Since 1975 the Earned Income Tax Credit (EITC) has been a godsend to low income earners who really cannot afford to pay Social Security and Medicare taxes (FICA) from an already limited income. The EITC has proved immensely helpful for millions of families across the US. Unfortunately, it is a tax credit that is often misunderstood.
For example, self-employed people otherwise eligible to claim the credit often fail to do so because they believe they are ineligible. Nothing could be further from the truth. As long as a self-employed individual meets all the same criteria as a standard employee, he or she can claim the EITC.
To qualify for the EITC, a taxpayer must be between the ages of 25 and 65. His or her filing status must also be single or married filing jointly. Finally, the taxpayer must be caring for dependent children or qualifying adult dependents not listed as dependents on anyone else’s tax return.
Definition of Self-Employment
The tricky thing with self-employment and the EITC is not actually the tax credit but defining self-employment. Whether or not a taxpayer is truly self-employed depends on how that person’s business is set up. We can start with sole proprietors, as they are the easiest to understand.
A sole proprietor is a person who does business individually, usually under a DBA arrangement. The business typically doesn’t have its own bank account, though some sole proprietors utilize alternative financial services to keep business finances separate. Finally, business income and expenses are reported on schedule C. All business income is treated as personal income for tax purposes.
You can technically be self-employed if your business is set up as an S Corporation or LLC. However, there are other tax implications to consider. Self-employed individuals working under a corporate arrangement tend to pay themselves through a combination of distributions and regular salaries. Corporate distributions are not subject to self-employment tax.
Claiming the EITC as a Sole Proprietor
Most self-employed people eligible to receive the EITC are sole proprietors. By their very nature, employees of S corporations and LLCs generally make too much to claim the credit anyway. Thus, our focus on sole proprietors.
The maximum credit for the 2019 tax year is $6,557. The average credit paid out for the 2018 tax year was just under $2,500. How much a given taxpayer might be eligible for depends on income and the total number of qualifying dependents claimed.
Claiming the credit is a matter of doing some calculations on your annual tax return. A sole proprietor begins with the previously mentioned schedule C. This is the form used to declare all business revenue and expenses. He or she uses the same calculations that he/she used to determine total income or loss from business dealings.
In essence, the amount of revenue left over after deducting all business expenses counts as the sole proprietor’s income. That number is used to determine EITC eligibility. If you were using computer software to do your taxes, the software would automatically calculate any EITC credit you were due. Preparing your taxes manually would require running the numbers yourself.
Play by the Rules
In closing, it is vitally important for self-employed taxpayers to play by the rules. Fudging the numbers in order to reduce self-employment taxes might also make one eligible for a higher EITC credit, but it could also result in losing access to the credit if the IRS discovers what has been done. In essence, the EITC is not guaranteed. Cross the IRS and you might not be able to claim it for up to 10 years.