Gaming the Earned Income Credit

The best opportunities in the tax code are not found in the book. Today I am going to show you how to game the Earned Income Credit (EIC) legally in a way you have never heard before. I know most readers on this blog have an income in the six figures and higher. The example I illustrate today is geared toward families with an income of $100,000 or less. Even if your income is higher you want to stick around. What I show here exposes the way I think about taxes and how I use the tax code to save my clients massive quantities of money.

The EIC has a history of fraud. Because of this the IRS watches tax returns with the EIC closely for fraud. You guys are not at risk of IRS scrutiny because you are not going to commit fraud. Right? Good. The program I outline below does not require cheating to ramp up your available tax credits. No fake income or expenses are required. We will do this all above board for everyone to see. The IRS will bless your tax return for its accuracy.

The EIC is meant to help poor families, but the credit extends all the way to $50,597 for a married couple with two children in 2017. Our example below will use this family unit to illustrate the tax benefits. When we are done you will know how to collect the EIC even if your wage income is over $80,000, or even a bit higher!


Setting the Stage

It all comes down to spending and saving. People who save get wonderful financial gifts and spenders get a bill from the IRS. Regular readers know I recommend saving half your gross income. First you fill retirement accounts and Health Savings Accounts before plowing excess funds into non-qualified accounts.

The great thing about saving half your income is the IRS pays you so much back in credits and reduced taxes that it doesn’t really hit your cash flow 50%. A small amount of self control goes a long way in building a massive net worth.

Meet our married couple Snow and Snap Pea, the proud parents of two sons. Our young couple is in their 30s and the kids are in grade school. Snow has a good job working at the Delicious Café. Snap works part-time at Beautiful Music. Their tax return is simple and straightforward. They have no other income except the W-2 wages and take the standard deduction. I’m keeping the illustration simple so it is easier to follow. Other income and deductions will change the results, but the tax reducing strategy I use here will still apply.

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As you can see from the W-2s, Snow has $53,000 in wages for 2016 and Snap had $19,000. Snow has health insurance from his employer and it is HSA qualified. Both Snow and Snap have a SIMPLE IRA retirement plan available at their jobs. (Once again I am keeping this simple. There are multiple retirement plans out there with the 401(k) the most popular. I chose the SIMPLE IRA because you can contribute the first $13,000 of earned income, no percentages like 401(k) and similar plans.)

On the 1040 it looks like this:

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Their combined wages of $72,000 drop down to the bottom of the page because there is no other income or adjustments to claim.

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The damages are totaled on page 2 of Form 1040. The standard deduction and personal exemptions are subtracted to arrive at the Taxable Income and Tax of $5,556. You will notice our couple gets a Child Tax Credit of $2,000. There are no additional Credits or Other Taxes so they have a 2016 tax of $3,556. They over withheld on their paychecks so they get a nice refund of $1,344. Their income was too high to qualify for the EIC or Saver’s Credit.

Snow and Snap Pea are happy with the results on their tax return until they discovered The Wealthy Accountant blog. They started to wonder if this crazy tax guy was on to something. They scheduled a consultation with the Wealthy Accountant and it went like this:

Keith discovered the HSA and SIMPLE IRA availability early in the phone interview. It took some smooth talking to get Snow and Snap onboard with the max-out of the SIMPLE and Health Savings Account. Of course they were a lot more confident when they saw how it affected their tax situation in real life.

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Notice each W-2 has less reported income than before in Box 1. Box 1 is what goes on your tax return to calculate income taxes. Snap has $13,000 less in Box 1 than Boxes 3 and 5. Boxes 3 and 5 is the income subject to Social Security and Medicare taxes (FICA). The SIMPLE contributions reduced the income for income tax purposes, but FICA taxes still apply. Where it gets interesting is on Snow’s W-2. He also filled his Health Savings Account from his paycheck through work. This lowered his income subject to income, Social Security, and Medicare taxes. At the end of this post we will tally the total tax savings and amounts invested/saved. (See note in comments section. Snap’s original W-2 started with $19,000, but was $16,000 on the second W-2.)

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Page one of the Wealthy Accountant approved tax return looks like it was hit by a truck! Our young couple started with a $72,000 income and now only report $36,250. Wow! $36,250 is plenty to live on comfortably, but Snow and Snap do not need to worry. The IRS wants to help these poor, poor people out. The IRS has a heart of gold for people who save their money intelligently. The IRS now thinks they are poor because they tucked a large chunk of their income into their back pocket rather than spending it.

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Once again the standard deduction and personal exemptions are subtracted before tax is calculated. The Peas now have a tax of $748! The Saver’s Credit is non-refundable, but they can use $748 of the credit so their total tax is zero YeeHaa!

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Paying zero tax is so last year. Major corporations have done better than that when they book billions in profits. Just ask General Electric. And Snow and Snap Pea will do the same. The bottom of page 2 on Form 1040 shows why this tax return is Wealthy Accountant approved.

The Saver’s Credit is non-refundable, but the Child Tax Credit is refundable and since it was not taken above, it increases the refund here by $2,000. See that $2,932? That is the Earned Income Credit. Nice, hey? That is why we started this post. The EIC is the goal here, but there is so much more that comes along with it. The refund was $1,344 before we had a talk with our young couple. Now they have a $9,832 refund! You might be tempted to subtract $1,344 from $9,832 to arrive at a tax savings of $8,488. And you would be wrong if you did.




