Does the IRS Look at Gross or Net Income for Earned Income Qualification?

by Patricia DeWitt ; Updated July 27, 2017

The federal Earned Income Credit is a tax credit for which middle and low income workers may qualify. To be eligible for EIC, you must satisfy several requirements. Three of the requirements are income-based: the adjusted gross income ceiling, the investment income ceiling and the earned income requirement. Some types of income are incorporated on a net basis and some on a gross basis.

Adjusted Gross Income Ceiling

One of the requirements for claiming the EIC is that your adjusted gross income cannot be over a certain amount. The particular amount depends on how many qualifying children you can claim as dependents, and can change from year to year. As of the time of publication, the AGI limit for taxpayers with three qualifying children is $43,352. Much of your income is included on a gross basis -- for example, W-2 wage income, interest and dividends. However, despite being called "gross" income, some types of income are actually included on a net basis, including self-employment or business income and capital gains. Once you know your gross income, you can determine whether you can claim any adjustments that might lower the amount of your AGI. These adjustments are not the same as the standard deduction or deductions you might itemize on Schedule A. Adjustments to the AGI include qualified moving expenses, half of the self-employment tax, Individual Retirement Account contribution deductions and the student loan interest deduction.

Investment Income Ceiling

In addition to the AGI ceiling, there is a separate, lower ceiling for investment income. If your investment income -- that is, interest, dividends and capital gains -- is over the ceiling, you cannot claim EIC. As of the time of publication the limit is $3,100. Just as with AGI, interest and dividends are included on a gross basis and capital gains on a net basis.

Earned Income Requirement

To qualify for EIC, you must also have earned income -- income you receive in exchange for your labor or business activities. The amount of the credit changes based on the amount of your earnings. W-2 income is included on a gross basis. Any employment-related deductions you take are not considered in the calculation. This is the case even if you are a statutory employee and claim your work related deductions on Schedule C rather than Schedule A. Very few employees are statutory employees, but if you are unsure whether you are a regular or statutory employee, examine Box 13 of your W-2. Business or self-employment income is considered on a net basis, after business expenses are deducted. If you have this type of income, complete Schedule C to determine how much to include in your earned income.

Special Circumstances

If you believe you may qualify for EIC, be sure that you are aware of how certain special circumstances can change the income calculations. Taxpayers with special circumstances include those on early disability retirement, members of the military with non-taxable pay and taxpayers with religious exemptions from Social Security and Medicare taxes. A complete description of all the various special circumstances can be found in IRS Publication 596.

About the Author

Patricia DeWitt is a CTEC-registered tax professional, a member of the California State Bar and a graduate of Harvard Law School, J.D. class of 2000. Her writing appears on a range of business and finance websites.