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Joseph S Spence, Sr.

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Earned Income Credit Overview
By Joseph S Spence, Sr.   
Rated "G" by the Author.
Last edited: Thursday, February 05, 2009
Posted: Wednesday, February 04, 2009

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The article gives a description of the Earned Income Credit (EIC). It highlights the historical development of EIC, list the American states with EIC, states who benefits from EIC and the misconceptions associated with the EIC program.

 Earned Income Credit Overview

By: Joseph S. Spence, Sr.
 
Introduction
 
            This report highlights the Earned Income Tax Credit (EITC) requirements. It shows the rules established by the Department of the Treasury and enforced by the Internal Revenue Service. It outlines the income requirements, lists the states which follow the federal EITC program, and explains the penalties for not complying with the established rules.
Background and Goals
            The EITC was designed to assist low income individuals who are burdened with taxes and to grant them some relief. It was implemented as an economic motive to produce revenue for the poor. It is also a social goal to encourage taxpayers to undertake activities to benefit themselves and society, passed into law in 1975 by the United States Congress.
Sixteenth Amendment of the Constitution Income Tax Creation
 
      On March 1, 1913, the sixteenth amendment to the U. S. Constitution created the federal taxing agency, the Internal Revenue Service (IRS). Before the amendment, the government imposed taxes for various reasons over limited periods to finance the Civil War. Based on court challenges and rulings, the taxes imposed were declared unconstitutional in 1894. The court challenges and rulings lead to the sixteenth amendment. Since then the constitutionally of the income tax has not been challenged in the U. S. Supreme Court (Whittenburg 1-1).
Earned Income Tax Credit Enactment by Congress
      The federal EITC law was passed by Congress in 1975. It was designed as a tax credit to off-set the burden on low-income workers in the areas of social security and Medicare payroll taxes. It allows low-income taxpayers to receive a refundable tax credit. This means that a taxpayer who does not owe taxes, or owes taxes that are less than the entitled tax credit, will receive an income tax refund of the difference (Beverly).
            The EITC program began during the presidency of Gerald Ford in 1975.   Subsequent presidents have expanded the program to grant tax relief to the poor (Flournoy). During the mid-1980s, Ronald Regan disapproved of the tax burden on the poor. He also believed it was driving poor families deeper in debt because of the inconsistencies in the tax laws. As a result, in 1986 he signed into law a revised tax reform package which eliminated income taxes on poor families. Thereafter, many states passed similar actions to reduce the tax burden on the poor (Zahradnik).
      Ronald Regan sympathized with the plight of the poor and signed legislation to boost their financial position. He signed the tax bill expanding the Earned Income Tax Credit, which was hailed by many as “the best anti-poverty, the best pro-family, and the best job creation measure to come out of Congress.” Many families have since filed for and received the EITC.
      The chart below shows EITC filed with the federal government from 1997 to 2006 and the amounts paid each year in refundable credit. This chart also includes states EITC filings.
Figure I
 Federal EITC Statistical Graphs
 Tax Year
 Return Count
 Total EITC
 1997
 19.4 million
$30.4 billion
 1998
 19.7 million
$31.6 billion 
 1999
 19.3 million
$31.9 billion 
 2000
 19.3 million
 $32.3 billion
 2001
 19.0 million
 $32.4 billion
 2002
 20.9 million
 $36.9 billion
 2003
 21.4 million
 $38.3 billion
 2004
 21.7 million
 $39.8 billion
 2005
 22.2 million
 $41.4 billion
 2006
 22.4 million
 $43.7 billion
Source: Internal Revenue Service, 2008  
State Earned Income Tax Credit
      “Many states do not have the EITC,” said Ike Gherezgher, president, Instant Tax Service, Milwaukee.[1] “We are fortunate in Wisconsin to have the credit. It is actually a benefit for low and moderate income taxpayers.”
      Only 20 of the 50 states have an EITC program. The credit the states offer is based on a percentage of the federal EITC ranging from 3.5 percent to 50 percent. Unlike the federal, only 19 of the 20 states have a refundable credit.  Wisconsin offers a credit of 4 percent for 1 child, 14 percent for 2 children, and 43 percent for 3 of more children as a percentage of the federal rates.
      Many states have petitioned their legislative bodies to implement an EITC program without success. The EITC may be claimed by filing a state income tax return. Citizens must meet certain requirements to be eligible for the EITC. The states with EITC for the 2007 tax year are listed below.
Figure 2
States with State-Level Earned Income tax Credit Program
District of Columbia
Kansas
Nebraska
Rhode Island
Delaware
Maine
New Jersey
Vermont
Illinois
Maryland
New York
Virginia
Indiana
Massachusetts
Oklahoma
Wisconsin
Iowa
Minnesota
Oregon
New Mexico
Note: The remaining 30 states do not have a state-level EIC program. New Mexico, which is included in the above chart, offers a “Low income Comprehensive Tax rebate” program which closely resembles the EITC.
 
