earned income

Earned income tax credit

The United States federal Earned Income Tax Credit (EITC or EIC) is a refundable tax credit. For tax year 2007, a claimant with one qualifying child can receive a maximum credit of $2,853. For two or more qualifying children, the maximum credit is $4,716. 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 tie-breaker situations in which more than one filer claims the same child, priority will be given to the parent. A foster child also counts provided the child has been 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 $428.

A qualifying child can be up to and including age 18 at the end of the tax year, up to and including age 23 if classified as a full-time student for one long semester or equivalent, or any age if classified as 'totally disabled' for the tax year.

Enacted in 1975, the initially modest EIC has been expanded by tax legislation on a number of occasions, including the more widely-publicized tax acts of 1986, 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). 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), and enjoys broad bipartisan support.

Other countries with programs similar to the EITC include the United Kingdom (see: working tax credit), Canada (see: working income tax benefit), Ireland, New Zealand, Austria, Belgium, Denmark, Finland, France and the Netherlands. In some cases, these are small (the maximum EITC in Finland is 290 euros), but others are larger than the U.S. credit (the UK's working tax credit is worth up to 6150 Euros).

In the United States as of tax year 2006, some 20 states and the District of Columbia had their own EICs. These state plans generally mimic the federal structure on a smaller scale, with individuals receiving a state credit equal to a fixed percentage—generally between 15 and 30 percent—of what they are eligible to receive from the federal credit. A few small local EICs have been enacted in San Francisco, New York City, and Montgomery County, Maryland.

Earned income

Earned income can be a rather technical term defined by the United States tax code. The following are the main sources:

  • Wages, salaries, tips, commissions, and other taxable employee pay,
  • Net earnings from self-employment,
  • Gross income received as a statutory employee, and
  • a minority of disability payments.

Qualifying child(ren)

Age

If a person is disabled, he or she can be any age and still count as a qualifying "child." The IRS uses the phrase "permanently and totally disabled." However, they go on to define this such that the person was disabled at any time during the tax year such that he or she could not engage in substantial gainful activity and a physician determined that the condition has lasted or is expected to last a year or more.

If a person is enrolled as a full-time student during some part of five calendar months, he or she can be up to and including age 23. For example, the standard Fall semester of an university in which classes start in late August and continue through September, October, November, and early December counts as part of five calendar months. A similar conclusion applies to the standard Spring semester. However, the five months need not be consecutive and can be obtained by any combination of shorter periods. Full-time status is often defined as ten semester hours, although the IRS defers to how each specific educational institution defines full-time status. Schools also includes technical and trade schools.

In all other cases, a person can be up to and including age 18 and can still count as a child for purposes of EIC.

Relationship

You must be related to your qualifying child(ren) through blood, marriage, or officialdom. In addition, the child must be either in your same generation or a later generation. A foster child counts provided he or she has been officially placed by an agency, court, or Native American tribal government. An adopted child counts and can be in the process of being adopted provided he or she has been lawfully placed. And so, for the relatively complete list, your qualifying child can be your daughter, son, stepdaughter, stepson, grandchild, great-grandchild, sister, brother, stepsister, stepbrother, half sister, half brother, niece, nephew, great niece, great nephew, or any further descendant of these related persons.

Shared residence

You must live with your qualifying child(ren) within the fifty states of the United States for more than half the tax year (six months and one day). Persons on active military duty are considered to be living within the United States. Temporary absences, for either you or the child, due to school, hospital stays, business trips, vacations, periods of military service, or jail or detention counts as time lived at home. "Temporary" is perhaps unavoidably vague and generally hinges or whether you or the child are expected to return, although the IRS is somewhat lenient and can count rather lengthy periods as temporary.

Other requirements

Investment income cannot be greater than $2,900.

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 United States for more than half the tax year. Perhaps surprisingly, Puerto Rico, American Samoa, the Northern Mariana Islands, and other U.S. territories do not count in this regard. A person on extended military duty is considered to have met this requirement for that period of time.

