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Does 401k Withdrawal Affect Earned Income Credit?

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Connor Sephton answered
Pub 596 states explicitly that any distributions that are deferred from compensation plans, even if they are reported on Line 7, are not classed as earned income for all purposes of earned income credit. The computation of the earned income credit for an individual that has gone about taking a distribution from 401k would be one of four things.

Firstly, if your complete AIG is larger than the earned income credit cut off, then you will not get any earned income credit at all despite however much you may have earned which is classed as 'earned income' in this instance.

Secondly, there's the figure that the earned income credit is based on earned income, and thirdly the figure that the earned income credit based on adjusted gross income. Lastly, take the lower amount.

So all in all, your distribution could ultimately disqualify you from having any earned income credit at all. If not, it could significantly lower your earned income credit.

This area of law is incredibly important for people to consider. If you do not arrange your finances properly then you could face one of two things - legal action, or huge repayments in the future. If you do not pay the right amount of tax or claim credit that you should technically not be claiming, then the future could be grim. If you can't afford to make the payment for the money that you owe immediately you may have to pay it over a long period of time, which will of course have a huge effect on your bank account and general finances for the rest of your life.

If you are worried about what is going to happen and feel this advice is not enough, the best thing for you to do is to get in touch with an accountant.

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