How the $10,200 Unemployment Compensation Tax Exclusion Affects Your Earned Income Credit for 2020

hello i'm eddie adkins welcome to my video how the 10 200 unemployment compensation tax exclusion affects your earned income tax credit for the year 2020. before i jump in i want to point out that this video covers a very specific issue related to the earned income tax credit if you've happened upon this video and what you're really looking for is an overall understanding of the credit then this video is not the one for you instead my quick summary video is the right one for you because it does provide an overall summary of the earned income tax credit i have put a link to that video in the description section for this video so that if you want you can find it quickly so why am i making this video why would you want to watch this video well there's been a recent change in the wall that applies retroactively to 2020 so even though we're now into the year 2021 this change goes back to 2020 and more specifically if you received unemployment compensation in 2020 this change is going to reduce your taxes for the year 2020 and also it may increase your earned income tax credit for 2020 and that last point that it may increase your earned income tax credit for 2020 is what this video is about so what has changed well the american rescue plan of 2021 was enacted into law on march 11 2021 and even though it wasn't enacted into law until march of 2021 it goes back to the year 2020 and it excludes from your taxable income up to ten thousand two hundred dollars of unemployment compensation paid to you in 2020. so if you received unemployment compensation in 2020 then this video is really for you and what does that mean it means that for your 2020 taxes you do not pay tax on unemployment compensation up to ten thousand two hundred dollars amounts above that are still taxable if you are married and both you and your spouse received unemployment compensation in 2020 you each get that thousand two hundred dollar exclusion which means a married couple can exclude potentially up to twenty thousand four hundred dollars of unemployment compensation from income this change does apply only if your income your total income is under 150 000 for the year 2020 but people who make that much money don't qualify for the earned income tax credit anyway so we're not really concerned about that limit in this video let me give you an example of how this change works there's nothing better than example to really see how it works let's say that for the year 2020 both you and your spouse received unemployment compensation and in this example i'm saying that you had twenty thousand dollars of unemployment compensation and your spouse had five thousand dollars of unemployment compensation for a total of twenty five thousand dollars now before the change in the wall that twenty five thousand dollars was fully taxable you had to pay tax on the full twenty five thousand dollars with the changing law you don't pay tax on the first ten thousand two hundred dollars that you get so for you with unemployment compensation of twenty thousand you get to subtract ten thousand two hundred dollars from that leaving you nine thousand eight hundred dollars that is taxable now for your spouse who had five thousand dollars of unemployment compensation you can subtract five thousand you can't subtract more than the amount of unemployment compensation that you received that's why we say it's up to an exclusion of ten thousand two hundred so you subtract five thousand and so the taxable amount of your spouse's unemployment compensation is zero and if you look at the number there at the very bottom all the way over on the right side the taxable amount of unemployment compensation after the changing law is nine thousand eight hundred dollars so it drops in this example from twenty five thousand being taxable to nine thousand eight hundred dollars being taxable so that's quite a drop in the taxable amount and as i said earlier this change in the law is going to reduce your income tax for 2020 and it may also increase your earned income tax credit for 2020 and it's that last point that we're going to really delve into in this video a question that you may be asking at this point if you're not asking it already you'll be asking it is how do you receive the benefit of this change in the wall well first of all if you have not yet filed your tax return for 2020 then you're going to want to file it using the new rules if you've already filed your tax return for 2020 and many people i think at this point have already filed their tax return the irs is currently saying that you should not amend your tax return in other words they don't want you to send in a new tax return for 2020 reflecting the change in the wall they do not want you to do that and i did check what they're saying right before i started recording this video and today's march 29th and that's what they're saying at this point in time now if you have already filed there's actually a possibility that you won't have to do anything at all because there's a possibility that the irs will automatically process refunds for the decrease in your income taxes and any increase in your earned income tax credit we don't know yet whether they're going to do that they are saying at this point unofficially through spokespeople that they are hoping to do that so that you don't have to do anything but once they decide what to do i will prepare another video probably a very brief video to let you know what they have decided to do and what action if any that you need to take to find out when that video is published if you do want to know subscribe to my channel and then you should get an alert from youtube when i publish that video there is a link in the description to this video to the irs website which they the irs updates with the latest information and so if you want you can check that length from time to time to see what the