Many Americans have been hit hard by the impact of the COVID-19 pandemic. It has affected many aspects of life, and in terms of the financial impact, a notable difference is the substantial reduction of income this tax year. The losses may have also had a negative impact on the allowable tax credits that can be claimed in the current tax year. One credit in particular to take note of is the Earned Income Tax Credit (EITC).
If you received the earned income tax credit in the prior year and your income has been substantially reduced due to the COVID-19 pandemic, you'll be excited to know that the IRS has implemented a new rule that may work for you. In response to COVID-19, the IRS has implemented the new "lookback" rule.
What is the lookback rule?
The new lookback rule is part of the American Rescue Plan and was created to aid those among us who have been hit the hardest. The rule as found in Sec. 9626 of the American Rescue Plan allows eligible taxpayers to use their 2019 earned income information to determine their eligibility for the Earned Income Tax Credit for tax years 2020 and 2021. You may decide to use this method, if the income you earned in the current tax year is markedly lower than the income you earned in 2019.
If you think you're eligible to use this rule, you must first determine whether the income you earned during the tax year meets the IRS’s definition of earned income.
What is earned income?
The IRS considers the following sources to be earned income for the purpose of claiming the earned income tax credit:
- Wages, salaries, tips, and any other type of taxable employee compensation reported to IRS Form W-2.
- Union strike benefits.
- Disability retirement benefits received prior to minimum retirement age.
- Net earnings from self-employment if:
- You own or operate a business or a farm.
- You are a minister or member of a religious order.
- You are a statutory employee and have income.
Note that rental income is not considered earned income for tax purposes. For tax purposes, income derived from rents paid falls into the category of investment income. While this category of income does not qualify, other rental activities may.
Qualifying real estate activities
In general, if you materially participate in real estate activities, then you're considered a real estate professional. Real estate professionals are considered self-employed for tax purposes and report their income to the IRS via Schedule C. As such, the income derived from the activity of a real estate professional is considered earned income and may be taken into consideration for the purpose of the IRS’s "lookback" rule.
In addition to the activities of a real estate professional, the IRS may also regard the activities of a real estate agent as self-employment, if certain criteria are met. To be considered self-employed, the following criteria must be met:
- ·Substantially all payments for service must be related to sales and outputs (the numbers of hours worked is not taken into consideration).
- Services must be performed under written contact. The contract must state that the services are not being provided as an employee for federal tax purposes.
If you fall into either category, then your income will be considered earned income and you may qualify for the new IRS "lookback" rule. If you believe you're qualified, consult your tax advisor so you can reap the benefits of the Earned Income Tax Credit.
The Millionacres bottom line
The COVID-19 pandemic has permanently changed the world. Many businesses have been left shuttered, and many business owners have been left with no choice but to put up their closed-for-business signs. While this has become the new normal, if you believe you're eligible to use the IRS "lookback" rule, you should work with your tax advisor to navigate hard times.