Article Highlights:

Largest Antipoverty Program
Taxpayers Not Required to File
Earned Income
Filing Age Threshold
Investment Income
Childless Workers
Maximum Credit and Phase-out Ranges
Qualifying Children
2019 AGI
Separated Spouses
Child Does Not Have an SSN
Refunds Delayed
Active Military
Disabled Individuals

The earned income tax credit (EITC) is regarded as one of the government’s largest antipoverty programs and helps millions of American families every year. You are urged to check to see if you qualify for this very beneficial refundable credit. Significant enhancements have been added (some only for 2021), and even if you have not qualified in the past, you may qualify this year. If you are not normally required to file a tax return because your income is below the filing threshold, you could qualify for this credit. You may also qualify for the child tax and the recovery rebate credits, plus get a refund of any income tax withholding you had during 2021, so don’t assume there is no benefit from filing a tax return. The IRS estimates that one in five individuals eligible for EITC fail to claim it simply because they don’t understand the criteria. Plus, many individuals who never qualified for the EITC previously may be eligible in 2021 because their income will be lower because of the COVID pandemic. Nationwide last year, almost 25 million eligible workers and families received over $60 billion in EITC with an average EITC of $2,411. To qualify for the EITC you must have earned income. Earned income is generally income from working, such as wages and net self-employment income, but also includes tips, union strike benefits, nontaxable military combat pay and nontaxable parsonage allowances for clergy. Wages for this purpose includes wages before reductions due to salary deferrals such as 401(k)s, cafeteria plans, and excludable dependent care benefits. There are several changes to EITC for 2021 that will allow significantly more individuals to qualify for the credit. Generally, the age threshold to claim the EITC is 19, with certain exceptions, and with no upper cap on age. In the past, the EITC was only available to people ages 25 to 64. In addition, individuals may have investment income of $10,000 (up from $3,650 in 2020) and still qualify for EITC. Childless workers and couples can qualify for the EITC if their earned income is below $21,430 ($27,380 for joint filers), and the maximum credit for a taxpayer with no qualifying children is $1,502, up from $538 in 2020. As mentioned previously, the EITC is based on the amount of your earned income and whether there are qualifying children in your household. The credit increases as the taxpayer’s earned income or adjusted gross income (AGI) increases, until it reaches a plateau, where it remains constant at the maximum credit amount until it reaches the AGI phase-out threshold. Once the threshold amount is exceeded, the credit is reduced by a set percentage, and no credit is allowed once the income exceeds the top of the phase-out range. The following table illustrates the maximum credit and phase-out ranges based on filing status and number of children for 2021.

Filing Status
Number of Children
Credit %
Maximum Credit
EI Phase-out Threshold Starts
EI Phase-out Threshold Ends

Joint Filing
None
15.30
$1,502
$17,560
$27,380

Others
None
15.30
$1,502
$11,610
$21,430

Joint Filing
1
34.00
$3,618
$25,470
$48,108

Others
1
34.00
$3,618
$19,520
$42,158

Joint Filing
2
40.00
$5,980
$25,470
$53,865

Others
2
40.00
$5,980
$19,520
$47,915

Joint Filing
3 or more
45.00
$6,728
$25,470
$56,414

Others
3 or more
45.00
$6,728
$19,520
$51,464

Qualifying children – A qualifying child must be under the age of 19 or be a full-time student under age 24 at the end of the tax year. This age test does not apply to a child who is permanently and totally disabled. In addition, they must meet relationship and residency tests. 2019 AGI – There is a special rule for 2021 only: Where a taxpayer’s 2021 earned income is less than their 2019 earned income, the taxpayer can elect to use the 2019 earned income amount to compute the 2021 EITC. This was put into effect for taxpayers whose income has decreased because of COVID but applies to anyone who chooses to use the 2019 AGI. However, one must be cautious when making the choice to ensure the AGI that produces the best result is used. Selecting the 2019 AGI to compute the EITC will have no effect on the 2021 income tax since the 2021 AGI will be used for that computation. Taxpayers should also note that any Economic Impact Payments or Child Tax Credit payments received are not taxable or counted as income for purposes of claiming the EITC. Eligible individuals who did not receive the full amount of their Economic Impact Payment may claim the Recovery Rebate Credit on their 2021 tax return. Separated Spouses – Married but separated spouses can choose to be treated as not married for EITC purposes. To qualify, the spouse claiming the credit cannot file jointly with the other spouse, must have a qualifying child living with them for more than half the year and either:

Not have the same principal residence as the other spouse for at least the last six months out of the year, or
Be legally separated according to their state law under a written separation agreement or a decree of separate maintenance and not live in the same household as their spouse at the end of the tax year for which the EITC is being claimed.

