Earned Income Tax Credit

The United States federal Earned Income Tax Credit or Earned Income Credit (EITC or EIC) is a refundable tax credit for low- and middle-income persons and couples, primarily for those with children. For tax year 2009, a claimant with one qualifying child can receive a maximum credit of $3,043, a claimant with two qualifying children a maximum of $5,028, and a claimant with three or more qualifying children can receive a maximum credit of $5,657.^[1][2]

Grandparents, aunts, uncles, and siblings can also claim a child as their qualifying child provided they shared residence with the child for more than six months of the tax year. However, in tiebreaker situations in which more than one filer actually claims the same child, priority will be given to the parent. A foster child also counts, either if a member of one's extended family (see below) or if officially placed by an agency or court. There is a much more modest EIC for persons and couples without children that reaches a maximum of $457.^[3][4]

A qualifying child can be as old as the age of 18 at the end of the tax year, and as old as the age of 23 if classified as a full-time student for at least one long semester. A qualifying child can be any age if classified as "permanently and totally disabled," although this actually means that a doctor has determined that the condition has lasted or can be expected to last for at least one year.^[1][5]

The EIC phases in over a certain range, travels along a plateau for another range, and then phases out more slowly than it phased in. In 2009, for Married Filing Jointed, whereas the plateau and phase-out is not doubled, its range is increased by $5,000.^[3]

Enacted in 1975, the initially modest EIC has been expanded by tax legislation on a number of occasions, including the widely-publicized Reagan Tax Reform Act of 1986, and was further expanded in 1990, 1993, and 2001, regardless of whether the act in general raised taxes (1990, 1993), lowered taxes (2001), or eliminated other deductions and credits (1986).^[6] Today, the EITC is one of the largest anti-poverty tools in the United States (despite the fact that most income measures, including the poverty rate, do not account for the credit).

Other countries with programs similar to the EITC include the United Kingdom (see: working tax credit), Canada, Ireland, New Zealand, Austria, Belgium, Denmark, Finland, Sweden, France and the Netherlands. In some cases, these are small. For example, the maximum EITC in Finland is 290 euros. Sweden has a medium credit with the maximum slightly above 21000 SEK, or about US$3000 ("jobbskatteavdrag" was introduced in 2006 and expanded in consecutive steps 2007-2010). Others are larger than the U.S. credit, such as the UK's working tax credit, which is worth up to £7782^{[citation needed]}.

As of tax year 2009, eleven states—Kansas, Maryland, Massachusetts, Michigan, Minnesota, Nebraska, New Jersey, New York, Rhode Island, Vermont, Wisconsin, plus the District of Columbia—have a refundable state EIC which is at least 10% of the federal EIC. In addition, a few small local EICs have been enacted in San Francisco, New York City, and Montgomery County, Maryland.^[7]

[edit] Earned income

Earned income is a technical term defined by the United States tax code. The following are the main sources:^[3]

• Wages, salaries, tips, commissions, and other taxable employee pay,
• Net earnings from self-employment
• Gross income received as a statutory employee
• A minority of disability payments
• Nontaxable combat pay that a member of the U.S. armed services elects to include solely for purposes of EIC calculation—the service member must include all or no combat pay in this calculation

[edit] Qualifying children

When you claim EIC with one or more qualifying children, you need to fill out and attach Schedule EIC to your 1040 or 1040A. This form asks for the child(ren)’s name, social security number, year of birth, whether an older ‘child’ age 19 to 23 was classified as a student for the year (full-time status for at least one long semester, or equivalent time period), whether an older 'child' is classified as disabled during the year (doctor states one year on more), your relationship to the child, and the number of months the child lived with you in the United States.^[4]

To claim a person as your qualifying child, the child must meet the following requirements of relationship, age, and shared residence.

