Incentives Watch: Earned Income Tax Credits 101

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Earned income tax credits (EITCs) present a unique challenge for tax practitioners, government officials, and those whom the credits are intended to benefit. The credit’s lengthy list of qualifications, thresholds, and calculations make what is difficult for a tax preparer potentially unnavigable for low-income families. Compounding the issue is a lack of knowledge and communication with the communities the credit is intended to benefit, leading, for example, to $1.8 billion of credits going unclaimed each year in California alone. Many states have followed the federal government, expanding the credit but in ways tailored to the state’s needs. Here are the EITC basics. 

EITC: A Primer

The federal government enacted the first EITC in 1975, and it has since been expanded both at the federal and state level. The federal credit is based on a percentage of income earned, up to an income threshold which varies based on filing status, type of income, and number of qualifying children claimed. Individuals with more qualifying children may receive a higher percentage of their income as a credit. The credit also phases in and out, maximizing the benefit for those with income between $8,050 and $16,800. The federal credit does not affect other welfare benefits and is refundable. 

28 states have enacted a version of the federal earned income tax credit, most of which offer a percentage of the FEITC against state income tax according to Bloomberg BNA’s Individual Income Tax Navigator (subscription required). The refundable percentage of the FEITC offered by states can vary from as high as 50 percent in Maryland to as little as 3.5 percent in Louisiana. Whether the credit is refundable adds another layer of diversity, with states offering full, partial, or no refund for credits which exceed the taxpayer’s state income tax liability. Finally, more states appear to be enacting or increasing the credit in past years

Increasing Awareness

Concerning the EITC, one of the issues facing federal and state governments is increasing awareness and information among the credit’s targeted individuals. Low-income families suffer from a lack of knowledge of the credit and insufficient resources to pay for tax preparation. In Illinois alone, close to 21 percent of families who qualify for the EITC fail to claim the credit on their return, leaving thousands of dollars on the table, according to the National Conference of State Legislatures. 

Federal and state agencies have recognized the problem and are attempting to respond. In 2007, the IRS established EITC Awareness Day, an attempt to work with local organizations and volunteers to raise awareness of the EITC’s availability, and January 27th marked the campaign’s 11th successful year. Oregon just took the extra step of requiring employers to provide written notice to low-income employees of the availability of the federal and state credit. 

Common Ground

State and federal EITCs are a rare anti-poverty tool that enjoy broad support from both Republicans and Democrats. Republicans such as Wisconsin Gov. Scott Walker and New Jersey Gov. Chris Christie have supported it because of the tie to earned income; Democrats such as California Gov. Jerry Brown and Montana Gov. Steve Bullock have supported it as a government benefit to help needy families. Several studies have backed up their claims, finding the EITC to have a positive impact in a number of areas, including health, poverty, and local economies. A CBO study in 2014 looked at the effects of raising the minimum wage versus increasing the EITC, and found the cost to employers of raising the minimum wage far outpaced the expense to the government of raising the EITC. 

Continue the discussion on the BBNA State Tax Group on LinkedIn: Should states expand their earned income tax credit to spur wage and employment growth? 

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