Many qualified taxpayers overlook the Earned Income Tax Credit (EITC), potentially missing out on thousands of dollars at tax time.
Tax credits mystify many Americans, if only because it's hard to know which ones they qualify for and why. They're worth having because they provide meaningful savings on a filer’s overall tax contribution and in some cases lead to a tax refund.
One of the most beneficial credits for families with low or moderate incomes is the Earned Income Tax Credit (EITC). It was established to offset the burden of Social Security taxes and provide an incentive to work. Experts of financial planning and taxes recommend all filers explore their eligibility for receiving the EITC.
"It is an overlooked credit all too often," says Sandy Zinman, committee chairman for the National Conference of CPA Practitioners. "If you're not earning a whole lot of money but are working, you can end up getting back more money than you pay in."
Here are five facts about the Earned Income Credit that should clarify some of the simpler mysteries of the credit.
“Just because you didn’t get it last year doesn’t mean you won’t get it this year. This economy has been rough on a lot of people. A lot of people’s tax situations can change in a year. Tax laws change. … You should check every year.”
—Louis Barajas, financial planner and author, Santa Fe Springs, California
1. Eligibility is limited to low-to-moderate income earners
The general eligibility rule for the EITC is fairly straightforward. Taxpayers must file as individuals or married filing jointly. If married, you, your spouse and your qualifying children must have valid Social Security numbers. You must also be 25 or older but younger than 65. For the 2018 tax year, the maximum credit is $6,444. According to the Internal Revenue Service, the average amount credited in 2016 was $2,455.
Louis Barajas, a financial planner based in Santa Fe Springs, California, strongly touts the benefit of the Earned Income Credit to qualifying taxpayers, emphasizing that a credit, unlike a deduction, is "like additional income."
"It’s basically additional support from the federal government," Barajas said.
In 2018, a married couple with three children and adjusted gross income of $54,998 or less could receive up to $6,444. An individual who earns $15,310 and has no children may receive up to $520. There are many variations in between that affect eligibility, Barajas said, and it behooves you to file electronically: Those taking the traditional paper and pencil route might miss opportunities.
Although the EITC typically is considered a "low income" credit, Barajas says, a spouse working as the sole income earner of the family, perhaps on an hourly or contract basis, may also qualify.
“If they work 2,080 hours in a year, they could be making over $25 an hour—what most people would not consider to be necessarily low income—(but) they would qualify for the tax credit,” Barajas said.
2. Self-employed still counts
Many filers—especially self-employed individuals—fail to take advantage of credits because they think they are ineligible, Barajas said.
"I have had a lot of people who I have seen need to amend their returns, who were self-employed, who missed out because they didn’t think they were eligible," said Barajas. "I don’t think they ever think that they qualify for it, but they do."
The IRS considers all income that is earned eligible for the credit. That includes wages, salaries, tips and other taxable employee pay, as well as union strike benefits and long-term disability benefits received prior to minimum retirement age. It also covers net earnings from self-employment if you own or operate a business, and gross income received as a statutory employee—an independent contractor under common law rules.
Other types of income that do not qualify as earned income for the credit include child support, retirement income, Social Security benefits, unemployment benefits and alimony. Pay received for work while in prison also does not count for the credit.
3. Investment income can disqualify you
In 2018, income derived from investments, whether it is stock dividends, rental properties or inheritance, disqualifies you if it is greater than $3,500 in one year.
"Let’s say your dad died and left you $500,000, and you’re saving it for retirement but the bank sent a (Form) 1099 for the interest," Barajas said. "You would not be able to qualify for the Earned Income Credit even though you didn’t touch that money."
4. Eligibility fluctuates
Taxpayers should pay attention to their EITC eligibility every filing year, Barajas said.
"Just because you didn’t get it last year doesn’t mean you won’t get it this year," he said. "This economy has been rough on a lot of people. A lot of people’s tax situations can change in a year. Tax laws change. … You should check every year.”
Status changes can include a new job, unemployment, loss of an annual bonus because of the recession, a change in marital status, or a change in a spouse's employment situation.
Zinman agrees, and reminds all filers to go slowly and provide all of their information correctly.
"A taxpayer’s status—dependent versus not—marital status, income changes (to) higher or lower and number of dependents will all potentially affect the EITC eligibility," Zinman said.
5. Tax software can help
Barajas suggests filers consider using a qualified tax software system to maximize all of the available credits, especially the earned income credit. Because the EITC is one of the most lucrative credits available to struggling Americans, it is also an area most rife with fraud from "unscrupulous tax preparers," he said.
"There’s a lot of abuse with this," Barajas says. "In low-income areas some preparers will scam the system by not filing or declaring income to get (a customer) the EITC, or they will hide certain income or claim a lot of deductions."
In some cases, an individual will pay exorbitant fees because a preparer promises a big payday.
"Someone who is making $20,000 a year will pay $500 for an accountant who says, 'I’m smart. I can get you a lot of money.' But $4,000 or $5,000 in taxes and penalties because of errors or fraud isn’t worth it," Barajas said.
He said electronic tax programs offer an advantage because—assuming you place checks in all the right boxes—they ensure that you receive the credits to which you are entitled.
Like everything else associated with the Internal Revenue Service, it doesn't pay to be dishonest. The IRS may reduce or even revoke a filer's access to the Earned Income Tax Credit for a number of years if the agency determines the filer committed fraud or flouted the rules to obtain the credit.
If the IRS finds that someone recklessly disregarded the rules to increase the credit, it may prohibit the filer from receiving the credit for two years, after which the filer would have to file a special request form to apply for the right to claim the credit.
In the event the IRS determines a filer has supplied fraudulent financial information to claim the EITC, it may penalize the filer by disallowing the credit for 10 years.
These penalties do not apply to math or clerical errors.
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