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The Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is a tax credit that goes to low-income workers based on their family size as well as on their income. The size of the credit increases as the taxpayer’s income increases, until it reaches a maximum. After a certain amount, the credit begins to decrease until the taxpayer earns too much to qualify. In this way, the EITC rewards work but remains targeted at those with low incomes. Additionally, while people without children are eligible for the EITC, the credit increases substantially for those with children. The EITC is extremely important for two reasons. First, it is a credit, not a deduction. Whereas a deduction reduces the overall income on which income tax is calculated, a credit directly reduces the actual amount the taxpayer owes. Second, the EITC is fully refundable. This means that the family gets a refund check even when the credit is greater than the amount they owe in taxes. That the EITC is a refundable credit has resulted in it becoming the largest federal income support program for low-income working families, benefiting more than 21 million households.
Take our hypothetical family, the Joneses, again. You may recall that they make $25,000, have two children and are treated, because of the personal exemption, as if they make $11,800, and therefore owe $1,180 in federal income tax. However, the Joneses also qualify for the Earned Income Tax Credit, which for them, amounts to $2,800. Because the EITC is a credit and not a deduction, the amount the Joneses owe is directly reduced (in this case, all the way to zero). Furthermore, because the EITC is fully refundable, the leftover money in the credit (in this case $1,620) is sent to the Jones family as a tax refund. Thus, with the combination of the personal exemption and the EITC, the Joneses pay $0 in income tax and receive a refund check for $1,620.
In order to highlight the relationship between the EITC and children, compare the Joneses to the Smiths, their neighbors. Recall that the Smiths have no children, but have the same income as the Joneses. In order to be eligible to claim the EITC, a married couple’s income must be less than $14,120. Since the Smiths make more than that, they are not eligible and receive no benefit from the EITC. Through the EITC, the Joneses, because they have children, have their income tax reduced to zero and get an additional $1,620 in refunds. The Smiths, without children, still owe about $2000 in federal income taxes.
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