Author: Leon Clinton

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 American Rescue Plan Act of 2021 (ARPA). Some of the favorable changes are only for the 2021 tax year. Others are permanent. 

EITC Basics

The EITC is targeted at low-income and moderate-income individual taxpayers. Perhaps most important, it’s a refundable credit. 

That means you can collect it even if you don’t owe any federal income tax. In other words, it’s free money. 

If you’re an eligible individual, your tentative EITC (the maximum you can hope for) equals the applicable credit percentage of your earned income for the year. 

The tentative EITC is then reduced by the phaseout amount, if applicable, to arrive at your allowable EITC. 

Eligible Individual Defined

In general, you are an eligible individual if you have at least one qualifying child for the tax year in question. 

Earned Income Defined 

The term earned income generally means

• wages, salaries, tips, and other taxable employee compensation, and 
• any net earnings from self-employment reduced by the deduction for 50 percent of self-employment tax.

Qualifying Child Defined

The term qualifying child means your child; a descendant of your child (such as a grandchild); or your brother, sister, stepbrother, or stepsister (or a descendant of one of those persons). 

To be your qualifying child, the individual must also have the same principal residence as you have for over half of the year in question. The individual must be younger than you and

• under age 19 at the end of the year, or 
• a student who is under age 24 at the end of the year, or 
• permanently and totally disabled at any time during the year. 

Finally, the individual cannot have filed a joint Form 1040 for the year.

EITC Calculations in a Nutshell

Under the rules that apply for your 2020 Form 1040, tentative EITC equals 

• 7.65 percent of the first $7,030 of earned income if you don’t have a qualifying child, 
• 34 percent of the first $10,540 of earned income for one qualifying child, 
• 40 percent of the first $14,800 of earned income for two qualifying children, or 
• 45 percent of the first $14,800 of earned income for three or more qualifying children. 

If the couple’s adjusted gross income exceeds $47,646, their EITC is completely phased out. Use the table in the Form 1040 instructions to find the exact allowable EITC amounts.

For 2021, the inflation-adjusted earned income amounts are $7,100, $10,640, $14,950, and $14,950, respectively.

Finally, if you have certain types of investment income over the applicable annual inflation-adjusted threshold, you’re completely ineligible for the EITC. For 2020, the investment income cap was $3,650.

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.

Calculate 2021 EITC Using Either Your 2019 or 2021 Earned Income (Whichever Offers the Bigger Credit)

To calculate your EITC for 2021, you can use either your 2019 earned income or your 2021 earned income. Use whichever number gives you the bigger 2021 credit.

While your income may be way too high to claim the EITC, you may have loved ones who are eligible. According to a report by the Treasury Inspector General for Tax Administration, about 5 million potentially eligible taxpayers fail to claim the EITC each year, resulting in about $7 billion in unclaimed credits each year. Don’t let a loved one fall into this category. 

There’s no IRS form dedicated to the EITC. You must use the worksheets provided in the Form 1040 instructions to calculate your allowable credit. Pack a lunch—it takes a while!

Sincerely,

P.S. If you would like to discuss the EITC, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• May 3, 2021

For tax year 2021, Congress is giving away billions of dollars in additional tax credits on your Form 1040 individual tax return.

These temporarily expanded tax credits include the child tax credit, the dependent care credit, and the health insurance premium tax credit.

With good planning on your end—which you have more control over than most do because you are in business for yourself—the various credits could easily put an additional $5,000 or more in your pocket for tax year 2021.

Child Tax Credit—Current Law

In tax year 2020, you received a $2,000 tax credit for qualifying children who had not reached age 17 by the end of the tax year. Up to $1,400 of the credit was refundable if you had earned income and had no overall tax liability.

If your modified adjusted gross income (MAGI) exceeded $200,000, or $400,000 on a married-filing-jointly return, then your 2020 credit decreased by $50 for each $1,000 (or fraction thereof) your MAGI was over the threshold.

Child Tax Credit—Tax Year 2021

For tax year 2021 only, the child tax credit amounts are

• $3,000 ($1,000 extra) per qualifying child, for qualifying children ages 6 through 17 at the end of the tax year; or
• $3,600 ($1,600 extra) if the qualifying child is 5 or under at the end of the tax year.

Planning point. The tax code measures your child’s age on December 31. For example, if your child turned 4 in July, your child is 4 on December 31.

Phaseout 1. You’ll reduce the 2021 credit amount that exceeds the $2,000 base credit by $50 for each $1,000 (or fraction) by which your modified adjusted gross income (MAGI) exceeds

• $150,000 for married, filing jointly, or for qualifying widower;
• $112,500 for head of household; or
• $75,000 for all other filing statuses.

Phaseout 2. Once your MAGI exceeds $200,000, or $400,000 on a married-filing-jointly return, then your $2,000 base credit decreases by $50 for each $1,000 (or fraction thereof) that your MAGI is over the thresholds.