Child Does Not Have an SSN – Single people and couples with children who do not have Social Security numbers cannot claim the EITC available for taxpayers with children. But they can claim the smaller EITC available to childless workers. In the past, these filers didn’t qualify for any credit. Refunds Delayed – Because of substantial fraud related to refundable credits, Congress revised the tax law a few years ago so that the IRS cannot issue refunds before mid-February for tax returns that claim the EITC or the Additional Child Tax Credit (ACTC). The IRS must hold the entire refund, giving the agency more time to detect and prevent errors and fraud. Active Military – Members of the military can elect to include their nontaxable combat pay in their earned income for the earned income credit. If that election is made, the military member must include all nontaxable combat pay received as earned income. If spouses filing a joint return both received nontaxable combat pay, then each one can make a separate election. Disabled Individuals – Disabled individuals frequently overlook the opportunity to claim EITC. Even though they may not be working and earning income, certain disability income is treated as earned income for purposes of the EITC and includes the following amounts:

Disability benefits attributable to the employer’s payment of disability policy premiums. However, nontaxable disability income from policies whose premiums the employee paid, and Social Security benefits, are not ‘earned income’ for purposes of the EITC.
Long-term disability benefits to an individual who is retired on disability are only earned income until the individual reaches the minimum retirement age, which is generally the earliest age at which the individual could receive a pension or annuity if not disabled.

If you qualify for but failed to claim the credit on your return for 2018, 2019 and/or 2020, you can still claim it for those years by filing an amended return or an original return if you have not previously filed. If you have questions about your qualifications for this credit or need help amending or filing a prior year’s return to claim the credit, please give this office a call.

Article Highlights:

Hobby Versus For-Profit Endeavor
Factors Used to Determine For-Profit
Three out of Five Rule
Hobby Deductions
Sales from Collections

If you are engaged in an activity that produces income, the big tax question is whether the activity is a hobby or a business. The tax treatment of your income or loss from this endeavor hinges on the answer. The tax code (Section 183 – the so-called “hobby loss rule”) limits deductions when an activity is not engaged in for profit, resulting in no loss being deductible for a hobby. A hobby is any activity that a person pursues because they enjoy it and with no intention of making a profit. This differs from operating a business with the intention of making a profit. That being said, it isn’t always clear-cut whether the activity is a hobby or undertaken to make a profit. The IRS has guidelines for determining whether an activity is carried on for profit, such as a business or investment activity, or if it is a hobby. This article provides information that is helpful in determining if an activity qualifies as an activity engaged in for-profit and what limitations apply if the activity is considered a not-for-profit hobby. Is your hobby really an activity engaged in for-profit? In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of taxable income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit. The following factors, although not all inclusive, may help you determine the status of your activity- is it for profit or a hobby?

Does the time and effort you put into the activity indicate an intention to make a profit?
Do you depend on the income from the activity?
If there are losses, are they due to circumstances beyond your control or did they occur in the normal start-up phase of the business?
Have you changed methods of operation to improve profitability?
Do you have the knowledge needed to carry on the activity as a successful business?
Have you made a profit in similar activities in the past?
Does the activity make a profit in some years?
Do you expect to make a profit in the future from the appreciation of assets used in the activity?

An activity is presumed to be engaged in for-profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training, or racing horses). An activity produces a loss when related expenses exceed income. If an activity is not for profit, losses from that activity cannot be used to offset other income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations. Hobby deductions – Prior to 2018, deductions for hobby activities, up to the amount of hobby income, could be claimed as miscellaneous itemized deductions on Schedule A, subject to a 2% of AGI (adjusted gross income) reduction. But the law was changed as part of the Tax Cuts and Jobs Act that was passed in 2017. That change, for years 2018 through 2025, prohibits any deduction for the types of miscellaneous deductions that were subject to the 2% of AGI haircut. So, if your activity is a hobby, this means that none of your hobby-related expenses can be deducted. But income you receive from the activity is still taxable and must be reported on your Form 1040, Schedule 1, line 8, for the year in which the income is received. Sales from collections – If you collect stamps, coins, or other items as a hobby for recreation and pleasure, and you sell any of the items, your gain is taxable as a capital gain, reportable on Form 8949 for Schedule D. However, if you sell items from your collection at a loss, you can’t deduct the loss. If you have questions related to your specific business or hobby circumstances, please give this office a call.