irs is saying as of right now and today is march 29th it simply says don't file an amended return and we the irs will be issuing more information in the future so we'll have to wait and see what they say but hopefully you won't have to do anything and you'll get a refund automatically so now let's really start to get into the earned income tax credit and answer the question how does the change in the wall this change in the tax treatment of unemployment compensation affect your earned income tax credit for 2020 well to start answering that question it's important for you to know that the amount of your earned income tax credit is based on three factors first of all your number of qualifying children for the year next your income tax filing status for the year are you married are you single etcetera and then your income for the year and if you're married filing jointly that means the combined income of you and your spouse so those are the three factors of the three factors in this video i'm focusing on income because that's what the change in the law affects it doesn't affect your number of qualifying children it does not affect your filing status it just affects your income now if you want more information on the other two factors i have put some links to other videos that i put out in the description for this video but again that's only if you want more information the focus of this video is on what's been changed by the change in the wall which is your income amount so we're going to focus on your income for the year in this video here's an important concept the income amount that is used to determine the amount of your earned income tax credit is income that is taxable so the change in the wall that excludes up to ten thousand two hundred dollars of your unemployment compensation from taxable income reduces your income that is used to determine the amount of your earned income tax credit so that's why your earned income tax credit may change as a result of this change in the law now when your taxable income goes down how does that affect your earned income tax credit well the answer to that question unfortunately is not a simple answer and that's because the earned income tax credit is determined based on a very complicated very complicated formula and because the formula is so complex the change in the tax treatment of unemployment compensation won't affect everyone the same way for some people it will not change their earned income tax credit amount for other people it will increase their credit amount perhaps substantially and some people who previously had too much taxable income to get a credit will now get a credit because their income goes down their taxable income goes down as a result of this change in the wall now as far as i can tell thinking of a lot of different scenarios this change in the law will not cause a person's credit to go down so in other words your credit will either stay the same or it will go up it will increase in this video i'm going to show you how to figure out step by step whether your earned income tax credit will increase and if so by how much so how can you determine whether your earned income tax credit changes well to answer that question first i need to give you some background information before we can start getting into more of the details and the first piece of background information to share with you is that to determine the amount of the credit you look it up in an irs table you don't use a formula you don't do any calculations yourself there is an irs table where you look up the amount of the credit i put a link to that table in the description for this video and i'll talk more about that later if you're using software many people do use software these days they don't fill out their tax return by hand then the software that you're using is looking up your credit for you in the irs table now here's what the irs table looks like it's actually very long it's nine pages long this is just a piece of it but you can see the three factors that i mentioned earlier in the table over on the left side you see various income amounts and then at the top you see filing statuses we have one set of columns for single head of household qualifying or widower and we see another set of columns for married filing jointly you will not see married filings separately because if you file married filing separately you can't take the earned income tax credit so there's no column for that then within those filing status columns you see the numbers zero one two three that's your number of qualifying children so do you have no qualifying children one two or three and the three is really three or more because once you have three qualifying children it doesn't matter how many more you have you're in that that column for three now to help you understand and to get us further along the road of helping you figure out what your new earned income tax credit is as a result of this change in the wall you need to know that there are two different income figures that you may have to use when you look up your credit amount in the irs table one of those is earned income the other is called adjusted gross income i'm going to take you through those definitions now because it's very important background information so starting with earned income what is earned income well it's money you have to work for to get so it's things like wages salary tips and self-employment income it's not money for work you did in the past so it's not retirement benefits you're getting from an employer it's not social security benefits it's not money you would take out of a 401k plan or an ira and very importantly for this video it's not unemployment compensation unemployment compensation is not part of earned income so that means the change in law where the amount of your taxable unemployment compensation goes down doesn't have any effect whatsoever on your earned income because unemployment compensation is not part of earned