[edit] Relationship

You must be related to your qualifying child through law, marriage, or blood. Your qualifying 'child' can be:

• Your daughter, son, stepchild, foster child, or any further descendant (such as grandchild, great grandchild, etc.),

• Or your brother, sister, half sister, half brother, stepbrother, stepsister, or any further descendant (such as niece, nephew, great-nephew, great-niece, great-great-niece, etc.).

A foster child not in your extended family as above must be officially placed by an agency, court, or American Indian tribal government. An authorized placement agency includes a tax-exempt organization licensed by a state, and also includes an organization authorized by an Indian tribal government to place Native American children.

Adopted children can be in the process of being adopted provided they have been lawfully placed.

A child might classify as the qualifying child of more than one adult family member, at least initially. For example, in an extended family situation, both a parent and an uncle may meet the initial standards of relationship, age, and residency to claim a particular child. In such a case, there is a further rule: If a single parent or both parents, whether married or not, can claim the child (residency and age) but choose to waive the child to a non-parent, such as a grandparent or uncle or aunt, this non-parent can claim the child only if they have a higher adjusted gross income (AGI) than any parent who has lived with the child for at least six months.

This still remains the parent’s choice. Provided the parent has lived with the child for at least six months and one day, the parent can always choose to claim his or her child for purposes of the earned income credit. In a tiebreaker situation between two parents, the tiebreak goes to the parent who lived with the child the longest. In a tiebreaker between two non-parents, the tiebreak goes to the person with the higher AGI. These tiebreaker situations only occur if more than one family member actually files and claims the same child. On the other hand, if the family can agree, per the above and following rules, they can engage in a limited amount of tax planning as to which family member claims the child.^[3]

[edit] Age

You must be older than your qualifying child unless this person is classified as “permanently and totally disabled” (physician states one year or more), in which case this person can be any age and still classify as your qualifying child as long as the other requirements are met. More fully, the definition of “permanently and totally disabled” is that a person has a mental or physical disability, cannot engage in substantial gainful activity, and a physician has determined that the condition has lasted or is expected to last one year or more, or can lead to death. If the person is so classified, the age requirement is considered to be automatically met.

The standard age requirement is that your qualifying child must be under the age of 19 at the end of the tax year. That is, the person can be 18 years and 364 days old on December 31 and still classify as your “qualifying child” as long as the other requirements are met.

A qualifying child who is enrolled as a full-time student during some part of five calendar months can be up to and including age 23. That is, this older student can be 23 years and 364 days old on December 31 and still classify as your “qualifying child,” as long as the other requirements are met (relationship and residence). The standard Fall semester of a university, in which classes start in late August and continue through September, October, November, and early December, counts as part of five calendar months. And a similar conclusion applies to the standard Spring semester. However, the five months need not be consecutive and can be obtained with any combination of shorter periods. A full-time student is a student enrolled for the number of hours or courses the school considers to be full-time attendance. Schools also include technical, trade, and mechanical schools. High school students who work in co-op jobs or who are in a vocational high school program are considered to be full-time students.^[3]

[edit] Shared residence

You must live with your qualifying child(ren) within the fifty states and/or District of Columbia of the United States for more than half the tax year (per instructions, six months and one day is listed as 7 months on Schedule EIC). U.S. military personnel stationed outside the United States on extended active duty are considered to live in the U.S. for purposes of the EIC. Extended active duty means the person is called to duty for an indefinite period or for a period of more than 90 days (and this is still considered to be extended active duty even if the period ends up being less than 90 days).

Temporary absences, for either you or the child, due to school, hospital stays, business trips, vacations, shorter periods of military service, or jail or detention, are ignored and instead count as time lived at home. "Temporary" is perhaps unavoidably vague and generally hinges or whether you and/or the child are expected to return, and the IRS does not provide any substantial guidance past this. If the child was born or died in the year and your home was the child's home, or potential home, for the entire time the child was alive during the year, this counts as living with you, and per instructions, 12 months is entered on Schedule EIC.

