This new lookback rule, which was part of the Taxpayer Certainty and Disaster Tax Relief Act of 2020, may allow certain taxpayers to claim these valuable credits based on their 2019 earned income when it is higher than their 2020 earned income.
The lookback rule refers to letting taxpayers “look back” to their 2019 earned income amount to calculate their credits and allows taxpayers to use the best year for the credits – as long as the taxpayer’s 2020 earned income is less than their 2019 earned income. This could result in larger EITC and ACTC credits to those who need it most during this financially challenging time. But it’s important to note that this lookback rule isn’t automatic. Taxpayers, or their Tax Pro, must be aware of the option and take the time to compare their total 2019 and 2020 earned income and calculate the credits to determine which choice is better for them and their family.
Who is the lookback rule for?
Unfortunately, millions of taxpayers were unemployed, had salary cuts, or reduced hours in 2020. These complications impact 2020 income for obvious reasons, but one thing that many taxpayers don’t understand is specifically how unemployment will impact their opportunities for various tax credits they may have qualified for in the past. One of the biggest credits that someone’s unemployment could impact is the EITC because this credit is calculated on EARNED income -- and unemployment, while taxable, is not earned income. Modified Adjusted Gross Income (MAGI) is also used in the final EITC calculations and it is possible to qualify for the credit based on 2019 earned income and lose the credit based on the 2020 MAGI.
Additionally, taxpayers who are Married Filing Jointly should be aware that if they decide to utilize the lookback rule, then both parties must use their 2019 income. One person cannot use their 2019, while the other uses 2020 income – it must match on their tax return. Furthermore, choosing to use this option won’t impact a taxpayer’s overall Adjusted Gross Income (AGI) for 2020; it’s only specifically an option for taxpayers who are calculating their EITC and ACTC. For the EITC calculation, once you determine the amount of earned income and look up the EITC for the earned income, you must look up the EITC amount and compare the two amounts of EITC. Only the smaller amount is permitted.
Alice and Bob are married with three children, all under the age of 17. Alice was able to maintain her full-time job during 2020 without any changes, while Bob was laid off and collected unemployment for several months during the year. Toward the end of summer, Bob started a new job but had his hours reduced by December. In 2019, the couple made a combined earned income of $56,000. In 2020, the couple only had earned income of $20,000. Due to the unemployment compensation that Bob received, their MAGI is $46,000. Overall, the couple had less earned income in 2020 than they did in 2019. The couple may be eligible for EITC based on 2020 unless their MAGI is too high. They will use the 2020 earned income to qualify for the highest possible EITC. The amount of MAGI still impacts the EITC and they will end up with a small amount based on the MAGI. Using the 2019 earned income will allow them to qualify for a larger amount of child tax credit than using the $20,000 earned income from 2020.
Joy and Zander are married with two children, all under the age of 17. While they both kept their full-time jobs in 2020, their hours were reduced significantly, and they earned less in 2020 than in 2019. In 2020, they made $30,000 while in 2019, they made $50,000. Joy and Zander may be eligible for some EITC based on earned income. The amount of MAGI still impacts EITC. Joy and Zander did not get unemployment during the year so they will qualify for EITC based on 2020 earned income and/or MAGI. The full child tax credit is available using either year earned income, so they will use the 2020 earned income.