In addition, the entire child tax credit is 100 percent refundable as long as either you or your spouse has a principal place of abode in the U.S. for more than one-half of the tax year.

Heads up. Here’s a new wrinkle you need to manage: the IRS will advance you 50 percent of your anticipated child tax credit based on your last filed tax return.

You’ll reconcile the advance payments received with your actual 2021 child tax credit, and if the advance payments exceed your actual credit, you have to pay back the excess with your 2021 tax return.

The IRS will make the advance payments in equal monthly amounts between July and December 2021. You will have access to an IRS online portal where you can opt out of the advance payments or can update your information to avoid having to repay any of the amounts on your 2021 tax return due to a change in circumstances.

Dependent Care Credit—Current Law

In tax year 2020, you could claim a tax credit if you paid someone to care for your under-age-13 dependent or for your spouse or dependent who isn’t able to care for himself or herself.

Your maximum expenses eligible for the credit were 

• $3,000 for one qualifying individual, or 
• $6,000 for more than one qualifying individual.

The credit rate was 35 percent up to an AGI of $15,000. Your credit rate then decreased by 1 percent for each additional $2,000 of AGI (or fraction thereof). Once your AGI was $43,000 or higher, you had a 20 percent credit rate.

Dependent Care Credit—Tax Year 2021

For tax year 2021 only, the maximum creditable expenses are

• $8,000 for one qualifying individual, or 
• $16,000 for more than one qualifying individual.

The credit rate is 50 percent up to an AGI of $125,000. Your credit rate then decreases by 1 percent for each additional $2,000 of AGI (or fraction thereof). Once your AGI is $185,000 or higher, you have a 20 percent credit rate.

However, there is a new upper limit: once your AGI reaches $400,000, you reduce your credit rate by 1 percent for each additional $2,000 (or fraction thereof) of AGI until the rate is 0.0 percent at an AGI of $440,000.

In addition, the dependent care credit is 100 percent refundable as long as either you or your spouse has a principal place of abode in the U.S. for more than one-half of the tax year.

Employer-Provided Dependent Care Assistance

For tax year 2021 only, the maximum employer-provided dependent care benefit excluded from your income as part of your cafeteria plan goes from $5,000 to $10,500 (or $5,250 for married filing separate).

Premium Tax Credit—Current Law

The Affordable Care Act (Obamacare) created the premium tax credit to help you afford insurance purchased on your state’s health insurance marketplace.

Your premium tax credit is equal to

• total monthly premiums for the tax year for the second-lowest silver health plan available on your state’s health insurance marketplace, less
• a certain percentage of your annual household income, with that percentage determined by your annual household income.

The percentage of your annual household income you must pay ranges from 2.06 to 9.78 percent in tax year 2020.

Once your household income exceeds 400 percent of the federal poverty level (FPL), you are no longer eligible for the premium tax credit. For example, the 400 percent thresholds outside of Alaska and Hawaii for tax year 2020 are

• $67,640 for a household of two,
• $85,320 for a household of three, and
• $103,000 for a household of four.

You can receive advances of the premium tax credit based on information you provide to the health insurance marketplace. On your tax return, you then compare your credit with the advance amounts and pay back any advance payments in excess of the actual credit, subject to limits.

New Law—Good Deal

The American Rescue Plan Act of 2021 (ARPA) retroactively removed the requirement to repay any excess advance premium tax credit payments for tax year 2020.

Premium Tax Credit—Tax Years 2021 and 2022

ARPA made several changes to expand access to the premium tax credit for tax years 2021 and 2022.

For tax year 2021 only, if you receive (or receive approval for) unemployment for any week beginning during tax year 2021, then

• you qualify for the premium tax credit (but if married, you must file a joint return with your spouse), and
• you will not take into account any of your household income in excess of 133 percent of the FPL for a family of the size involved.

The above provision creates larger premium tax credits for most anyone who receives unemployment during tax year 2021.

In addition, for tax years 2021 and 2022 only

• you can claim the premium tax credit even if your household income exceeds 400 percent of the FPL, and
• the amount of your household income you must contribute toward your health insurance to calculate your premium tax credit ranges from 0.0 percent to 8.5 percent based on your household income, which is a significant decrease over tax year 2020. The 0.0 percent rate goes up to 150 percent of the FPL.

As you can see, you have far more opportunities for tax credits in 2021. If you would like to discuss any of the credits, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 30, 2021

The American Rescue Plan Act of 2021 (ARPA) makes major, but temporary, changes to the federal income tax child and dependent care credit (CDCC). 

Except for when it comes to high-income taxpayers, the changes are all favorable.

To understand the changes, let’s first review the basics. Here goes.

CDCC Basics 

If you have one or more qualifying individuals (usually your children) under your wing, you’re eligible for the CDCC. 