Unlike the rules for claiming a dependent, there is no rule that a qualifying child for the EIC not having supported themselves. A child who supports himself or herself can still qualify as a your qualifying child for purposes of the EIC. There is an exception, as there often is in tax law. If your qualifying child is married, you need to be able to claim this child as a dependent or be waiving this dependency to the child’s other parent.^[8].^[3][4]

[edit] Other requirements

Investment income cannot be greater than $3,100.

A claimant must be either a United States citizen or resident alien. In the case of married filing jointly where one spouse is and one isn't, the couple can elect to treat the nonresident spouse as resident and have their entire worldwide income subject to U.S. tax, and will then be eligible for EIC.

Filers both with and without qualifying children must have lived in the 50 states and/or District of Columbia of the United States for more than half the tax year (six months and one day). Puerto Rico, American Samoa, the Northern Mariana Islands, and other U.S. territories do not count in this regard. However, a person on extended military duty is considered to have met this requirement for the period of the duty served.

For persons without a qualifying child, there is an age requirement in that the person must be from age 25 to 64. For persons with a qualifying child, there is no age requirement per se, other than the fact that the filer themselves must not claimable as a qualifying child (which can happen in some extend family situations, including up to age 23 if the filer is enrolled as a full-time college student for at least one long semester).

All filers (and children being claimed) must have a valid social security number. This includes social security cards printed with "Valid for work only with INS authorization" and "Valid for work only with DHS authorization."^[3]

Single, Head of Household, Qualifying Widow(er), and Married Filing Jointly are all equally valid filing statuses for EIC. In fact, depending on the income of both spouses, Married Filing Jointly can be advantageous in some circumstances because, in 2009, the phase-out for MFJ for begins at $21,450 whereas phase-out begins at $16,450 for the other filing statuses. A couple who is legally married can file MFJ even if they lived apart the entire year and even if they shared no revenues or expenses, as long as both spouses agree. However, if both spouses do not agree, or if there are other circumstances such as domestic violence.,^[9] a spouse who lived apart with children for the last six months of the year and who meets other requirements, can file as Head of Household.^[10]Or, for a couple that is split up but still legally married, they might considering visiting an accountant at separate times and perhaps even signing a joint return on separate visits. There is even an IRS form that can be used to request direct deposit into up to three separate accounts.^[11] In addition, if a person obtains a divorce by December 31, that will carry, since it is marital status on the last day of the year that controls for tax purposes. In addition, if a person is "legally separated" according to state law by December 31, that will also carry.^[12] The only disqualifying filing status for purposes of the EIC is married filing separately.^[1][3]

EIC phases out by the greater of earned income or adjusted gross income.

A married couple, in 2009, whose total income was just shy of $21,450, but who had more than $3,100 of investment income, would have received the maximum credit of $3,034 with one qualifying child, $5,028 with two qualifying children, or $5,657 EIC with three or more qualifying children, but because of the rule, for any claimant—whether single of married, with or without children—that investment income cannot be greater than $3,100, will instead receive zero EIC. This is of course an edge case, but there are income ranges and situations in which an increase of investment dollars can result in a loss of after-tax dollars. (Instead of $21,450, the beginning of phase-out for Single, Head of Household, and Qualifying Widow(er) is $16,450.)

[edit] 2 year disallowance for 'reckless' EIC claim, 10 year disallowance for fraudulent claim

A person will be disallowed EIC for two years if they make a claim with reckless or intentional disregard of the EIC rules. A person will be disallowed for ten years if they make a fraudulent claim.^[13]

[edit] EIC Table, 2009

The credit is characterized by a three-stage structure that includes phase-in, plateau, and phase-out.

For Married Filing Jointly, the plateaus travel $5,000 further, and thus the phase-outs both begin and end $5,000 further.

The same data, in words: for a person with two qualifying children, the credit is equal to 40% of the first $12,570 of earned income, thus reaching a plateau of $5,028 of credit received and staying there until earnings increase beyond $16,420, at which point the credit begins to phase out at 21.06%, reaching zero as earnings pass $40,295.

