Disqualifying Income

What Is Disqualifying Income?

Disqualifying income is a type of income that can prevent an otherwise eligible low- or moderate-income taxpayer from receiving the earned income tax credit (EITC) when filing their annual income taxes. To determine whether a taxpayer's income level qualifies for the EITC, they should consult IRS Publication 596. If a taxpayer’s income qualifies to claim the EITC on a federal income tax return, they may also be eligible to take a similar credit on their state and local returns.

Key Takeaways

  • Disqualifying income is a type of income that can prevent an otherwise eligible low- or moderate-income taxpayer from receiving the earned income credit (EITC) when filing their annual income taxes.
  • Disqualifying income consists of investment income, such as taxable and tax-exempt interest, dividends, pensions and annuities, net income from rents and royalties, net capital gains, and net passive income (not received as a result of self-employment).
  • For the tax year 2021, income derived from investments cannot exceed $10,000.

Understanding Disqualifying Income

Disqualifying income consists of investment income, such as taxable and tax-exempt interest, dividends, pensions and annuities, net income from rents and royalties, net capital gains, and net passive income (not received as a result of self-employment).

The American Rescue Plan, signed by President Biden on March 11, 2021, made changes to the Earned Income Credit for 2021. For 2021 only, the size of the earned-income tax credit will increase for childless households. The maximum credit amount for childless people increases to $1,502, from $543. The age range has also been expanded. People without children will be able to claim the credit beginning at age 19, instead of 25, with the exception of certain full-time students (students between 19 and 24 with at least half a full-time course load are ineligible). The upper age limit, 65, will be eliminated. For single filers, the phaseout percentage is increased to 15.3% and phaseout amounts are increased to $11,610.

Earned income also excludes child support and alimony, retirement income, Social Security benefits, workers’ compensation benefits, nontaxable foster care payments, veterans’ benefits, and unemployment compensation. A child’s tax-exempt interest and dividend income reported on a parent’s return is also considered disqualifying income.

In 2021, as a result of the American Rescue Plan, the investment income limit has been raised from $3,650 or less to $10,000 or less. In addition, this $10,000 figure will be pegged to inflation and adjusted accordingly every year going forward. 

The EITC also cannot be claimed if a taxpayer has filed Form 2555 for Foreign Earned Income, which must be filed to exclude income earned in foreign countries from gross income.

In order to qualify for the EITC, taxpayers must have a valid Social Security number by the tax return due date, be a United States citizen or resident alien for the entire year, and the filing status cannot be married filing separately. Children must meet the relationship, age, residency, and joint return tests, and can’t be claimed by more than one person.

If a taxpayer does not have a qualifying child, they must be at least age 19 but under age 65, cannot be the dependent of another person, and must have lived in the United States for at least half of the year. Income earned for work performed while an inmate in a penal institution is also disqualifying income when calculating the EITC.

Taxpayers are disqualified from receiving the EITC if they receive more than a certain amount of income, which is adjusted annually for inflation. For unmarried taxpayers filing individually in 2021, adjusted gross income was required to be less than $51,464 with three or more qualifying children, $47,915 with two qualifying children, $42,158 with one qualifying child, or $21,430 without qualifying children.

For married taxpayers filing jointly in 2021, the maximum income to claim the credit was $57,414 with three or more qualifying children, $53,865 with two qualifying children, $48,108 with one qualifying child, or $27,380 without qualifying children.

Article Sources
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  1. Internal Revenue Service. "Publication 596: Earned Income Credit (EIC)," Pages 4-8.

  2. Democratic Policy & Communications Committee. "American Rescue Plan Expanding Tax Relief for Working Families."

  3. U.S. Congress. "H.R. 1319."

  4. Internal Revenue Service. ”Publication 596: Earned Income Credit (EIC),” Pages 9-15.

  5. Internal Revenue Service. ”Publication 596: Earned Income Credit (EIC),” Pages 15-17.

  6. Internal Revenue Service. "About EITC."

  7. Internal Revenue Service. ”Earned Income Tax Credit Income Limits and Maximum Credit Amounts.”

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