The earned income tax credit (EITC) can help some low-income workers receive a lower tax bill or a higher refund. Recent changes to the law may even allow some workers without children to receive a benefit from the EITC. If you have taken income from your 401k, that will probably count against you for the purposes of calculating the earned income tax.
Taxable, Non-Taxable and Disqualified Income
It is important to understand the difference between taxable and nontaxable income. The EITC takes taxable income into account but not non-taxable income. Generally, any income from investments you made with pre-tax dollars is taxable as income, and reportable as earned income. This includes 401k distributions. In addition, IRS rules disallow those with more than $3,100 in "disqualifying income," or income from passive activity, rents, royalties and interest from qualifying for the EITC.
Your 401k plan is a workplace-sponsored, qualified deferred compensation defined benefit plan. As such, contributions are never paid to you, but are withheld from your pay by your employer. You never paid the income tax, so you get taxed on the income when you receive it from the company.
401ks and Income Thresholds
Your allowable credit begins to phase out when your income reaches a certain point, and it reaches zero at different points depending on the number of children you have and your marital status. The more you receive from your 401k plan, the more likely you are to have your credit reduced or eliminated, because your 401k income gets added to your income.
Claiming the Credit
To claim the credit, your adjusted gross income, after deductions, should be within the income parameters. If you have a child, he should have lived with you for at least six months out of the year. You should not be a qualifying dependent on another taxpayers' return. If you served overseas in a combat zone, special rules apply that could make it easier for you to qualify for the earned income credit. Speak to your tax adviser for details.
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