The dollar amounts are indexed annually for inflation. The actual dollar amounts are given by an IRS table that divides earned income into fifty dollar increments.

[edit] EIC Graph, 2006

[edit] Impact

Under traditional welfare, a dollar-for-dollar decrease of benefits corresponded to an increase in earnings. Standard indifference curve analysis shows that this creates a "spiked" budget constraint of OABC, making it very likely that an individual's utility maximizing bundle includes no work.

The EITC, in contrast to traditional welfare, creates a "smoother" budget constraint of OABCD, making it theoretically much more likely that an individual's utility-maximizing bundle will include some hours of work.

The EITC is the largest poverty reduction program in the United States. Almost 21 million American families received more than $36 billion in refunds through the EITC in 2004. These EITC dollars had a significant impact on the lives and communities of the nation's lowest paid working people, lifting more than 5 million of these families above the federal poverty line.^{[citation needed]}

Further, economists suggest that every increased dollar received by low and moderate-income families has a multiplier effect of between 1.5 to 2 times the original amount, in terms of its impact on the local economy and how much money is spent in and around the communities where these families live. Using the conservative estimate that for every $1 in EITC funds received, $1.50 ends up being spent locally, would mean that low income neighborhoods are effectively gaining as much as $18.4 billion.^{[citation needed]}

The stimulus effects of the EITC and other consumption-augmenting policies have been challenged by more recent and rigorous studies. Haskell (2006) finds that the unique spending patterns of lump-sum tax credit recipients and the increasingly global supply chain for consumer goods is counter-productive to producing high, localized multipliers. He places the local multiplier effect somewhere in the range of 1.07 to 1.15, more in line with typical economic returns. The lower multiplier is due to recipients emphasizing "big-ticket" durable good purchases, which are typically produced elsewhere, versus locally-produced products and services such as agricultural products or restaurant visits. However, Haskell points to a silver lining: there are perhaps more important benefits from recipients who use the credit for savings or investment in big-ticket purchases that promote social mobility, such as automobiles, school tuition, or health-care services.^[14][15]

Due to its structure, the EIC is effective at targeting assistance to low-income families. By contrast, only 30% of minimum wage workers live in families near or below the federal poverty line, as most are teenagers, young adults, students, or spouses supplementing their studies or family income.^[16][17] Opponents of the minimum wage argue that it is a less efficient means to help the poor than adjusting the EITC.^{[citation needed]}

[edit] Cost

It is difficult to measure the cost of the EITC to the Federal Government. At the most basic level, federal revenues are decreased by the lower, and often negative, tax burden on the working poor for which the EITC is responsible. In this basic sense, the cost of the EITC to the Federal Government was more than $36 billion in 2004.

It is also estimated that between 22% and 30% of taxpayers claiming the EITC on their tax returns do not actually qualify for it. This led to an additional cost to the government (in 2010) of between $8 and $10 billion. ^[18]

At the same time, however, this cost may be at least partially offset by two factors:

1) any new taxes (such as payroll taxes paid by employers) generated by new workers drawn by the EITC into the labor force;

2) taxes generated on additional spending done by families receiving earned income tax credit.

Additionally, some economists have noted that the EITC might cause a reductions in entitlement spending that result from individuals being lifted out of poverty. However, because the pre-tax income determines eligibility for most state and federal benefits, the EITC rarely changes a taxpayer's elibigility for state or federal aid.

[edit] Uncollected tax credits

Millions of American families who are eligible for the EITC do not receive it, leaving billions of additional tax credit dollars unclaimed. Research by the Government Accountability Office (GAO) and Internal Revenue Service indicates that between 15% and 25% of households who are entitled to the EITC do not claim their credit, or between 3.5 million and 7 million households.

Many nonprofit organizations around the United States, sometimes in partnership with government and with some public financing, have begun programs designed to increase EITC utilization by raising awareness of the credit and assisting with the filing of the relevant tax forms.

