Our Taxing Times

EITC Awareness Day

Who said?

“The Earned Income Tax Credit is the best anti-poverty, the best pro-family, the best job creation measure to come out of Congress.”

Today (1/27/12) is Earned Income 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. Today, EITC is available to taxpayers with and without children and on 2011 returns the maximum credit is $5700. In 2009, the IRS processed 27.4 million tax returns and paid $60.4 billion in claims. 23 states have their own variations of the credit.

EITC is based on earned income. This is moneys 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. Because of the complexity, the IRS estimates about 25% of the claims it sees are incorrect or fraudulent.

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.

"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 the Capital Journal, 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.

 McIntire Tax Center - on Facebook - on Google+ - or Twitter @ mactax.

It's Not a Race

Filing your taxes is not a race. Getting your return in first doesn't mean you in a prize. And it doesn't mean that you get something your shouldn't because your return is filed first.

This early in the season I see clients who pick up their W-2 and make a bee-line for my door. Sometimes all they need is the W-2 but sometimes they forget a something in their haste. Something like unemployment or interest income. I give them an estimate and send them away until they get all their paperwork. A slight delay but they will get their money. So far this year, I haven't heard of any tax departments holding refunds because of cash shortages.

But the other group of taxpayers who are in a hurry this year are those who racing to claim a dependent before someone else does. Some are legitamently entitled to the exemption but they're afraid an ex-spouse, parent or child will beat them to filing and cost them the exemption and any credits that go with it. And there are those taxpayers who try to claim an exemption they know they shouldn't. They are under the impression that taxes are a race and the first to file gets the money. Maybe temporarily but paybacks, as they say, are hell

Let's say the kids lived with Mom all year and she qualifies to claim them as dependents and for several credits tied to the dependent exemption (earned income credit, child tax credit, day care credit). Before she can file her return, Dad files his return and claims the kids. (By the way this doesn't mean the preparer was at fault. Too many taxpayers know how to answer the questions to maximise their refund. Yeah, they lie!) When Mom e-files her return, it's rejected because the children have already claimed on another return.  Since we're sure that she does qualify and could supply the IRS with all the documentations they need, the return is paper filed.  In a few months, both Mom and Dad will get letters asking them to check their returns because they claimed a dependent claimed by someone else. If they made a mistake, they need to amend the original return.  If Dad doesn't amend his return, both will get "prove it letter" requesting documentation to show they are entitled to the exemptions and credits.  Since Mom can prove everything, Dad must now payback any refund from claiming the kids. And that will include interest and penalty. Also if earned income credit was involved, Dad could lose the ability to claim the credit, even if actually entitled to it, for a long time.

So, I know you want your refund but waiting to get everything you need might be faster than charging in with pieces at a time. And no matter what your barber, guy at work or buddy says, filing with dependents you shouldn't use will come back on you.

 

No Ks Tax Credits With ITIN

At school this week, I picked up more info on a change in Kansas Individual returns for 2011 (KS-40). I mentioned it in a September post but I now have more background info for it.

As most other states, Kansas is working within budget issues. In order to ensure that those receiving state credits such as the Earned Income Credit, Child Care Credit, and Food Sales Tax Refund are qualified, the KDOR is now requiring the name, SSN and date of birth for all dependents on the return on the KS-40. Taking it one step further, if the dependent or taxpayer doesn’t have a SSA but uses an ITIN (Individual Tax Identification Number) the return will not qualify for any of the special credits mentioned above. That person can still qualify for an exemption but at the cost of all credits. The example Terry Hunt of the KDOR used at the workshop concerned a family who qualified on their 2010 return for Kansas EITC and Food Sales Tax Refund (FSTR). In 2011, the taxpayer’s father moves in with the family. Because he has an ITIN, the family will lose those credits on the 2011 return. This change could have a big economic impact since there were 14, 976 returns filed for 2010 in Kansas with ITINs used by the taxpayer or spouse. The new rules will expand the ITIN returns. Kansas EITC is 18% of the federal credit. The Food Sales Tax Refund was either $90 or $45 depending on income. My estimated average KS EITC on 2010 return was $344. Just for reference, if all the 2010 ITIN returns had qualified for EITC at my average, the EITC for those returns would have $5,151,744. That doesn’t even consider the FSTR or any new ITIN returns. This could create a considerable savings to the state.

This idea does bring up a question. Kansas has always been tied to the dependents claimed on the taxpayer’s Federal return. Can a dependent be claimed on the Federal return and not on Kansas? I doubt it, but that will mean letters from KDOR in a few years when the IRS / State matching program kicks in.

Back-to-School Record Keeping

It’s back to school time and time to talk tax records. Specifically, I want to talk about records and receipts for your back-to-school expenses. Nope I’m not talking about that cute dress or awesome backpack you bought for the first day of school. I want to talk about college expenses; tuition, fees, books, supplies and room and board. And it doesn’t matter if the student is a young person going full time or a parent picking up a class or going back part time or either in a graduate program, you need to keep records of what you spend and what you receive.
Congress has created several tax programs to help parents and/or students with college expenses. There are credits like the American Educational Opportunity Credit and Lifetime Learning Credits, the Higher Education Tuition Deduction, educational IRAs and the Qualified Tuition Program(QTP). All of them have different qualifications and cover different expenses. And I’m not going to cover them right now. I want to get you thinking about keeping track of school expenses and income while you’re spending the money. The basic ideas apply to most and should get you set come tax time. Then we can figure out which program you qualify for.
It doesn’t matter if you might qualify for a credit or deduction or need to show that withdrawals are for educational expenses, you need to be proactive about keeping records. Don’t rely on the 1098T that the college will send out. Schools have gotten more accurate completing the 1098T but they can be misleading.
What do you need to keep?

• Receipts for books, supplies needed for school and tuition and fee payments. Don’t rely on credit card statements, keep the receipt. Right now this can include a computer (but not school tee shirts or beer.)
• Receipts from textbook buy back and other returns.
• Amounts for scholarships, grants and student loans even if the school is handling the money. (Actually, especially if the school is handling the money.)
• What money is being pulled out of educational IRAs and QTPs.
• If money is coming from Ed IRAs and QTPs, room and board needs to be tracked too.
• If there is more than one student, keep expenses for each separate.
• Most schools have account info online and that can be helpful but don’t rely on it. It may not have everything and you still need the receipts for bookstore purchases.

This information will allow me (or your tax preparer) to accurately calculate the different educations programs and how they effect your taxes and use which program is best for your situation. Believe me, it’s better to put the info aside as you get it than to try to find it in February. Especially if you need you taxes prepared ASAP because you forgot the FASFA deadline.

Advanced EIC to End

Last December, I wrote a post about the Advanced Earned Income Credit program. Well, it looks like the program is ending after 2010. Since only 3% of those eligible took advantage of the program, it was eliminated as a way to help cover the costs of the Education Jobs and Medicaid Assistance Act of 2010.