income so your earned income is not going to change as a result of this change in the wall next is adjusted gross income now adjusted gross income you start to calculate your adjusted gross income you start with your earned income and then you make adjustments to earned income that's why it's called adjusted gross income you add the taxable portion of some types of income and you subtract the tax deductible portion of some other items now you see the list here i'm not going to go through the list but i do want to point out what's really important is that adjusted gross income does include the taxable portion of unemployment compensation so you would have your earned income plus the taxable portion of unemployment compensation to get the amount of your adjuster gross income you might have some of the other items that are shown here that affect your adjusted gross income but we're not going to focus on those because we're really focused on unemployment compensation because that's what the change in the wall is so the change in the wall reduces your adjusted gross income because it reduces the amount of your unemployment compensation that's taxable so that's a key part of what we need to understand about the impact on the earned income tax credit that there's this income figure adjusted gross income that's used to determine the amount of the earned income tax credit and that amount has changed as a result of the change in the law now let's think back to the irs table at lower levels of income you use only your earned income to look up your credit in the table in other words you don't use adjusted gross income well if you fall into that category of a lower level of income then this change in the law is is not going to change your earned income tax credit because it doesn't change your earned income so your credit amount will stay the same now at higher levels of income you actually have to look up your credit in the table two ways first you look it up using your earned income next you look it up using your adjusted gross income next you compare the two credit amounts so you've come up with one credit amount based on your earned income you come up with another credit amount based on your adjusted gross income you compare those two numbers and your credit the credit you're going to get is the smaller of the two amounts and since the law changes the amount of your adjusted gross income your credit amount may change and specifically it may increase as i said earlier i don't see any scenario where it will go down it'll either increase or it will stay the same now are you at a lower level of income or a higher level of income so are you one of those people where you just use your earned income to look up the credit and so this change in the law is not going to affect you or are you one of those people would have that where you would have to use your adjusted gross income to look up the credit in the table and therefore your credit may go up well to start to answer this question you need to know the amount of your adjusted gross income before the change in the wall in other words adjust the gross income where you included the full amount of all of your unemployment compensation for 2020 in determining the amount of your adjusted gross income if you've already prepared your income tax return for 2020 you'll actually find the amount of your adjusted gross income on line 11 of your income tax return and here's what that looks like on the income tax return you can see it right there line 11 adjusted gross income if you used tax software and filed electronically then you should still be able to find somewhere in the software the amount of your adjusted gross income so you may want to pause the video right now or keep going but come back later look up the amount of your adjusted gross income assuming you've already filed and included the full amount of your unemployment compensation and i can't give you any general rules on whose tax credit is going to change and who's not but this one thing i can tell you if your adjusted gross income before the change in the law was less than the amount in this table so again if your adjusted gross income before the change in the law was less than the amount in this table then there's not going to be any change in your earned income tax credit because you're at the lower level of income where only your earned income is used to determine your credit amount in the irs table and your earned income has not changed so you'll see in this table the number and and by the way there's just one number in this table that should apply to you and it's based on your number of qualifying children your filing status one column is single head of household qualifying would or widower the other is married filing jointly so look up your number in the table so for example let's say you have two qualifying children and you're married filing jointly your number in the table is twenty five thousand two hundred fifty dollars if your adjusted gross income before the change in the law was less than that number then your credit's not going to change and you can actually just stop listening to this video because your credit's not going to change on the other hand same table but if your adjusted gross income before the change in law was equal to or greater than the amount in the table then you're going to have to follow a few steps to figure out whether your earned income tax credit changes and i'm going to take you through those steps so again look at the number if your adjusted gross income before the change in wall was equal to or greater than the number in the table that applies to you then you're going to have to take some extra steps to figure out whether your credit changes and how much now to figure out how your earned income credit changes first you have to gather your information no different from preparing a tax return right you always have to gather your information here's what you're going to need