The earned income tax credit, or EITC, can be a great benefit for workers who don't make much money or to those who did work but then lost a job. This tax break returns to qualified individuals a portion of the taxes they paid.
It even can produce a tax refund for eligible filers who had no tax liability. Most tax credits are nonrefundable, meaning they simply zero out a tax bill. For example, you owe $800 and have a $1,000 credit. That credit will erase your $800 bill, but you lose the extra $200.
But a refundable credit, which the EITC is, will allow you to get that extra $200 back as a refund from the Internal Revenue Service.
There is, however, a drawback to the credit. It is rather complicated, and because eligible taxpayers usually don't have much cash to spare, they generally cannot afford professional help in filing for it. The IRS has an online program, the Earned Income Tax Credit Assistant, to help these filers.
By answering some questions and providing basic income information, the online program will help you determine your correct filing status, whether your children meet the credit's requirements and will give you an estimate of the amount of credit you may receive.
So that you'll know what to expect when you go to the online program, here's a look at the earned income credit's basic guidelines and pitfalls.
Many people think the credit is available only to parents. It's not. But the amount the IRS will give back is greater for eligible low-wage taxpayers with children. The amount is adjusted for inflation each year.
Tax year 2012 maximum credit
- $5,891 with three or more qualifying children.
- $5,236 with two qualifying children.
- $3,169 with one qualifying child.
- $475 with no qualifying children.
To qualify for the credit, a taxpayer must earn money, but not too much.
Tax year 2012 earned income and adjusted gross income must be less than:
- $45,060 ($50,270 if married filing jointly) in households with three or more qualifying children.
- $41,952 ($47,162 if you're married and file jointly) with two qualifying children.
- $36,920 ($42,130 if you're married and file jointly) with one qualifying child.
- $13,980 ($19,190 if you're married and file jointly) with no qualifying children.
All wage or salary income, as well as any self-employment earnings, count toward the eligibility limits. Investment income also must be taken into account. If you collect too much of this unearned income, it could disqualify you. For 2012 returns, if you made more than $3,200 in investment income, you cannot file for the earned income credit.
Married couples who file separate returns are not eligible for the earned income credit. If you are married, but your spouse did not live in your home for the last six months of the year, you may be able to file as head of household and take the credit.
And if you have no children, you must meet four additional tests before you can claim it.
Tests for childless EITC claimants
- You must be at least 25 years old, but younger than 65 at the end of the tax year for which you are making the claim. If you're married, at least one spouse must meet the age requirement.
- You cannot be the dependent of another taxpayer.
- You cannot be the child that another taxpayer could use to qualify for the credit.
- You must live in the U.S. for more than half of the tax year.
Requirements children must meet
All taxpayers claiming credits based on the children they are raising must take into account each child's age, the child's relationship to the taxpayer, where the child lived during the tax year and the child's tax-filing circumstances.
In most cases, the child must be younger than 19 at the end of the tax year in which the EITC is claimed. However, if the child is a full-time student, he or she can be as old as 23 and be claimed for the credit. Also, a permanently disabled child, regardless of age, can be claimed in connection with the earned income credit.
The relationship test is met if the child is your son or daughter (either by birth or adopted), stepchild or grandchild. Your brother, sister, stepbrother or stepsister (or the child or grandchild of these relatives) may also be considered for credit purposes.
A foster-child relationship may qualify for the credit as long as the child was placed with you by an authorized placement agency. This includes a state or local government agency or court, as well as a tax-exempt organization licensed by a state.
As for residency, the IRS generally demands that the child live with the taxpayer in the United States for more than half of the year.
Finally, if the child is married and files a joint return, then that child no longer qualifies the parent for the EITC.
Claiming the earned income credit can be especially confusing for people sorting through child custody issues.
When custody is split, only the parent who physically housed the child for more than six months can claim the credit. Sometimes, however, a child might be claimed by either parent.
This would be the case if you and your spouse lived together with your daughter until July 1 and then you separated. You shared custody of your daughter equally until your divorce became final in December. Since the girl lived with both of you for more than half the year and neither parent exceeds the credit's earning limits, you must decide who will claim the larger credit amount that is available when a child is involved.
If you and your spouse cannot agree, and each of you files naming your daughter in your credit claim, the IRS invokes tiebreaker rules to determine which taxpayer gets the tax break.
First, the agency looks at whether only one person is the child's parent. This would be the case, for example, if one credit claimant is a stepparent. The parent would get the credit.
If neither person is the child's parent, the IRS would then give the credit to the filer with the highest eligible adjusted gross income.
Finally, if both filers are parents of the child, the parent with whom the child lived the longest during the tax year would be given the credit. If the child lived with both separated parents for an identical amount of time, the credit would go to the parent with the highest adjusted gross income.
If several children are involved in a family situation where two taxpayers may claim them, the adults can decide to share the children for credit purposes. For example, you can use one child to claim the earned income credit and your spouse can use the other children. Again, if a sharing agreement cannot be reached, the tiebreaker rules would come into play.
The earned income credit can be claimed on any individual tax return: the 1040EZ, 1040A and 1040. Each form's instruction booklet devotes several pages and accompanying work sheets to the credit.
In addition to the online assistance program, you also can find information and filing examples in IRS Publication 596, Earned Income Credit. Taxpayers with specific questions about or problems with filing for the credit can call the IRS at (800) 829-1040.
Military personnel also need to pay attention to special provisions that could require them to compute the credit two ways. Normally, combat pay is not taxable, but servicemen and servicewomen who received this income now can choose to count it if it will help in their earned income tax credit claim.
Don't forget your state
If you qualify for the EITC on your federal tax return, you also may be eligible for a similar credit from your state. Twenty-two states and the District of Columbia as well as New York City and Montgomery County, Md., offer their residents an earned income tax credit.
The IRS maintains a list of jurisdictions that offer their own EITC. If you have questions about state or local eligibility requirements or how to claim EITC on those returns, check with those tax officials. Bankrate's state tax directory has information on how to contact those offices.
As the federal, not to mention the possible state, paperwork devoted to the earned income credit demonstrates, filing for it can be daunting. But don't be discouraged by the rules. Just make sure you follow them.
If you qualify, the earned income tax credit can give you back a nice chunk of change.
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