Time for Some Math

Snow and Snap had to give something up for the tax benefits received. They reduced their available income as follows:

SIMPLE IRAs: $13,000 each

Health Savings Account: $6,750

So Snow and Snap had to deduct $13,000 + $13,000 + $6,750 from their paychecks. $32,750. That is a lot of money. Things must be tight around the house.

Well, maybe not as much as we think. Remember the tax return showed a tax advantage of $8,488 in the form of a bigger refund. But the Health Savings Account also reduced wages subject to FICA taxes of 7.65%. This adds another $516 (rounded down) in tax savings! The real tax benefits equal $8,488 + $516, for a total tax benefit of $9,004. I told you the IRS loves you. You just need to learn their language. They have plenty of money to give away. (See note in comments section below. There was a slight change to the final tax savings.)

The family cash flow is down, but not $32,750. When you add the tax benefits back into the family budget the Peas only saw their cash flow decline $23,746. But wait for it. Your net worth went up $32,750! In effect the IRS gave you $9,004 tax free! Now where you going to get a better deal than that?

Here we have a family earning a modest, but comfortable income and turning it into a wealth building powerhouse. We didn’t even include the company 3% match added to the SIMPLE contributions.

One final thought. Doing what I outlined here is so powerful because the IRS doesn’t get you on the back-end either. SIMPLE IRAs act the same as a traditional IRA. You are taxed when you withdraw the money. You will pay tax at ordinary rates on that future date. What you will never pay back is the credits. The Saver’s Credit and Earned Income Credit are yours to keep. There is no future payback date. Just tuck it into the First National Bank of Wallet.

Now aren’t you glad you stopped by today?

Note: I checked and rechecked my numbers, but I wrote this in the middle of the night while sitting on the floor and using a preliminary 2016 tax program which arrived at the office November 30th. If you see a math error let me know in the comments. I’ll get right on it. As an accountant I’ll be the first to admit I never make a mistake.

Keith Schroeder

10 Comments

  1. Bill on December 2, 2016 at 5:58 pm

    I think there is a mistake or at least something not explained.

    The $19000 is reduced to $3000 by a $13000 IRA contribution. Wouldn’t that leave $6000?

    Perhaps you intend for health insurance premiums of $3000 to be a reduction.

    Didn’t look into it further than that and I assume the principle is still valuable.

    • Keith Schroeder on December 2, 2016 at 9:33 pm

      Thanks for pointing it out, Bill. I couldn’t get the preliminary program to print at first so I took photos of some and a printout of the others. I forgot my starting point. Snap should have $3,000 less on the first tax return without any SIMPLE contributions. The refund on that return should be $1,794 and the total tax benefit of maxing out the SIMPLEs and Health Savings Account is $8,554 ($9004-($1,794-1344)).

  2. jo on December 3, 2016 at 10:32 am

    Could you touch on the investment income limit?
    Here is useful example (for me): $50k W2 income, $20k in interest income, $25k in passive rental losses on schedule e’s.
    thx!

    • Keith Schroeder on December 4, 2016 at 7:49 am

      Unfortunately you can’t net the interest income with the rental loss. Since your interest income is over $3,400 you are not allowed to claim the EIC. Sorry.

  3. James on December 3, 2016 at 7:01 pm

    I thought the Savers Credit was non refundable. When you were talking about the credits not being taxable, you said the Savers and EIC they get to keep, but I believe you meant the additional child tax credit and EIC. Correct me if I am wrong. Either way, this is powerful stuff! I am right at what they earn, but since I am the only worker, I can’t quite game the EIC.

    • Keith Schroeder on December 3, 2016 at 7:46 pm

      The Saver’s Credit is non-refundable, James. The credits in explained in this post are not included in income later. I actually meant all the credits. You keep the EIC, Child Tax Credit, Refundable Child Tax Credit, and Saver’s Credit. Refundable or not does not change the fact that you never pay them back. Think of it this way: Suppose you are exactly like the couple in the post. You get all those credits. The very next year you say “Screw it” and take all the money out of the SIMPLEs and Health Savings Account and pay the tax and penalty. You still keep the credits received when you took the deductions the prior year! Hope I am clear on this. I know taxes get complicated fast.

  4. crack_cocaine on December 3, 2016 at 9:11 pm

    Hey Keith, I’ve read your whole blog and I’m really enjoying all these advanced tax reduction techniques you’ve been talking about in your recent entries. Have you thought about doing a post on how you can basically get free insurance through Obamacare if you’re self-employed and max out your solo 401k?

  5. Mustard Seed Money on December 4, 2016 at 6:05 pm

    I love reading the ins and outs of the tax code especially when they are advantageous to me 🙂 Thanks for sharing, I will definitely investigate to see if this is something that will be applicable to me. Thanks for sharing!!!

  6. Jonah on March 31, 2017 at 1:14 pm

    Hey Keith,

    I just wanted to say thank you for this. I discovered your blog a little bit too late (November of 2016) to max out my 401k for 2016, but definitely using all means available to me in 2017. Your blog personally, has already saved me thousands of dollars in taxes, and helped set me up for future years of blissful tax free living. It is amazing. I have almost read all of your posts, now.

    SO thank you, and please keep writing!

  7. Frugal Professor on September 1, 2017 at 4:02 pm

    To those interested in reading my take on EITC hacking as well, you can find my thought here: http://www.frugalprofessor.com/etic-guest-post-on-gocurrycracker/

    ETIC hacking earned me $8k last year, through maxing out retirement contributions to 403b&457 with my 5 kids.

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