The credit covers eligible expenses that you pay to care for one or more qualifying individuals so you can work, or (if you’re married) so both you and your spouse can work. If you’re married, to claim the CDCC, you generally must file a joint Form 1040 for the tax year in question. 

But some married-but-separated taxpayers are exempt from the joint-filing requirement. 

Qualifying individuals are defined as your under-age-13 child, stepchild, foster child, brother or sister, step-sibling, or descendant of any of these individuals. The child must live in your home for over half the year, and must not provide more than half of his or her own support. 

A handicapped spouse or handicapped dependent who lives with you for over half the year can also be a qualifying individual.

Eligible expenses include payments to a day-care center, nanny, or nursery school. Costs for overnight camp don’t qualify. K-12 costs don’t qualify either because those are considered education expenses rather than care expenses. But costs for before-school and after-school programs can qualify. Costs of domestic help can also qualify, as long as at least part of the cost goes toward care of a qualifying individual. 

Key point. Except for tax year 2021, the CDCC is non-refundable. That means you can use it to offset only your federal income tax liability. If you have no liability, you get no credit.

Expense Limitation

Eligible expenses cannot exceed the income that you earn—or that your spouse earns, if you’re married—from work, self-employment, and certain disability and retirement benefits. 

If you’re married, you generally must use the income earned by the lower-earning spouse for this limitation. So, under the general limitation rule, if one spouse has no earned income, you cannot claim the CDCC. 

But if your spouse has no earned income and is a full-time student or disabled, he or she is deemed to have imaginary monthly earnings of either $250 (if you have one qualifying individual) or $500 (if you have two or more qualifying individuals). Under this exception, you can potentially claim the CDCC even though your spouse does not actually work and has no actual earnings. 

Credit Limitations

Except for tax year 2021, your eligible expenses cannot exceed $3,000 for the care of one qualifying individual or $6,000 for the care of two or more qualifying individuals. 

The maximum credit equals 35 percent of eligible expenses if your adjusted gross income (AGI) is $15,000 or less. So, for taxpayers with very modest incomes, the maximum credit is $1,050 ($3,000 x 35 percent) for one qualifying individual or $2,100 ($6,000 x 35 percent) for two or more qualifying individuals. 

Except for tax year 2021, your credit rate is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI in excess of $15,000, until the rate bottoms out at 20 percent. 

Once your AGI exceeds $43,000, you are in the minimum rate (20 percent) income category. The maximum credit for folks in this income category is therefore $600 ($3,000 x 20 percent) for one qualifying individual or $1,200 ($6,000 x 20 percent) for two or more qualifying individuals. 

Taxpayer-Friendly Changes for 2021

For your 2021 tax year only, the ARPA makes the temporary changes summarized below.

Credit Is Potentially Refundable 

For 2021, the CDCC is refundable if your main residence is in the U.S. for more than half the year. For joint-filing married couples, either spouse can meet this requirement. 

Credit Will Be Much Bigger for Many Families 

For 2021, the dollar limits on the amount of eligible expenses for calculating the CDCC are increased to $8,000 if you have one qualifying individual (up from $3,000) or $16,000 if you have two or more qualifying individuals (up from $6,000). 

For 2021, the maximum credit rate is increased to 50 percent (up from 35 percent). But the credit rate is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI in excess of $125,000. So the rate is reduced to 20 percent if your AGI exceeds $183,000. 

For 2021, the maximum CDCC if you have AGI of $125,000 or less is $4,000 for one qualifying individual ($8,000 x 50 percent) or $8,000 for two or more qualifying individuals ($16,000 x 50 percent). Under the “regular” rules for tax years before and after 2021, the maximum credit amounts are only $1,050 and $2,100, respectively.

For 2021 the maximum CDCC if you have AGI of more than $183,000 is $1,600 for one qualifying individual ($8,000 x 20 percent) or $3,200 for two or more qualifying individuals ($16,000 x 20 percent). Under the regular rules for tax years before and after 2021, the maximum credit amounts when the credit rate is reduced to 20 percent are only $600 and $1,200, respectively.

Credit Rate Is Further Reduced or Eliminated for High-Income Taxpayers

For 2021, the credit rate is 20 percent if your AGI is between $183,001 and $400,000. But once your AGI exceeds $400,000, a second credit-rate-reduction rule kicks in. Your rate is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI in excess of $400,000. So, the rate is reduced to 0 percent if your AGI exceeds $438,000.

Flexible Spending Account Deal for 2021 

For tax year 2021, the ARPA also increased the maximum amount you can contribute to an employer-sponsored dependent care flexible spending account (FSA) from $5,000 to $10,500. Your contribution reduces your taxable salary for federal income and payroll tax purposes (and usually for state income tax purposes, too, if your state has an income tax). Then you can take tax-free withdrawals to reimburse yourself for eligible dependent care expenses. 

If you would like to discuss the CDCC, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 28, 2021