to know for 2020. you're going to need to know your earned income you're going to need to know your adjusted gross income before the change in the wall and your adjusted gross income after the change in the wall so again you might want to pause the video and get that information together or maybe just continue listening come back later and take the steps that i'm explaining to you in this video you'll also need to know your filing status so single married etc and your number of qualifying children now as i said earlier i'm not covering for example the details on who are qualifying children but if you feel like you need those details i have put links to other videos that i've put out in the description for this video if you need to go review what is a qualifying child here are the steps that we're going to take and i'm going to go through those very carefully with you in this video you need to use one of the worksheets for the earned income tax credit that are found in the instructions for form 1040. form 1040 is the u.s individual income tax return you're going to use worksheet a unless you're self-employed if you're self-employed you're going to use worksheet there is a link link in the description of this video to the forum 1040 instructions and so you don't have to go through the instructions page by page by page i'm letting you know that you're going to find worksheet a on page 45 of the instructions and you're going to find worksheet b on page 46 of the instructions the first thing you do is you complete the worksheet whichever worksheet applies to you using your adjusted gross income before the change in the wall and when you do that the worksheet is going to have you use the irs table to look up your earned income tax credit you're going to find that on page 48 of the 1040 instructions and again there's a link to that in the description for this video that's where the table starts i mentioned earlier it's nine pages long but that's where it starts now this is going to enable you to determine the amount of your earned income tax credit before the change in the law and if you've already completed your 2020 income tax return where you treated your unemployment compensation as fully taxable you can skip this step because you'll be able to find the amount of your earned income tax credit on line 27 of your tax return and here's what that looks like that's the way it looks on the paper return if you filed using tax software you should be able to find out somewhere in the software or a printout or an image on the screen what your earned income tax credit was before this change in the law and i'm assuming that if you've already filed you your return did not reflect this change in the wall because the change was so recent next step is you're going to complete worksheet a or worksheet b depending on whether you're self-employed or not using your adjusted gross income after the change in the law and this is going to give you the amount of your earned income tax credit for the year and what your credit truly is because it it reflects the change in the wall and then you're going to be able to see how the amount of your credit has changed as a result of the change in the wall so those are the steps we're going to take now i'm going to do an example to show you exactly how to do this because i think without an example you might not be able to figure out how to do it so i'm going to show you exactly step by step how to do it and i'm using an example so obviously this example won't apply exactly to you but it'll give you a good feel for how you do how you go through the steps so my example i have a couple married filing jointly they have two qualifying children and here are their income figures for 2020. their total earned income is 30 thousand dollars their total unemployment compensation for 2020 is 25 000 here's their adjusted gross income before the change in the wall their unemployment compensation was a total of twenty five thousand their earned income was a total of thirty thousand so their adjusted gross income is fifty five thousand and remember when you're married filing jointly it's the combined income of those spouses i've broken down the between you and your spouse doesn't really matter you're going to use the grand total amount for both spouses now how about adjusted gross income after the change in the wall well i'm going to use the same example i used earlier when i demonstrated how this new law works so you received unemployment compensation in 2020 you 20 000 your spouse five thousand for a total of twenty five thousand remember how we did the exclusions we ended up with over on the right there nine thousand eight hundred dollars of taxable unemployment compensation earned income doesn't change it's still thirty thousand so we have adjusted gross income after the changing wall of thirty nine thousand eight hundred so now we have all of our information together we're ready to calculate or determine the amount of the earned income tax credit before the change in wall and after the changing law so we're going to go to worksheet a and we're going to start with calculating the credit before the change in the wall this is what worksheet a looks like line 1 says enter your earned income so we're going to enter our earned income which is 30 000 that's the total earned income of both spouses next it says look up your credit uh in the or look up the the uh income amount on line one in the earned income tax credit so this is referring to the irs table so we go to the table and we find on the nine pages of the table we find the thirty thousand dollar income figure and so if you look there what you can see here is that there are fifty dollar income ranges in the table and we find where it says at least thirty thousand but less than thirty thousand fifty dollars we're right at thirty thousand so that's the row we should be looking at in the table then we're married filing jointly we have two qualifying children