Earned Income Tax Credit Eligibility Income Level
      Each taxpayer must meet certain requirements to be eligible for the EITC. The refund varies based on the taxpayer’s income, tax filing status, and number of dependents. Married individuals with more that one child must have earned income of $39,783 or less; if only one child, $35,241 or less; and if no qualifying children, $14,590 or less. A single person with two or more children must earn $37,783 or less; if only one child, $33,241; and if there are no qualifying children, $12,590 or less (IRS 1040 Instructions 44).[2] Furthermore, the EITC may be denied for other reasons, not withstanding the income levels.
      The following chart shows the tax credit for each income level with and without children.
Figure 3
Federal Earned Income Tax Benefits for Tax Year 2007

 
 
No Children
One Qualifying Child
Two or More Qualifying Children
Single
 
Adjusted gross income of less than $12,590
Maximum Tax Credit $428
Adjusted gross income of less than $33,241
Maximum Tax Credit $2,853
Adjusted gross income of less than $37,783
Maximum Tax Credit $4,716
Married (filing jointly)
 
Adjusted gross income of less than $14,590
Maximum Tax Credit $428
Adjusted gross income of less than $35,241
Maximum Tax Credit $2,853
Adjusted gross income of less than $39,783
Maximum Tax Credit $4,716

Source: Copyright © 2007 World Institute on Disability
Reasons for Awarding and Denying EITC
            The Latino Student Association at MATC raised concerns regarding the Individual Tax Identification Number (ITIN) and the treatment of immigrant workers. “Only illegal immigrants have an ITIN,” said Maria Sanchez, president, MATC Latino Student Association.[3] “There are restrictions placed on the use of the ITIN by immigrants. However, if they are allowed to work and pay taxes, then why are they not allowed to get the EITC as other qualified taxpayers?”
            Each taxpayer must have a valid social security number (SSN) to be eligible to receive the EITC. Immigrants possessing only an ITIN do not qualify to receive the EITC. Individuals who have a missing or lost SSN do not qualify, as most immigrants do not. Additionally, the taxpayer must be a citizen of the United States or a resident alien for the entire year. Part year residents or nonresidents do not qualify for the EITC.
            Married individuals who file separate tax returns do not qualify for the EITC. However, married individuals who have lived apart from their spouse for the last six months of the year for which they are filing and have a qualifying child, may then receive the EITC.
            Individuals with foreign earned income do not qualify for the EITC. Additionally, individuals claiming more that $2,900 in investment income do not qualify. Investment income includes: taxable interest from banks, dividend income from credit unions, capital gains income from the sale of stocks or property, and tax exempt income. Other factors may lead to disallowance of the EITC.
Disallowance of the EITC
            A taxpayer will be denied the EITC for reckless or intentional disregard of the rule. Once a person has been denied the credit, there is a waiting period of two years before the taxpayer is eligible to reapply.   If the error resulted from fraud, the waiting period is ten years.
            Once the waiting period has passed, the taxpayer must file IRS Form 8862, Information to Claim Earned Income Credit after Disallowance. If the denial was based on a clerical error, such as the transposition of numbers, IRS Form 8862 is not required to claim the EITC (IRS Publication 596).[4] Also, not meeting certain qualifications will lead to a denial of the EITC.
EITC Qualification Test
 
