A client loses job early in 2020. Can they use their 2019 earned income to figure their 2020 credits?
Question of the week: Can a taxpayer use their prior year earned income to figure their 2020 EIC or ACTC credits? What about gross income and AGI?
Q: Can prior year earned income (PYEI) be substituted for 2020 earned income for the EIC and child tax credit?
Kiesha is a head of household filer with two young children. In 2019 she earned about $30,000. In 2020 she lost her job early in the year due to the pandemic. She earned about $5,000 before the layoff plus $7,500 in unemployment benefits.
Because of her low earned income, her EIC is smaller than last year’s credit and she’s eligible for only a small refundable child tax credit.
Can my client use her 2019 earned income to calculate her 2020 EIC and child tax credit? If so, how does this affect her tax return? For instance, does she have to add the $30,000 to income (which would make her unemployment taxable)?
A: Yes, if 2019 earned income is higher than 2020 earned income taxpayers can make elections to substitute 2019 earned income only to calculate the EIC and/or the additional child tax credit. The elections have no impact on the rest of the tax return.
The Consolidated Appropriations Act 2021 (CAA21) allows taxpayers to substitute 2019 earned income for 2020 earned income to calculate the earned income credit (EIC) and additional child tax credit (ACTC).
Taxpayers may make these PYEI or lookback elections if 2020 earned income is less than 2019 earned income. Earned income is figured in the usual manner, i.e. wages, tips, salaries, self-employment income, etc.
Calculating the taxpayer's figures:
- For EIC, substituting $30,000 for $5,000 earned income results in EIC of $3,668 instead of $2,010.
- For the ACTC, the substitution results in the full refundable credit of $2,800 ($1,400 × 2) instead of $375 [($5,000 - $2,500) × 15%].
- Overall, the elections result in total refundable credits of $6,468 ($3,668 + $2,800) for Kiesha instead of $2,385 ($2,010 + $375), a difference of $4,083.
Under CAA21, the substitution does not affect any other aspect of the taxpayer’s tax return and tax calculations. For instance, it doesn’t increase gross income, AGI, or taxable income or impact other credits or deductions.
Earned income in wages or self-employment
It does not matter if the current year has a different mix of earned income from the prior year. If Kiesha’s 2019 earned income had been self-employment income and 2020 earned income from wages, the substitution does not require her to pay self-employment tax on the 2019 income in 2020.
On the other hand, if her 2019 earned income was from wages and her 2020 earned income from self-employment, she would have to calculate self-employment tax in 2020 even if substituting the 2019 wages for earned income.
Making the PYEI election
The elections are made by substituting 2019 earned income on EIC worksheets and Schedule 8812, Additional Child Tax Credit. Notice that the election applies to the additional child tax credit and not to the nonrefundable CTC.
That is, Kiesha can’t use the $30,000 to obtain the full $4,000 nonrefundable credit and is still limited to the maximum $1,400 per child ACTC.
Effects of the election
Other points about using prior year earned income (PYEI) elections:
- The prior year elections for EIC and ACTC are separate elections under the 2020 form instructions.
- If one election results in a better credit and the other in a lower credit, the taxpayer may elect to make only the lookback election (EIC or ACTC) that is beneficial.
- Although not applicable for your client, if joint filers make an election the 2019 earned income of both spouses must be substituted for their 2020 earned income.
- If a taxpayer is making a lookback election and also electing to use nontaxable combat pay, then 2019 rather than 2020 nontaxable combat pay should be included in the calculation.
It is clearly beneficial for Kiesha to make both elections (EIC and ACTC) to substitute 2019 for 2020 earned income.
For some taxpayers, higher 2019 earned income could result in lower credits or even no credits at all. Taxpayers should make one or both elections if it is to their advantage to do so.