so we look down the column and the credit amount based on thirty thousand dollars of earned income is four thousand nine hundred and eight dollars so we write in on the worksheet four thousand nine hundred eight dollars next it says on line three enter the amount from 10 form 1040 line 11. well line 11 is your adjusted gross income and remember our adjusted gross income before the change in the wall was 55 000 so we're gonna write in fifty five thousand dollars on line three of the worksheet next it says are the amounts on line three and one the same but let's look at that line one is thirty thousand dollars line three is fifty five thousand dollars they're not the same so we need to put the mark there in no are the amounts on line three and one the same no they're not and so it says go to line five we go to line five and it says if you have no qualifying children is the amount on one three less than eight thousand eight hundred dollars or fourteen thousand seven hundred if you're married filing jointly or if you have one or more qualifying children is the amount on line three less than nineteen thousand three hundred fifty dollars or 25 250 if you're married filing jointly and we have to mark yes or no so the question we're asking because in my example we have a couple married filing jointly with two qualifying children our question really is if you have one or more qualifying children is the amount of line three less than 25 250. well line three was 55 000. and the question was is it less than twenty five thousand two fifty well it's not so we are going to mark no on line five and then it says look up the amount on line three in the earned income tax credit table referring to the irs table well the why the amount of line three remember is fifty five thousand dollars so now we go to the irs table and we find fifty five thousand dollars in the table we're married filing jointly we have two qualifying children we look down the column and it's zero so we're going to enter zero on line five of the worksheet the next thing it tells us is to look at the amounts on lines five and two and enter the smaller amount on line six so let's look at the amounts on lines five and two line two is four thousand nine zero eight line five is zero it tells us to enter the smaller amount on line six so we go to line six and we put in zero and line six says this is your earned income credit so in this example the married couple actually had adjusted gross income that was high enough that they did not get any credit in other words they made too much money to get the earned income tax credit so before the change in the wall their credit is zero now adjusted gross income after the change in the wall we've already looked at this table and just as a reminder it's thirty nine thousand eight hundred so before it before the change in the wall was fifty five thousand after the changing wall it's thirty nine thousand eight hundred so we go to the worksheet and now we're going to go through the worksheet using adjusted gross income after the change in the wall so we're going to enter our earning earned income that hasn't changed so that's thirty thousand dollars we have to look it up in the table well we did that before same number 4908 that doesn't change we put in the 4908 and then it says enter the amount from line 11 that's your adjusted gross income well that's 39 800 after the change in the wall so we're going to put in 39 800 and then it says are the amounts on lines three and one the same line three is thirty thousand i'm sorry line one is thirty thousand line three is thirty nine thousand eight hundred so no they're not the same and it tells us to go to line five line five as we know asks this question about whether the amount of line three is less than a certain amount we know from previously working through this that our question is if you have one or more qualifying children is the amount on line three less than 25 250 because in the example we're married filing jointly and it's not less than that because it's 39-800 so we are going to mark no in line five and so now it tells us to look up the amount on line three which is our adjusted gross income in the irs table so we're going to look up 39 800 that's line three that's our adjusted gross income in the irs table and when we do that we find that amount 39 800 in the irs table any number that falls between 39 800 and 39 850 is on this row we're married filing jointly we have two children so the number looking down the column is 2844. so we're going to put 2844 on line five now it says look at the amounts on line five and two enter the smaller amount on line six well wine two is four thousand nine oh eight wine five is two thousand eight forty four the smaller number is 2844 so we enter that on line six and it says this is your earned income credit so after the change in law our credit is 2844. so just to sum it up and this is a really really good news in this example the earned income tax credit before the change in the wall was zero after the change in the wall it's forty 2844. so almost three thousand dollars of credit that this couple did not get before the change in the wall but now will get after the change in the wall so some really good news so that's it that's how you figure out whether your credit has changed thank you so much for watching this video i hope you learned something i hope this comparison that i've walked you through will bring some good news for you and you'll get additional earned income tax credit for the year 2020. as a reminder don't forget to subscribe to my channel to learn about any new developments in this area in particular whether you're going to need to do anything to claim the extra credit or will the irs just do that automatically for you thanks so much take care

Channel: Eddie Adkins, CPA

Views: 6,912

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Id: zKJS-1LaOt8

Length: 35min 10sec (2110 seconds)

Published: Tue Mar 30 2021