Article Highlights:

American Opportunity Tax Credit
Lifetime Learning Credit
Refundable Credit
Which Credit to Take
Post-secondary Education
3-month Rule
Maximizing the Credit
Qualified Expenses
Who Claims the Credit
Qualified Educational Institutions
Gift Tax Issues

If you have a child or children in college, or perhaps you or your spouse is a student, it can be confusing to figure out which of two potential education tax credits (1) you are eligible for and (2) gives you the greater tax benefit. This article looks at some of the twists and turns of these credits. There are two higher-education tax credits: the American Opportunity Tax Credit (AOTC) provides up to $2,500 worth of credit for each student, 40% of which may be refundable. The credit is equal to 100% of the first $2,000 of college tuition and qualified expenses and 25% of the next $2,000. The AOTC only applies to the first 4 years of post-secondary education. The other credit is the Lifetime Learning Credit (LLC), which only provides a maximum $2,000 of credit (20% of up to $10,000 of eligible expenses) per family per year. None of it is refundable, meaning it can only be used to offset your tax liability, and any additional credit amount is lost. Here are some of the issues that arise with these two credits: 1. Many students attend local colleges for the first two years and then transfer to a university for the remainder of their education. Knowing the university tuition will be higher, some parents take the LLC and wait on the AOTC, thinking they can use it in years with higher tuition and get a larger credit. This isn’t a good plan because the AOTC credit is only good for the first four years of post-secondary education. Thus, it is always better to claim the AOTC in the first four years. 2. A special rule allows the tuition for an academic period that begins in the first three months of the next year to be paid in advance and thus increase the amount of tuition qualifying for the credit in the year the tuition is paid. This allows for planning when to make tuition payments to maximize credits, especially in the first partial calendar year.
Example: Jill graduated from high school in June and will start college in September. Her tuition and credit-qualifying expenses for the semester covering the last four months of the year and January of the next year are $1,500. Her mother, Cindy, is aware of the 3-month rule, and in December she prepays Jill’s $1,700 tuition for the semester beginning February 1 of the next year, bringing the qualifying expenses to a total of $3,200. The AOTC is equal to 100% of the first $2,000 of qualifying expenses and 25% of the next $2,000. Thus the AOTC for Jill is $2,300 ($2,000 + 25% of $1,200). Cindy could increase the credit for the year to the full $2,500 maximum by purchasing $800 worth of course materials needed for “meaningful attendance or enrollment” in Jill’s course of study.
3. Qualifying expenses other than tuition are often overlooked. Taxpayers can take advantage of a tax regulation that specifies for the AOTC that qualifying expenses include course materials needed for “meaningful attendance or enrollment” whether purchased from the school or an outside vendor. However, for the Lifetime Learning Credit only course material purchased from the school qualifies. 4. Taxpayers also often overlook another very important fact: Whoever claims the student as a dependent gets to claim the education credit even if someone else paid for the tuition and qualified expenses.
Example: Suppose Jill’s Uncle Lee pays her tuition but Cindy, her mother, claims Jill on her tax return. Cindy is the one who qualifies for and receives the credit.
5. What many also overlook is the fact that the AOTC and LLC are phased out for higher-income taxpayers based on their adjusted gross income (AGI). The phaseout kicks in for AGIs between $160,000 and $180,000 for married taxpayers filing jointly, and between $80,000 and $90,000 for others. As an exception, married taxpayers filing separately aren’t eligible to claim either credit. In past years the phaseout ranges were different for the AOTC and LLC, but in a simplification move, Congress made them the same starting with 2021 returns. So, if the parent claiming the student has an AGI above the phaseout range, regardless of who paid the tuition and qualified expenses, no one will be able to claim the credit. Thus, it is important to consider the income of the individual who is claiming the student as a tax dependent when there is an option of who claims the child, such as in cases of some divorced parents. 6. Because of gift tax issues, a person other than the one qualifying for the credit, such as a grandparent, may hesitate to volunteer to pay a tuition expense. Where payments are made directly to the educational institution, they are excluded from gift tax rules. However, depending on the amounts involved, there may be a gift tax reporting requirement if a monetary gift is given to the student or the individual who is claiming the credit and then the gift money is used to pay tuition. 7. A question that often comes up is whether tuition payments to a trade school or foreign university will count toward the education credit. To qualify for the credit, the tuition must be paid to any accredited public, nonprofit or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education. This would rule out foreign educational institutions because they don’t qualify for the student aid program administered by the Department of Education, but it would generally include most accredited public nonprofit or privately owned, profit-making post-secondary educational institutions in the U.S. As you can see, there are several aspects of the education credits that must be considered. If you need assistance with education planning or have questions about the education tax credits as they apply to your particular circumstances, please call this office.