Earned Income Credit – How Does It Work?

The earned income credit (EIC) is one of the most beneficial credits for individuals with children or those that are low income. Created in 1975 as an incentive for people to work, this credit potentially translates to huge tax savings.

As with many other credits, you may not claim the earned income credit (EIC), also known as the earned income tax credit, if you file under the married filing separately status. You are also required to have had earned income during the year and must have a valid social security number for yourself, your spouse, and any individuals you are claiming for the purpose of the credit. In order for an individual to be claimed for the credit, they must be a qualified child and meet certain age and relationship requirements.

The amount you may claim for the earned income credit ranges from $0 to $4,400 depending on the number of individuals you are claiming and the amount of your earned income. If you have very low income, you may qualify for the credit without any dependents; however, the amount of the credit is very limited in this case. The earned income range in which the credit is maximized is between $11,000 and $16,400 and is completely phased out between $35,263 and $37,263, depending on your filing status.

Special circumstances may arise that cause the ability to claim the earned income credit to become complicated. For example, in the case of non-custodial parents that have permission to claim a child as a dependent that does not live with them are not eligible to claim the earned income credit for that child because the residency requirements are not met. Therefore, in such cases, the custodial parent may be eligible to claim EIC even though they are not claiming the child as a dependent. Also, in the instance a person receives non-taxable combat pay, the individual may elect whether or not they want to claim the income for the purpose of calculating the credit. This would be beneficial if, by claiming the income, they are placed within the maximum earned income range to claim the credit, or if doing so would simply improve the credit they receive.

Because calculating the earned income credit is somewhat complicated, the Internal Revenue Service will compute the credit for you. However, you can also calculate the credit yourself using the worksheets provided in the instructions of forms 1040, 1040A, and 1040EZ. However, you are required to file a schedule EIC if you have a qualified child and are claiming the credit. The purpose of this document is to provide data on the child(ren) for the IRS to verify the accuracy of your information and be sure the child qualifies for the credit in regards to residency, relationship, and age. As with all other tax documentation, you should retain copies of all worksheets and forms filled out for the purpose of calculating and claiming the earned income credit.