Personal Finance

This Valuable Tax Break Could Put $6,431 Back in Your Pocket

Notebook with the words tax credit sitting next to cash and a calculator

Over 40% of Americans don't end up paying federal income taxes each year, and while that's partly a function of their low earnings, it's also because many households qualify for lucrative tax credits that knock their IRS liability to $0. If you're a low-income household, there's one credit in particular that could be extremely valuable to you: the Earned Income Tax Credit, or EITC. This year, the EITC has a maximum value of $6,431, and if circumstances align, the IRS could end up writing you a check in that amount.

How tax credits work

Many folks use the terms "tax credit" and "tax deduction" interchangeably, when they're actually very different beasts. A tax deduction works by exempting a portion of your income from taxes, and your savings are based on your effective tax rate. This means that if you qualify for a $1,000 tax deduction with an effective tax rate of 25%, you'll save $250.

Notebook with the words tax credit sitting next to cash and a calculator

IMAGE SOURCE: GETTY IMAGES.

A tax credit , on the other hand, is a dollar-for-dollar reduction of your tax liability. If you qualify for a $1,000 tax credit, you'll save $1,000; your effective tax rate won't come into play in determining that credit's value.

Now most tax credits are nonrefundable, which means the most they can do is lower your tax liability to $0. But there are a few refundable tax credits out there that enable you to get money back from the IRS if that's how the math works out. For example, if your tax liability works out to be $0 and you qualify for a nonrefundable tax credit of $1,000, you won't get that money back. But in the case of a refundable credit , the IRS would owe you $1,000.

So, in case you couldn't tell where this was headed, here's some good news: The EITC is one of those rare refundable tax credits, which means that if you're eligible for it, you could see some money back in your pocket. And that's reason enough to look into it.

How the Earned Income Tax Credit works

The Earned Income Tax Credit is designed to give low-wage households a dose of tax relief. To qualify for the credit, you must have earned income from a job or a business you own and your tax filing status needs to be single, married filing jointly, head of household, or qualifying widow. You also can't have investment income that's more than $3,500.

Here's what the current EITC income limits look like based on the number of qualifying children you have in your household:

Tax Filing Status No Qualifying Children 1 Qualifying Child 2 Qualifying Children 3 or More Qualifying Children
Single, head of household, or widowed $15,270 $40,320 $45,802 $49,194
Married filing jointly $20,950 $46,010 $51,492 $54,884

DATA SOURCE: IRS.

The income threshold for eligibility, as you can see, is pretty limited across the board because, again, this credit is designed for the country's lowest earners. As far as the EITC's value goes, here's how to determine what it might be worth to you:

Number of Qualifying Children Maximum Value of EITC
0 $519
1 $3,461
2 $5,716
3 $6,431

DATA SOURCE: IRS.

Now one thing to keep in mind about all of the above numbers is that they apply to the 2018 tax year. Here's what the EITC's various limits looked like in 2017.

One final thing: Even if you're not required to file a tax return, it pays to see whether you're eligible for the EITC. Amazingly, a good 20% of filers who would otherwise qualify pass up this credit each year, but if you're entitled to the EITC based on your earnings, filing status, and dependents, you could get a nice windfall from it.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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