What is the Earned Income Credit (EIC)?

The EIC is a tax credit provided to help offset the basic living expenses (including FICA taxes) of low income employees.

Who is eligible for the EIC?

To qualify for the EIC an employee:

  1. With no qualifying child: (a) must have expected 1995 earned income and adjusted gross income of less than $9,000, (b) must have lived in the US for at least 6 months, (c) must be over age 25 but below age 65, (d) cannot be claimed as a dependent by anyone, (e) cannot be the qualifying dependent child of another person, (f) must have worked and earned income even if such income is not taxable, (g) must have a filing status other than married filing separately, (h) must not be able to exclude any income that is earned in foreign countries, and (i) must file a return that covers a 12 month period; or
  2. With one qualifying child: (a) must have expected 1995 earned income and adjusted gross income of less than $24,396, (b) must have the child living with him in the US for more than 6 months out of the year (12 months for foster children), (c) must claim the child as a dependent, (d) whose qualifying child cannot be the qualifying child of another person whose adjusted gross income is more than his, and (e) requirements (e) through (i) under number 1 above.
  3. With more than one qualifying child: (a) must have expected 1995 earned income and adjusted gross income of less than $26,673, and (b) requirements (b) through (h) under number 2 above.

Who is a qualifying child?

A qualifying child: (a) is the employee’s child, adopted child, stepchild, foster child, or a descendant of his child or adopted child, (b) is under age 19 or is a full time student under age 24 or is permanently and totally disabled, and (c) lived with the employee in the US for more than 6 months out of the year (12 months for foster children) or was born, or died, during the year and the employee’s home in the US was the child’s home for its entire life.

How does an eligible employee claim the EIC?

The EIC may be claimed as a direct offset to an employee’s income tax liability on his Form 1040. The EIC may lead to a refund even if no income tax was withheld or owed.

An employee with at least one qualifying child may also be eligible for advance payments of the EIC.

Do I, as an employer, have any responsibilities related to the EIC?

You must notify employees whose wages are not subject to federal income tax withholding (unless they are exempt because they did not incur any liability for the previous year and expect to incur no liability for the current year) that they may be eligible for a refund as a result of the EIC. You might also want to notify employees making less than $26,673 that they might be eligible.

Notification may be made by providing to the employee: (a) Form W-2, Wage and Tax Statement, (b) Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit (EIC), or (c) a written statement equivalent to Notice 797. The posting of Notice 797 on an employee bulletin board is not considered sufficient notification.

How do I make advance payments of the EIC to an employee?

Obtain Form W-5, Earned Income Credit Advance Payment Certificate, from the employee. To elect the credit, the employee must give you a signed Form W-5 indicating that he expects to be eligible for the credit, whether he is married, and whether his spouse has a Form W-5 in effect with an employer. Form W-5 must be renewed annually by January 1. You must discontinue advance payments if a new Form W-5 is not submitted for the year. Employees not currently receiving advance payments may file Form W-5 at any time during the year.

Determine the employee’s wages. Wages are generally payments subject to FIT withholding or FICA taxes (including tips). Employees not subject to FIT or FICA withholding are not entitled to advance payments.

Determine the amount of the advance payment. Once you know an employee’s wages, the relevant pay period, and whether a married employee’s spouse has a Form W-5 in effect, you may use tables provided by the IRS for determining the amount of the advance payment. Tables are also printed in Circular E.

Add the advance payment to the employee’s pay check. The amount of the advance payment is added to the employee’s net pay; the advance payment is not compensation for services and does not change the amount of income or FICA taxes that are withheld for the employee.

What do advance payments cost me?

Advance payments are deducted from your deposit of FIT and FICA withholdings and taxes and so involve no out of pocket cost to you.

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