Tax Talk: Good news and bad news in IRS Publication 596 (Earned Income Credit)

Last week's column promised more detail about the Earned Income Tax Credit (EITC). Below is our fulfillment of the promise.

There is mostly good news and some bad news in IRS Publication 596 (Earned Income Credit). The good news starts on page 2: "The earned income credit (EIC) is a tax credit for certain people who work and have earned income under $57,414. A tax credit usually means more money in your pocket. It reduces the amount of tax you owe. The EIC may also give you a refund."

What we really like about the EIC is that it provides a strong incentive for people to get off the parlor couch and onto a payroll. Put differently, the EIC rewards earned income … up to a point … which includes wages, salaries and net earnings from self-employment. Empirical research shows that most of the refunds generated by the EIC are spent quickly — another positive because that helps the economy. Our experience with the Notre Dame Tax Assistance Program adds anecdotal evidence that complements the research findings. In many situations, taxpayers would react to the news about a refund with comments indicating the money would be used to replace a worn-out appliance, repair a leaky roof or "right a wrong" by paying off a debt owed to a friend, family member or a fierce debt-collection agency.

The EIC is slowly phased in — meaning the more earned income reported the higher the EIC — then plateaus before encountering phase-out rules that reduce the credit to $0. Check out the Earned Income Credit (EIC) Table in Publication 596 available at our favorite website this time of the year — irs.gov.

The EITC can climb to as much as $6,728 in married filing jointly situations where the taxpayers have at least three children. For taxpayers with no qualifying child(ren), the credit tops out at $1,502.

In a very unique twist, taxpayers are allowed to use their 2019 (not 2020 as reported last week) earned income to determine the EIC if the 2019 number provides a higher EIC than the  2021 figure. For example, a single or head of household filer with one qualifying child whose 2021 earned income of $10,000 is lower than the $19,000 tallied in 2019, reports an EIC of $3,618 based on 2019's income. This is $209 higher than the EIC using $10,000. Another illustration — a married filing jointly couple with three (3) qualifying children and the same earned income configuration (i.e., $10,000 in 2021 and $19,000 in 2019) finds the above provision generates an EIC of $6,728 (using the 2019 number) which is $2,217 more than $4,511 — the EIC Table figure for 2021's earned income. Notes: Using the 2019 earned income is only allowable when it exceeds your 2021 earned income; report the information on line 27c of Form 1040.

The letter "R" plays a prominent role as we wrap up our abridged coverage of the EITC. Namely, the credit is Refundable. In other words, the credit can generate a refund in and of itself. The Rigorous age barriers have been addressed since the minimum age has moved down to 19 from 25. Recklessness when reporting the EIC can cause repercussions, especially if the IRS gives a "thumbs down" in the form of a deficiency notice. When this happens, the taxpayer must use Form 8862 to demonstrate that he/she is eligible to take the credit. If the IRS ("after further review") goes with a "thumbs up" (i.e., recertifies eligibility), the EIC can be reported and Form 8862 will become a "rearview mirror memory" unless the IRS again denies the EIC in a deficiency proceeding.

As mentioned, the above is an abridged coverage of the EIC. The IRS provides much more information in Publication 596. The EIC is one of the most generous tax credits and also one of the most complex to compute. If you are eligible for the credit (see pages 2 and 32 of Publication 596, which provide checklists about eligibility) and you find it too difficult to compute the EIC, ask the IRS to "do the math" (see page 22 of Publication 596 for the specifics).

Rick Klee served as the tax director at the University of Notre Dame from 1998 through August 2019. A retired CPA, Klee is a graduate of Notre Dame. You can contact him at rklee@nd.edu.

Ken Milani is a professor of accountancy at Notre Dame where he served as the faculty coordinator of the Notre Dame Tax Assistance Program. Contact him at milani.1@nd.edu. E-mail questions to either.