you may be able to greatly increase
this credit while also saving on marginal tax and potentially increasing other credits.
As you can see in this chart, the maximum credit is $6,728 for people with 3 or more children,
but even people without children can still get more than $1,500!
There are a number of changes to this credit that applies only to the 2021 tax year.
The lower age limit has been reduced to 19 while the maximum age of 65 was eliminated.
You may also substitute your 2019 earnings if that would result in a higher credit.
In 2022, these provisions will revert to previous law.
The investment income limit has been increased to $10,000 in 2021,
which will be adjusted annually thereafter for inflation, rising to $10,300 in 2022. The
increased investment income limit is permanent. I will present a general overview of this credit,
but you can find much more detailed information in the instructions for Form 1040. It is a little
lengthy, but fairly easy to follow. To understand the earned income credit,
you must understand the distinction between earned income and adjusted gross income. The tax
code defines earned income as the income earned from work. Adjusted gross income includes not
only income earned from work, but also all other income, including investment income,
alimony, and other forms of income. To claim the earned income credit based on
your children, they must qualify for the credit. This screen contains most of the details, but the
basic requirement is that they must be closely related to you, younger than age 19 by the end
of the tax year, or age 24 if they are a student, or any age if they are disabled, and they lived
with you in the United States for more than half of the year.
If more than one taxpayer can potentially claim
the child, then certain tie-breaking rules apply, with priority given to the parent for
whom the child resided for the longest period during the tax year, or who has the highest
AGI. Parents have priority over non-parents. If you have qualifying children, then you must
file Schedule EIC and fill in the appropriate information for up to 3 children. You only need to
list up to 3 children for the maximum credit. The children must have valid Social Security numbers when you file your tax return.
This is the EIC worksheet for employees in the Form 1040 instructions.
Note that Part 2 limits the credit to only earned income, not AGI,
below the income where the phaseout range begins. Worksheet B for the self-employed is a little
more complicated, but you can increase your earned income credit using the same method as
for employees, which I will show later. For the self-employed, the earned income
equals the net business income minus 50% of the self-employment tax. Other
sections of this worksheet pertain to clergy or statutory employees.
The earned income credit can be found in the EIC table in the instructions for Form 1040.
You can find the appropriate credit by selecting the row for your income,
then selecting the column based on your filing status and number of qualifying children.
Although most people will use software that calculates this automatically,
this is a good way to quickly see how much you will qualify for, before you file your return.
In the unlikely event that you do file a paper return,
you can let the IRS figure your credit simply by writing “EIC” on line 27(a) on Form 1040.
This chart shows the 2021 earned income tax credit for people with no children,
1 child, 2 children, or 3 or more children. Obviously, the credit is much more generous
to people with children. The EIC increases as earned income increases, then reaches a plateau
where the credit remains the same for a limited range of income, then the phaseout range begins
when the credit declines with increasing AGI. If your income is less than the limits displayed
on the screen, then your earned income credit will depend only on your earned income, not AGI.
So, if your income is below these limits, or if your adjusted gross income consists only of earned
income, then the technique that I am going to show you on how to increase your earned income credit
will not work. It will only work if your AGI is above these limits and above your earned income.
This chart shows how the 2 zones are divided. The income range for which the credit depends only on
earned income, not AGI, is on the left side. If your AGI exceeds the start of the phaseout
range, indicated by the rightward pointing arrows, then the credit will depend on either earned
income or AGI, whichever yields the lowest credit. Hence, a higher AGI will decrease the credit,
but it will never increase the credit. This table shows the maximum credit
and the income limits for a complete phaseout of the credit. The figures in red are for
married couples filing jointly. Note that investment income cannot exceed $10,000.
Most of your earned income will show up on Line 1 on Form 1040.
All other forms of income will increase your AGI, which will decrease your earned income
credit if your income is above the start of the phaseout range mentioned earlier.
Note that Line 10 has adjustments to income, which is subtracted from your total income on Line 9,
yielding your adjusted gross income, or AGI, which is listed on Line 11.
The key to increasing your credit is by increasing your adjustments to income, so that your AGI will
be lower, but not below your earned income. Other common forms of additional income
include alimony, business income, passive income, and cancellation of debt income.
By increasing your adjustments to income, you can lower your AGI, which will increase your
earned income credit if your income is not far above the start of the phaseout zone.
The most common adjustments to income include contributions to deductible IRA accounts,
contributions to health savings accounts, and the student loan interest deduction.
If you are self-employed, the deductible part of self-employment tax, deductible contributions
to self-employment retirement plans, and the health insurance deduction also lower your AGI.
Keep in mind that contributions to health or retirement accounts cannot be withdrawn
without penalty unless an exception applies or you qualify for distributions, so be sure
that you will not need the money until then! Here is a simple example to show how much you can
save. Let’s say that you are a head of household with earned income of $40,000, investment income
of $10,000, yielding an AGI of $50,000. This yields an earned income credit of $314.
If you contribute $6,000 to your traditional IRA and $4,000 to your Health Savings Account,
then your AGI is reduced to $40,000. This yields an earned income credit of $2,420.
That is an increase of $2,106 just for the earned income credit, but you also save $1,200 of marginal
tax, and you even earn a $200 saver's credit. This yields a total savings of $3,506, which
is an instant, risk-free return of 35% on your $10,000 investment.
Thank you very much for your time. If you liked my video, please give me a THUMBS UP and SUBSCRIBE!
I would appreciate any suggestions, so please leave them in the comments below.
Check out my website at https://thismatter.com for more than 850 in-depth fundamental tutorials
on personal finance, investments, and economics. Check out my books on money at
https://williamspaulding.com. Thank you.