Yesterday (1/30/2015) was Earned Income Credit Awareness Day. So in honor of the program, here is a little information. The Earned Income Tax Credit (EITC) is a refundable credit targeted at low income families. It was enacted in 1975 to offset the social security taxes taxpayers with children paid through withholding. At that time, the credit was 10% of wages up to $4000. But in 1986, the credit was seriously expanded. There have been several more expansions of the credit since then. Today, EITC is available to taxpayers with and without children and on 2014 tax returns the maximum credit is $6143. In 2013, the IRS processed 29.1 million tax returns with EITC and paid $69.4 billion in claims. That averages out to $2,384 per return qualifying for the credit. 23 states have their own variations of the credit.
EITC is based on earned income. That is money from wages and self-employment income. If you charted EITC benefits vs. earned income, it would look like a flat top pyramid. As income increases, the amount of the credit also rises until the top refund amount is reach. Then here is a plateau before the refund begins back down to no credit. Actually, there are 8 charts. Two are for taxpayers without children; one for married and one for unmarried taxpayers. Three more charts are for married taxpayers with one, two or three (or more) children. The final three charts are for unmarried taxpayers with one, two or three (or more) children. Besides having to decide which chart to use, qualified taxpayer also need to look up both their earned income and their Adjusted Gross Income (AGI) on that chart. Their EITC is the lower of the two numbers. One of the disadvantages of EITC is the complexity.
Complexity is a big issue with EITC. Before deciding which chart to use, the taxpayer needs to decide if they qualify to take the credit. That is daunting. As a tax pro, I have to do Due Diligence on potential EITC clients to make sure they qualify. I have to check age, residence, relationship, foreign income, investment income, and potential conflicts with other taxpayers. This has to be documented on Form 8867 and sent in with the tax return. I also have to keep copies on any documentation the taxpayer brings in with them. The new due diligence requirements have forced many tax pros to stop doing returns with EITC.
There is also a real belief that the IRS should not be handling the credit. That it’s a social program and the tax code should be for tax administration. A social service agency would do better at screening EITC beneficiaries than relying on tax pros or taxpayers to do that. The IRS estimates about 25% of the claims it sees are incorrect or fraudulent. On the other hand, is the concern that it would reduce the number of taxpayers who would take advantage of a social service program out of pride. Let’s face it, for many people “welfare” is a dirty work but a “tax credit” is acceptable.
But is the credit worth the problems with it? According to Alice Lieberman, of The University of Kansas School of Social Welfare as quoted in the Topeka Capital Journal (1/21/2012).
"The Earned Income Tax Credit is the most effective anti-poverty program in the United States," Lieberman said. "It both encourages and rewards work by allowing low-income workers to recoup money that otherwise would have gone to taxes. And since low-income people are more likely to spend their income than to save it out of necessity, it is also an economic stimulus."
Also from that Capital Journal article, a 2005 National Bureau of Economic Research study found the federal program raises employment by making low-wage jobs more attractive.
“(The EITC) successfully meets its explicit goal of encouraging low-income parents to go to work by, in effect, lowering their tax rate and providing a financial bonus for that work effort,” the study found. “It has been especially effective in encouraging single parents, particularly women, to obtain employment.”
As a tax practitioner, I like the EITC (and I know many preparers who don’t). The due diligence is time consuming and it can be difficult to explain why a taxpayer doesn’t qualify or why their credit is less than a prior year. But I’ve seen the benefits. My client base included many hard working people who have low paying jobs. The EITC they receive is used to pay for unexpected expenses and as a cushion right before payday. It keeps them in their homes. I think it’s one of the better things Congress has done. So I don’t mind the extra work if helps reduce fraud and keep the credit for the good people who need it.
The quote that started this post was from Ronald Reagan.