Earned income tax credit

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The United States federal Earned Income Tax Credit (EITC or EIC) is a refundable tax credit. For tax year 2007, a filer 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 have shared residence with the child for more than half the tax year. However, in tie-breaker situations in which more than one filer actually claims the same child, priority will be given to the parent. A foster child also counts provided the child has been placed officially by an agency or court. There is a much more modest EITC for persons and couples without children that reaches a maximum of $428.^[1]

A qualifying child can be up to age 18 at the end of the tax year, up to age 23 if classified as a full-time student for at least one long semester or equivalent, or any age if classified as totally disabled for the tax year.^[2]

Enacted in 1975, the then modest EIC was expanded in 1986, 1990, 1993, and 2001 with each major tax bill, regardless of whether the tax bill 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 income measures, including the poverty rate, generally do not account for the credit), and enjoys broad bipartisan support.

Other countries with EICs include Great Britain (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. EITC (the UK EITC is worth up to 6150 Euros).

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

[edit] Earned income

Earned income can be a rather technical term defined by the United States tax code. The following are the main sources:^[2]

• 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.

[edit] Qualifying child(ren)

[edit] Age

If a person is disabled and cannot engage in substantial gainful activity and a physician has determined that the condition has lasted or is expected to last for at least a year, the person can be any age and still count as a qualifying "child." If a person is a full-time student during some part of five calendar months, they can be up to and including age 23 and still count. For example, the standard fall semester of an university in which classes start in late August and continue through September, October, November, and part of December counts as part of five calendar months. However, the five months need not be consecutive. Full-time status is often defined as at least ten semester hours, although the IRS defers to how the specific educational institution defines full-time. In all other cases, a person can be up to and including age 18 and can still count as a child for purposes of EITC.^[2]

[edit] 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. 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 further descendant of any of these related persons.^[2]

[edit] 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.^[2]

[edit] Other requirements

Investment income must be under $2,901. And, once a person is past the plateau and in the phase-out range, EITC is phased out by the greater of earned income or AGI (adjusted gross income, and as is often the case in tax law, this is a "modified" adjusted gross income).

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

And, just like a claimant with a child in the rules above, a claimant without a child must have lived in the United States for more than half the tax year. And perhaps surprisingly, Puerto Rico, American Samoa, the Northern Mariana Islands, and other U.S. territories do not count. A person on active military duty does count as living within the United States.

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

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

All claimants (and spouses and children) must have a valid social security number. This does include social security cards printed with "Valid for work only with DHS authorization" and "Valid for work only with INS authorization."^[2]

For all claimants, married filing separately acts as a disqualifying status and a person filing under that status will not be eligible for EITC. However, if a person has lived apart from their spouse for the last half of the year, has a qualifying child for whom they can claim a dependency exemption, and has paid more than half the cost of keeping up a main home (or several main homes) where they lived with their qualifying child for more than half the tax year, the person can then file as Head of Household. Alternatively, if a person obtains a divorce by December 31st, that will carry, since it is marital status on the last day of the tax year that controls for tax purposes. In addition, if a person is "legally separated" by December 31st, that will also carry for tax purposes. [see 1040 Instructions]

[edit] Table for this year

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

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 at this plateau 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 and thus the phase-outs travel $2,000 further.

However, the above table and below graph, might make it appear as though EIC 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).

[edit] Graph for last year

For tax year 2007, the maximum credit for one qualifying child is $2,853.

[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.Template:Seccombe, 2007

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.Template:Seccombe, 2007

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.^[3][4] Opponents of the minimum wage argue that it is a less efficient means to help the poor than adjusting the EITC.

[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.

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.

[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.

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.

[edit] "RALs" (Refund Anticipation Loans)

The combination of Refund Anticipation Loans and EITC is the main engine which has built the storefront tax preparation industry, including the 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^[5][6]. 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 bank account merely sits empty waiting for the IRS refund, and still end up paying the bulk of the 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. This has become common practice simply because such debt collection is a profitable sideline. And this practice is often not adequately disclosed to the tax preparation client.^[7] Questions can be raised whether such a business practice would be tolerated if it also affected middle-income persons.

[edit] See also

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

[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 Publication 596 - Earned Income Credit, a publication aimed at people who will potentially be claiming the credit.

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