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Update - The advance earned income credit was repealed in 2010

Advance Earned Income Credit

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Maximum Advance Earned Income Credit Payment

The advance earned income credit was repealed in 2010.

The information on this page was left for historical purposes.

The regular earned income credit is still available and may be claimed when filing your 2011 return, if you're eligible.

Withholding Taxes

Advance earned income credit payments are not subject to withholding of federal income tax, social security and Medicare taxes.

Advance Earned Income Credit Payments Treated as Tax Deposits

 

For purposes of making advance earned income credit payments, the amount of the payment is treated as a employment tax deposit

However, you don't actually make a tax deposit for the amount of the earned income credit payments.

You just reduce the amount of employment taxes shown on Form 941 by the amount of the earned income credit payments you made for the quarter and pay the difference to the U.S. Treasury.

Advance earned income credit payments are considered deposited on the day you pay wages to your employees.

You add the amount of the advance earned income credit payment to the employee's net pay.

How Advance Earned Income Credit Payments are Provided to Employees

To pay an employee an advance earned income credit, the employer reduces the amount of employment taxes due the government by the amount of the advance payments made to the employee and sends the government the difference.

For example, if during the third quarter the employer included $200 in advance earned income payments in an employee's paychecks, the employer would subtract the $200 from whatever the employer's normal tax liability would have been for the quarter based on the employee's gross wages.

How it works:

1) Prepare your quarterly Form 941 to report what your withholding taxes would have been without considering any advance earned income credit payments:

Form 941 is used to report:

2) On line 9 of Form 941:

3) Subtract the advance payments shown on line 9 from the total tax liability shown on line 8 of Form 941.

Advance earned income credit payments are treated as deposits in the following order:

  1. Federal income taxes.
  2. The employee's share of social security and Medicare taxes.
  3. The employer's share of social security and Medicare taxes.

Example:

You have 4 employees.

Note: You are considered to have made a deposit of the advance earned income credit payments on the date you paid your employees even though no deposit was actually made.

Result:

  1. Applying the advance earned credit payment:
    • The total advance earned income credit payment of $100 is treated as if you made a tax deposit in the following order:
      • First, $90 of federal income taxes.
      • Second, $10 of the employee's share of social security and Medicare taxes.
  2. The $100 of advance earned income credit payments has been fully applied.
  3. The remaining employment tax liability is $112.60.
    • $212.60 minus $100.
  4. You, as the employer, remain liable for $112.60, which represents:
    • $51.30 of the employee's share of social security and Medicare taxes.
      • $61.30 minus the $10 subtracted from the employee's share of social security and Medicare taxes equals $51.30.
    • Plus, $61.30 of the employer's share of social security and Medicare taxes.

Note that none of the $100 in advance earned income credit payments was applied against the the employer's share of social security and Medicare taxes because after applying the $100 in the specified order, it was used up.

Next:

Earned Income Credit: Reporting Advance Earned Income Credit payments

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