       The qualifying child being claimed by the taxpayer for the EITC must
 
meet certain guidelines. The child must be related to the taxpayer or is a
 
descendant. This includes foster children and adopted children.
 
Brothers, sisters and their descendants also qualify. Additionally, the
 
child cannot be the qualifying child of another person.
 
            The child must be a citizen of the United States or a resident alien of a state for one year or more. This includes all fifty states and the District of Columbia. However, Puerto Rico, U. S. territories, and Guam are excluded.
            The child must be under the age of 19 at the end of the tax year the claim is filed. The age is extended to 24 if the child is attending school on a full time basis for at least five calendar months of the school year. If the child is permanently and totally disabled there is no age limit.
            Only one person may claim the child. The child may not be split between two parents, or another relative who cared for the child. The parent will be allowed the credit over a third party. When both parents can claim the EITC, preference will be given to the parent with whom the child resides. If the child resided with both parents, the parent with the highest income will be able to claim the EITC (Publication 17).[5] There are also some common EITC issues to avoid.
Most Common Filing Errors
            Claiming a non-qualifying child or ineligible dependents will affect the EITC. Each taxpayer may claim a qualifying child as a dependent only if the child meets the legal requirements of a dependent. Each dependent is required to have a valid SSN, which the parent must include on the tax return. The failure to include a dependent’s name and SSN on the tax return, or claiming an ineligible child, may result in an underpayment of tax and possibly a denial of the EITC.
            Using the wrong filing status such as single, married filing jointly, married filing separately, head of household, and qualifying widower will impact the EITC. The most common mistake is when a taxpayer incorrectly uses the "head of household" filing status without meeting the requirements. Using the wrong filing status will affect the taxpayer’s eligibility for the EITC.  There are also some individuals who conceal their income to obtain the EITC.
            “There are individuals who will refuse to report certain income to obtain the EITC,” said Shelly English, Community Tax Service. “Taxpayers, who are working for cash, and knowing they are on the borderline of the EITC bracket, may at times withhold reporting cash income to obtain the tax credit. This is one of the most common areas of fraud with the EITC.”
            The failure to report income not included on a Form W-2, Form 1099 or other income reporting documents will cause a denial of the EITC. Each taxpayer must report income from all sources, even if the income was not reported on a Form W-2, Form 1099, or other similar document. The failure to report all income could result in an assessment of additional taxes and penalties. Obviously, there some are misconceptions regarding the purpose of the EITC.
EITC Misconceptions
            Confusion exists among taxpayers regarding the EITC. For example, some are under the impression that the less income they make the greater the EITC will be. On the other hand, some believe that the more income they earn, the greater the EITC they will receive. Both sets of taxpayers are incorrect with their assumptions. There is an income amount at which taxpayers will receive the maximum EITC. Beyond that income, the EITC refund starts to decrease. The following chart shows income levels of $8,000 to $17,000 where taxpayers obtained the maximum EITC refund in 2006; however, some taxpayers have used the rules to their benefit. 
The Federal Earned Income Tax Credit in Tax Year 2006
Source: Center on Budget & Policy Priorities
            “The most depressing part of the EITC refund is when a taxpayer stops working at a certain income level just to obtain the maximum EITC,” said Lance Quigley, president, Quigley Tax Service. “Individuals will call the office seeking information just to see at what point they should stop working. They want to make sure they do not exceed the income level in order to obtain the maximum EITC refund. If a person has three children and obtains the maximum refund from the federal, that individual also receives an additional 43 percent EITC refund from the state, thus receiving approximately a $6,500 tax free credit. This takes away the incentive to be gainfully employed, and it prevents a person from being self actualized by relying on the government for support.”