For persons without a qualifying child, there is an age requirement in that the person must be from age 25 to 64.

Persons without a qualifying child must themselves not be claimable as a dependent; persons with qualifying children must merely not be claimable as a qualifying child. This is a subtle distinction that sometimes plays out.

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."

For all filers, married filing separately acts as a disqualifying status and a person filing under that status will not be eligible for EIC. However, if the person has lived apart from their spouse for the last six months of the year, has jointly or individually paid more than half the cost of keeping up a main home (or several main homes) for six months for themselves and their qualifying child, and can claim that child as a dependent (or could claim, but are waiving the dependency to the other parent), the person can file as head of household and thus be eligible for EIC. Alternatively, 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" by December 31, that will also carry. [see 1040 Instructions]

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

EIC Table, 2007

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

Size of credit (tax year 2007)
Earned income (x) Stage Credit (2+ children)
$0–$11,790 phase in 40% * x
$11,791–$15,399 plateau $4,716
$15,400–$37,782 phase out $4,716 - 21.06% * (x - $15,399)
>= $37,783 no credit $0
Earned income (x) Stage Credit (1 child)
$0–$8,391 phase in 34% * x
$8,392–$15,399 plateau $2,853
$15,400–$33,240 phase out $2,853 - 15.98% * (x - $15,399)
>= $33,241 no credit $0
Earned income (x) Stage Credit (no children)
$0–$5,595 phase in 7.65% * x
$5,596–$6,999 plateau $428
$7,000–$12,589 phase out $428 - 7.65% * (x - $6,999)
>= $12,590 no credit $0

The same data, in words: for a person with two qualifying children, the credit is equal to 40% of the first $11,790 of earned income, thusly reaching a plateau of $4,716 and staying there until earnings increase beyond $15,399, at which point the credit begins to phase out at 21%, reaching zero as earnings pass $37,782. The dollar amounts are indexed annually for inflation.

For married filing jointly, the plateaus travel $2,000 further.

This table, and the graph below, might make it appear as though EITC moves smoothly. In actuality, the amount of the credit is given by an IRS table that divides earned income into fifty dollar increments from $1 to $39,783 (the three cases of no child, one child, and two or more children all end at somewhat awkward numbers).

EIC Graph, 2006



Impact

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.

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.

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. Opponents of the minimum wage argue that it is a less efficient means to help the poor than adjusting the EITC.

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.

At the same time, however, this cost may be at least partially offset by several 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) any reductions in entitlement spending that result from individuals being lifted out of poverty by the EITC (the poverty line is sometimes a watermark for eligibility for state and federal benefits), and 3) taxes generated on additional spending done by families receiving earned income tax credit.

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.

The average EITC amount received per family in 2002 was $1,766. Using this figure and a 15% unclaimed rate would mean that low-wage workers and their families lost out on more than $6.5 billion, or more than $12 billion if the unclaimed rate is 25%.

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.

"RALs" (Refund Anticipation Loans)

The combination of EIC and Refund Anticipation Loans is the primary engine which has built 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. The loans are often not as easy to be approved for as the advertising implies. In fact, advertisements such as "Rapid Refund" do not make it clear that it's a loan at all. Customers denied the loans are then required to accept the two-week bank product, in which the account merely sits empty waiting for the IRS refund. And although such customers do not pay interest, they still pay all the other fees. In addition, there is the practice known as "cross-collection," in which the loan-issuing bank, such as HSBC or Santa Barbara Bank & Trust in recent years, engages in debt collection for other companies, notably credit card companies. That is, HSBC or Santa Barbara will take all or part of a client's tax refund for purposes of third party debt collection. This practice is often not adequately disclosed to the tax preparation client.

See also

References

External links

Taxpayer info/tools:

Organizations/campaigns:

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:

Podcast:

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

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