What is Earned Income Tax Credit (EITC)?
Earned Income Tax Credit or EITC also called as EIC is an important benefit for working people who have low to moderate income. The EIC is a refundable credit, enacted as a work incentive in the Tax Reduction Act of 1975. It provides a financial boost to working individuals and families. It has become one of the primary forms of public assistance for low income working taxpayers.
A tax credit means more money in your pocket. It reduces the amount of tax you owe and may also give you a refund. Eligibility for the EIC is based on the taxpayer’s earned income, adjusted gross income, investment income, filing status, and work status in the United States. The amount of the EIC is based on the presence and number of qualifying children in the worker’s family, as well as on adjusted gross income and earned income.
The earned income credit generally equals a specified percentage of earned income up to a maximum dollar amount. Earned income is defined as wages, salaries, tips and other employee compensation, but only if such amounts are includible in gross income, plus the amount of the individual’s net self-employment earnings. The maximum amount applied over a certain income range and them diminishes to zero over a specified phase-out range. For taxpayers with earned income (or adjusted gross income(“AGI”), if greater) in excess of the beginning of the phase-out range, he maximum EIC amount is reduced by the phase-out rate multiplied by the amount of earned income(or AIG, if greater) in excess of the beginning of the phase-out range. For taxpayers with earned income (or AGI, if greater) in excess of the end of the phase-out range, no credit is allowed.
An individual is not eligible for the EIC if the aggregate amount of disqualified income of the taxpayer for the taxable year excess $3450 (for 2017). This threshold is indexed for inflation. Disqualified income is the sum of interest (taxable and tax-exempt), dividends, net rent and royalty income (if greater than zero), capital gains net income and net passive income (if greater than zero) that is not self-employment income.
The EIC is a refundable credit, meaning that if the amount of the credit exceeds the taxpayer’s Federal income tax liability, the excess is payable to the taxpayer as a direct transfer payment.
The EIC generally equals a specified percentage of earned income up to a maximum dollar amount. Earned income is the sum of employee compensation included in gross income (generally the amount reported in Box 1 of Form W2, Wage and Tax Statement) plus net earnings from self-employment determined with regard to the deduction for one half of self-employment taxes. Special rules apply to computing earned income for purposes of the EIC. Net earnings from self-employment generally includes the gross income derived by an individual from any trade or business carried on by the individual, less the deductions attributable to the trade or business that are allowed under the self-employment tax rules, plus the individual’s distributive share of income or loss from any trade or business of a partnership in which the individual is a partner.
When to expect EIC Refunds in 2018
Due to changes in the law, the IRS cannot issue refunds before February 15, 2018, for returns that claim the EIC. This applied to the entire refund, not just the portion associated with the EIC.
The Protecting Americans from Tax Hikes Act of 2015 (PATH) made several changes for claiming this credit. The PATH Act made the following changes, which became effective for the 2016 filing season, to help prevent revenue loss due to identity theft and refund fraud related to fabricated wages and withholdings:
The IRS may not issue a credit or refund to a taxpayer before February 15th, if the taxpayer claims the Earned Income Tax Credit on their return.
This change only affects returns claiming EITC that are filed before February 15.
The IRS will hold the entire refund, including any part of the refund that isn’t associated with the EITC.
The PATH Act prevents taxpayer from filing retroactive returns or amended returns claiming EITC.
Maximum Adjusted Gross Income for EIC
The maximum amount of income you can earn and still get the credit has been increased for 2017 tax year. In order to receive EIC your Adjusted Gross Income (AGI) should be less than the limit listed below:
— You have three or more qualifying children and you earned less than $48340 ($53930 if married filing jointly),
— You have two qualifying children and you earned less than $45007 ($50597 if married filing jointly),
— You have one qualifying child and you earned less than $39617 ($45207 if married filing jointly), or
— You don’t have a qualifying child and you earned less than $15010 ($20600 if married filing jointly).
The IRS considers disability retirement benefits as earned income until you reach minimum retirement age. Minimum retirement age is the earliest age you could have received a pension or annuity if you did not have the disability. After you reach minimum retirement age, IRS considers the payments your pension and not earned income. Benefits such as Social Security Disability Insurance, SSI, or military disability pensions are not considered earned income and cannot be used to claim the EITC. You may qualify for the credit only if you, or your spouse, if filing a joint return, have other earned income. Payments one receives from a disability insurance policy that one paid the premiums for are not earned income. It does not matter whether you have reached minimum retirement age.
The EITC is a complex law that involves eligibility rules based on a taxpayer’s income, marital status and parental arrangements, which can often change on a year-to-year basis. To claim EITC on your tax return, one must meet all the following rule:
— You, your spouse (if you file a joint return), and all others listed on Schedule EIC, must have a Social Security number that is valid for employment and is issued before the due date of the return including extensions. You cannot get EIC if, instead of an SSN your (or your spouse, if filing a joint return) have an individual tax identification number (ITIN). ITINs are issued by the IRS to non-citizens who can’t get an SSN.