            There is another misconception regarding the EITC regarding immigrants. Individuals who do not have a SSN and are working in the United States are under the impression they are entitled to receive the EITC. “There are many individuals with a social security card which states ‘for employment purposes only’ and they are not entitled to the EITC,” Quigley said. “Some are teachers, students, and illegal immigrants. Giving them the credit is a disincentive to becoming a citizen. It actually takes needed cash away from Americans who are working hard to make ends meet.” Based on the comments, there are differences of opinions regarding the poor.
Conclusion and Recommendations
            Obviously, the federal government is unable to convince all the states to take certain actions regarding taxation to benefit poor families. Only 19 of the states have allowed an EITC refund for their residents. Budgetary restraints could be one reason why all states do not have an EITC program. However, it would be a tax benefit to the poor if each state had a program. Some states are still filing petitions to have the credit approved.
            The EITC was designed to provide tax relief for poor families; however, it appears that it is being used in ways it was not intended, based on taxpayers’ misconceptions. There are many Americans who are deserving of the EITC. On the other hand, there are others who are able to work and they refuse to be gainfully employed in order to receive the credit.
            There should be some balancing factors by the states and the federal government regarding the EITC. One must wonder why the other states in America do not have an EITC program. Are they providing incentives for their residents to be gainfully employed and not rely on the government for support? Some are under the impression that it is an incentive issue of achieving self actualization through gainful employment. However, in times of economic crisis such as the present, the poor needs help to maintain their basic needs. One of the programs which assist them in making this possible is the EITC.
Works Cited
Beverly, Sondra G. "What Social Workers Need to Know About the Earned Income Tax Credit." Social Work. July 2002: 259.
Department of the Treasury. Internal Revenue Service 1040 Instructions. Catalogue No. 11325E. Washington: GPO (2007).
Department of the Treasury. Internal Revenue Service: Publication 17. Catalogue No. 11311G. Washington: GPO (2007).
Department of the Treasury. Internal Revenue Service: Publication 596. Catalogue No. 15173A. Washington: GPO (2007).
English, Shelly. Personal Interview (face-to-face). 27 Apr. 2008.
Flournoy, Melissa S. A Tax Credit That Works. Louisiana Association of Nonprofit Organizations. Jun. 2007. Retrieved 2 May 2008     <http://www.stateeitc.com/documents/louisiana>.
Gherezgher, Ike. Personal Interview (face-to-face). 30 Apr. 2008.
Quigley, Lance. Personal Interview (face-to-face). 3 May 2008.
Sanchez, Maria. Personal Interview (face-to-face). 18 Apr. 2008.
Whittenburg, Gerald and Altus-Buller, Martha. Income Tax Fundamentals. Southwestern-Thompson Higher Education, 2008.
Zahradnik, Bob. Reducing Hawaii’s Income Tax on Working Poor Families: Three Options.Center on Budget and Policy Priorities. 2004. Retrieved 30 Apr. 2008
            <http://www.cbpp.org/3-11-    04sfp.htm>.
 

[1] Instant Tax Service is a franchised tax preparation firm with eleven offices in Milwaukee servicing individuals and business customers.

[2] The 1040 Instruction Booklet is the official guide from the IRS for taxpayers to follow when completing their personal income tax return.

[3] The Latino Student Association consists of Hispanic-Americans and Spanish speaking students from mostly Mexico and South America. It is the second largest minority group attending MATC.

[4] Publication 596 is the official IRS publication with specific guideline for filing the EITC. It includes examples and line by line instructions for completion of the required forms.

[5] Publication 17 is the official IRS booklet with references to the IRS official publications and tax tables for individual taxpayer reference when completing their tax returns.

 

 

 

 

 

 



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