Earned Income Credit - How Is It Calculated?

The Earned Income Credit - How Is It Calculated?

The article The Earned Income Credit – Who Qualifies for the Credit? discussed the purpose of the EIC and presented the qualifications and tests that must be met by any individual taxpayer who wish to claim the credit. As mentioned in that article, on August 10, 2010, President Obama signed legislation that terminated the Advance EIC program. However, individuals may still claim the credit on their Form 1040 each year.

IRS Publication 596, Earned Income Credit, provides instructions on how to claim the credit, including tables to determine how much the credit will be. Since the EIC tables in Publication 596 are always for the prior tax year, this article will discuss how the credit is actually calculated so taxpayers can calculate the credit on their own.

How Is the Earned Income Credit Calculated?

The EIC is calculated based on a three-stage structure as follows:

Phase-In – The credit is calculated as a percentage of the taxpayer’s earned income up to a certain limit. At that limit the taxpayer receives the maximum credit.
Plateau – The amount of the credit is fixed at the maximum credit between the maximum Phase-In earned income limit up to the beginning earned income amount for the Phase-Out stage.
Phase-Out – The credit is reduced by a certain percentage of any portion of the earned income that is over the second stage limit until the credit is completely phased out.

The beginning income for the Phase-Out stage is increased for married taxpayers who file jointly. In 2014 the beginning earned income limit for these taxpayers was increased by $5,430, and in 2015 it will be increased by $5,520 for married taxpayers with children and $5,510 for married taxpayers without children. (Earned income limits and phase-out amounts are published in a Revenue Procedure each year by the IRS in October for the following tax year. The amounts for 2014 were published on page 10 of Rev. Proc. 13-35, and the amounts for 2015 were published on pages 9 and 10 of Rev. Proc. 14-61.)

The amount of the credit depends on the number of qualifying children claimed by the taxpayer, with a maximum of three children claimed. The credit for the Phase-In stage is a percentage of the taxpayer’s earned income up to a certain limit. The credit rate for each category is as follows:

No children – 7.65%
1 child – 34%
2 children – 40%
3 children – 45%

The earned income limits for the Phase-In stage in 2015 are as follows:

No children – $6,580
1 child – $9,880
2 children – $13,870
3 children – $13,870

For instance, if an individual taxpayer has two qualifying children and earns $11,000, then the EIC would be $4,400 ($11,000 x 40%). The maximum credit for a taxpayer with one qualifying child would $3,359 ($9,880 x 34%). (Please note that all amounts are rounded to the nearest whole dollar.)

In the Plateau stage the taxpayer receives the maximum credit until the earned income reaches the beginning income amount for the Phase-Out stage. The beginning incomes for the Phase-Out stage in 2015 are as follows:

No children – $8,240
1 child – $18,110
2 children – $18,110
3 children – $18,110

In the Phase-Out stage the credit is reduced by a specific percentage of any portion of the earned income that is in excess of the beginning income amount. The Phase-Out rates are as follows:

No children – 7.65%
1 child – 15.98%
2 children – 21.06%
3 children – 21.06%

An Example of the EIC Calculation

Suppose that a taxpayer is married filing jointly, he and his wife have 4 children who qualify, and his estimated earned income for 2015 will be $48,000. Of course, only 3 children can actually be claimed on Schedule EIC.

Since the taxpayer’s earned income is greater than the limit for the Phase-In stage, the maximum credit would be $6,242. ($13,870 x 45% = $6,241.50). The beginning income for the Phase-Out range is increased by $5,520, so the Phase-Out range would begin at $23,630.

To calculate the Phase-Out amount, calculate how much the taxpayer’s earned income exceeds the beginning income limit. ($48,000 - $23,630 = $24,370) Multiply the excess income by the Phase-Out percentage. ($24,370 x 21.06% = $5,132.33) Subtract the Phase-Out amount from the maximum benefit. ($6,242 - $5,132 = $1,110)

Estimating the Earned Income Credit

Each year the IRS provides an EIC calculator on its website. However, the calculator is always for the prior tax year. The above discussion is provided so that taxpayers may estimate whether or not they may be able to claim the EIC for the current tax year.

As for the actual process of claiming the EIC, instructions are provided in the article entitled The Earned Income Credit – How to Claim It on Form 1040.