If an SSN for you or your spouse is missing from your tax return or is incorrect, you may not get the EIC. If an SSN for you or your spouse is missing from your return because either you or your spouse didn’t have a valid SSN by the due date of your 2017 return (including extensions), and you later get a valid SSN, you can’t file an amended return to claim the EIC.
If you don’t have an SSN, you can apply for one by filing Form SS-5, Application for a Social Security Card, with the SSA. You can get Form SS-5 online at SSA.gov or from your local SSA office or by calling the SSA at 1-800-772-1213
— You must have earned income from working for someone else or owning or running a farm or business. Earned income includes wages, salaries, tips, and other taxable employee pay. Employee pay is earned income only if it is taxable. Nontaxable employee pay, such as certain dependent care benefits and adoption benefits, isn’t earned income.
— Your filing status cannot be married filing separately. If you are married, you usually must file a joint return to claim the EIC. If you are married and your spouse didn’t live in your home at any time during the last six months of the year, you may be able to file as head of household, instead of married filing separately. In that case, you may be able to claim the EIC.
— You must be a US Citizen or resident alien all year. You are taxed on your worldwide income.
— You cannot be a qualifying child of another person.
— You must meet the earned income, AGI and investment income limits.
— You must have a qualifying child. Sometimes a child is a qualified child of more than one person. Only one of such persons can actually treat the child as a qualifying child. He could claim exemption for the child, claim child tax credit, can claim head of household filing status, claim credit for child and dependent care expenses, could claim the exclusion for dependent care benefits and the EIC. You and the other person cannot agree to divide these tax benefits between you. The child must be under age 19 at the end of the tax year and younger than taxpayer (or taxpayer’s spouse, if filling jointly) or under age 24 at the end of the tax year, a student, and younger than taxpayer (or taxpayer’s spouse, if filling jointly).
If the parents don’t file a joint return together but both parents claim the child as qualifying child, the IRS will treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher adjusted gross income for the year.
— If you don’t have a qualifying child, you must be age 25 years but less than 65 years at the end of the year and lived in United States for more than half the year and not qualify as a dependent on another person.
— If you qualify for EITC, you have to file a tax return with the IRS, even if you owe no tax or are not required to file. Many taxpayers miss out because they owe no tax so do not file a tax return. EITC is not automatic.
Taxpayer can also move in and out of EITC eligibility from year-to-year based on your tax filing status, the number of qualifying children you can claim, and your financial situation. Every year, approximately one-third of taxpayers qualifying for EITC are newly eligible.
A Qualifying child with a disability must have a Social Security Number that is valid for employment and is issued before the due date of the return. There is no age limit and the child does not have to be younger than you if the qualifying child is permanently and totally disabled. Your qualifying child is permanently and totally disabled if he or she cannot engage in any substantial gainful activity because of a physical or mental condition and a doctor determines the condition has lasted or can be
Common EITC errors
The population of taxpayers who rely on the EITC share a common set of characteristics, such as low education and high transiency, which create challengers for taxpayer compliance. IRS persists in using traditional audits as its primary compliance tool. Common EITC errors we find the most are that for the qualifying child test, with relationship, residency age and joint return etc. Most common are because the child is not related in one of the listed relationship or the child didn’t live with the person or persons on the tax return. The second common error is more than one person claiming the same child. This is often due to the child lived with more than one person for more than half the tax year. But, sometimes, a person claims a child who did not live with them for more than half the tax year. Third common error is Social Security number or last name mismatches. Look at the Social security card of everyone listed on your return to make sure the number matches and that you use the name the same way the Social Security Administration lists the name. Fourth common error is when you are married, filing as single or head of household. Avoid an audit, additional tax, penalties or interest by making sure all the information on your tax return is complete and correct. There are consequences for filing your returns with errors whether you made a mistake or knowingly did it. Expect your preparer; whether you pay or it’s free, to ask you a great deal of questions to make sure your return is correct.
Improper Claim’s made in prior year
If your EIC for any year after 1996 was denied or reduced for any reason other than a math or clerical error, you must attach a completed Form 8862 to your tax return to claim the EIC. You must also qualify to claim the EIC by meeting all the rules mentioned above.
If your EIC for any year after 1996 was denied and it was determined that your error was due to reckless or intentional disregard of the EIC rules, then you can’t claim the EIC for next 2 years. If your error was due to fraud, then you can’t claim the EIC for the next 10 years. Such a system does not promote future compliance.
Some taxpayers would appeal their EITC claim denials to the US Tax Court. This increases systemic costs. The taxpayer may retain a pro bono attorney through his or her local Low Income Taxpayer Clinic (LITC). LITCs represent low income individuals in disputes with the IRS, including audits, appeals, collection matters, and federal tax litigation. Due to litigation, it increases the cost for the IRS for IRS attorneys and Appeals staff, in addition to court’s expenses. It also delays the refund to a taxpayer. IRS would also have to pay interest on the delayed refunds when EITC claims are later allowed due to litigation or appeals.
T. Rinu Cherian
Low Income Taxpayer Clinic
Northeast New Jersey Legal Service