The state of California requires employers to notify every employee about the EITC every year, in writing, at the same time W-2 forms are distributed.^[19]

[edit] "RALs" (Refund Anticipation Loans)

The combination of EIC and "RALs" (Refund Anticipation Loans) has been the primary engine of the storefront tax preparation industry, including the very familiar companies of H&R Block, Jackson Hewitt, and Liberty Tax, as well as smaller chains and independent practitioners. RALs have been criticized on various grounds^[20] including the high interest rates common to short-term loans.^[21] The loans are often not as easy to be approved for as the advertising implies. In fact, RAL advertisement phrases such as "Rapid Refund" have been deemed deceptive and illegal. Customers denied these loans then have their RAL application converted to a RAC, which is an estimated two-week bank product (10 days or more, no set date, no guarantee), in which the account merely sits empty waiting for the IRS refund (if any). And although such customers do not pay interest, they pay other fees. In addition, there is the practice known as "cross-collection" or more vaguely as "previous debt," in which the loan-issuing bank (such as HSBC or Santa Barbara Bank & Trust in recent years) engages in debt collection for other banks who issued RALs in previous years to persons whose expected tax refunds then went uncollected. That is, HSBC or Santa Barbara will take all or part of a client's tax refund for purposes of third-party debt collection. And this practice may not be adequately disclosed to the tax preparation client, just as some clients fail to disclose obligations that result in government taking their refunds.^[22][23] Of course, modernization of tax return processing may reduce or eliminate the remittance delay on which these short-term loans are based. For the upcoming 2010 tax season, the IRS will no longer be providing preparers and financial institutions with the “debt indicator.”^[24][25] Presumably, the result will be that fewer RALs are approved and that more RALs are then converted to RACS (estimated two-week product).

[edit] See also

• Guaranteed minimum income
• Negative income tax
• Taxation in the United States

[edit] References

[edit] External links

Taxpayer info/tools:

• IRS EITC Assistant, which can help determine if you qualify for EITC
• IRS 1040 Instructions, 2007, Earned Income Credit instructions on pages 44–50, table on pages 51–58.
• IRS Schedule EIC. A person or couple claiming qualifying child(ren) needs to attach this form to the 1040 or 1040A tax return.
• IRS Publication 596 - Earned Income Credit, a publication aimed at people who will potentially be claiming the credit.
• EITC Calculator, which can help estimate your credit amount.
• 2009 EIC Table, embedded pdf of the Earned Income Credit - IRS Publication 596 (Adobe Reader not required).

Organizations/campaigns:

• National Community Tax Coalition, an organization that supports the EITC and tries to help make sure people claim it
• Boston EITC Campaign

Background:

• Section 13 ("Tax Provisions Related to Retirement, Health, Poverty, Employment, Disability, and Other Social Issues") of the House Ways and Means Committee's Green Book provides historical information, including previous EITC parameters. (The version linked to here is the 2004 edition. Note: it's not published anuually.)

Policy Analysis:

• Congressional Budget Office report for Senate Finance Committee, on "the Effects of Increasing the Federal Minimum Wage Versus Expanding the Earned Income Tax Credit" (January 9, 2007)
• New Research Findings on the Effects of the Earned Income Tax Credit, Center on Budget and Policy Priorities, March 11, 1998
• The Earned Income Tax Credit (EITC): Percentage of Total Tax Returns and Credit Amount by State a Congressional Research Service (CRS) Report
• The Earned Income Tax Credit at Age 30: What We Know, Steve Holt, the Brookings Institution
• The Hidden Welfare State: Tax Expenditures and Social Policy in the United States, Christopher Howard, Princeton University Press, 1997. Mr. Howard discusses the mortgage interest deduction, employer pensions, EITC, and the targeted jobs tax credit as examples of tax expenditures.

Podcast:

• http://bostontaxhelp.libsyn.com/ Boston Tax Help podcast. Produced by Craig Far-Corporate/Community Partnerships/Boston EITC Campaign