The earned income tax credit (EITC) has been around for years. But for some folks, it’s never been worth as much as it will be for 2021. That’s thanks to liberalizations included in the new American Rescue Plan Act (ARPA). Some of the favorable changes are only for the 2021 tax year. Others are permanent. Here’s what you need to know, starting with some necessary background information.
The basics of the Earned Income Tax Credit
The EITC is targeted at low-income and moderate-income individual taxpayers. Although it’s regarded as an effective tool for lifting families out of poverty, many taxpayers have no idea it exists. Importantly, it’s a refundable credit. That means you can collect it even if you don’t owe any federal income tax. It’s free money.
If you are an eligible individual, your tentative EITC equals the applicable credit percentage times your earned income for the year. The tentative EITC is potentially reduced by the phase-out amount to arrive at the allowable EITC.
For instance, under the rules that apply for your 2020 Form 1040, your tentative EITC equals 7.65% of the first $7,030 of earned income if you have no qualifying children, 34% of the first $10,540 of earned income for one qualifying child, 40% of the first $14,800 of earned income for two qualifying children, and 45% of the first $14,800 of earned income for three or more qualifying children.
The phase-out rule only applies if your adjusted gross income (AGI), or earned income (if greater than AGI), exceeds the applicable phase-out threshold. For 2020, the maximum tentative credit, the phase-out percentages, and phase-out ranges are as follows.
Beginning/Ending of Phase-Out Range
|MAXIMUM TENTATIVE CREDIT||PHASE-OUT PERCENTAGE||OTHER THAN JOINT||JOINT FILERS|
|no children||$538||7.65%||$8,790 / $15,820||$14,680 / $21,710|
|one child||$3,584||15.98%||$19,330/ $41,756||$25,220/ $47,646|
|two children||$5,920||21.06%||$19,330/ $47,440||$25,220/ $53,330|
|three or more children||$6,660||21.06%||$19,330/ $50,954||$25,220 /$56,844|
For instance, a married joint-filing couple with one qualifying child and AGI of $27,000 has a tentative 2020 EITC of $3,584. The phase-out rule reduces the allowable credit by $284: 15.98% x ($27,000 − $25,220) = $284. So, the allowable credit is $3,300 ($3,584 – $284). To find exact allowable EITC amounts, use the table in the Form 1040 instructions.
For 2021, the inflation-adjusted earned income amounts are $7,100, $10,640, $14,950, and $14,950 respectively. For 2021, all the other numbers in the preceding table are also adjusted slightly upward for inflation. For instance, the maximum credit for 2021 is $6,728 if you have three or more qualifying children and are unaffected by the phase-out rule.
Under the “regular” EITC rules before the ARPA changes, someone without any qualifying children must be at least age 25 but no older than age 64 as of the end of the year to claim the EITC. If you’re 24 or younger or 65 or older, you’re out of luck.
Finally, if you have certain types of investment income over the applicable annual inflation-adjusted threshold, you’re ineligible for the EITC. Before the ARPA, the 2021 threshold was scheduled to be $3,650.
Temporary changes to the EITC for 2021 only
For 2021 only, the ARPA makes the following taxpayer-friendly changes to the EITC rules.
More generous rules for taxpayers with no children
For 2021, the age restriction for taxpayers with no qualified children is significantly liberalized. For 2021, you generally must be at least age 19 as of 12/31/21 (versus age 25 under the “regular” rules), and there’s no upper age limit (versus an upper age limit of 64 under the “regular” rules).
If you are a specified student, the minimum age is 24 for 2021.
If you are a qualified former foster youth or a qualified homeless youth, the minimum age is 18 for 2021.
Under the “regular” rules, the maximum tentative EITC for 2021 for a taxpayer with no qualifying children was scheduled to be only $543. Thanks to the ARPA, the maximum 2021 EITC is upped to $1,502. That increase is because the credit percentage is doubled to 15.3%, the earned income base is increased, and the AGI phase-out threshold is increased.
You can calculate the EITC using either your 2019 or 2021 earned income
For 2021, you can calculate your EITC for 2021 using either your 2019 earned income or your 2021 earned income. Use whichever number gives you the bigger credit. If you choose to use the 2019 number, it has no effect on any of your other 2021 federal income tax calculations. For example, if some or all of your earned income is from self-employment, choosing to use your 2019 earned income to calculate your 2021 EITC won’t increase your 2021 self-employment tax bill. So, this is a no-lose deal.
Bigger EITC maximums
For 2021, the maximum EITC can range from $1,502 for someone with no qualifying children who is unaffected by the AGI phase-out rule to $6,728 for someone with three or more qualifying children who is unaffected by the AGI phase-out rule.
Permanent changes for 2021 and beyond
For 2021 and beyond, the ARPA makes the following permanent taxpayer-friendly changes to the EITC rules.
You can have more investment income and still be eligible
Under the pre-ARPA EITC rules, you would have been ineligible for the EITC in 2021 if you had more than $3,650 of disqualified income (basically, certain types of investment income). Thanks to the ARPA, you can have up to $10,000 of disqualified income without losing out on the EITC for 2021. For 2022 and later years, the $10,000 limit will be adjusted for inflation.
Liberalized rule for married-but-separated individuals
In general, married individuals must file joint federal income tax returns to be eligible for the EITC. However, if you are separated from your spouse, filing a joint Form 1040 may be inadvisable. That’s because filing jointly generally makes you jointly and severally liable for your spouse’s federal income tax misdeeds. Then the IRS can come after you to collect, even after you’ve divorced. Not good.
For that reason, pre-ARPA law granted an exception that allowed eligible separated spouses to file separate returns using married-filing-separate status, or head-of-household status when allowed, and still claim the EITC.
Filing a separate return insulates you from your spouse’s federal income tax foibles. To be eligible for this prior-law relief, a separated spouse had to meet certain requirements — including living with a qualifying child and not living with the spouse during the last six months of the year.
For 2021 and beyond, the ARPA makes a permanent change that will allow more married-but-separated individuals to claim the EITC without having to file a joint Form 1040.
Under the new general rule, you can claim the EITC on a married-filing-separate return or on a head-of-household return (if you qualify as a head of household), as long as a qualifying child lives with you for more than six months during the year and you either: (1) do not have the same principal residence as your spouse for the last six months of the year or (2) are under a separation instrument (a court decree or agreement other than an actual divorce decree) and do not live in the same household with your spouse as of the end of the year.
You can claim the EITC even if you don’t meet child ID requirements
Under the pre-ARPA EITC rules, you cannot claim the EITC based on a qualifying child unless you include the child’s name, age, and taxpayer identification number (which generally means a Social Security number). Under those old-law rules, failure to provide child identification information also made you ineligible to claim the credit under the rules for someone with no qualifying children. In other words, you were completely out of luck. For 2021 and beyond, the ARPA permanently removes that rule. So, if you fail to provide child ID information, you can claim the EITC under the rules for someone with no qualifying children. Fair enough.
The bottom line
There you have it: the gist of important temporary and permanent EITC changes under the ARPA. The changes are favorable, but they don’t make the EITC any simpler. So, when you get around to preparing your 2021 Form 1040 sometime next year, have your favorite headache remedy at the ready.