What is Earned Income Credit (EIC)?
Earned income credit (EIC) is a U.S. tax benefit offered to working families with low-to-moderate income, especially those with children. It lowers the tax amount owed on a dollar-for-dollar basis. The taxpayer gets a refund if the tax amount owed is less than the credit amount.
- Earned income credit (EIC) is a tax credit for low-to-moderate income-earning families, particularly those with children.
- The maximum credit value and the EIC rate depend on the size of the taxpayer’s family, with higher credits offered to families having more children.
- EIC encourages people to join the labor force and supplements the income of low wage earners, moving them out of poverty.
How Earned Income Credit (EIC) Works
Working families receive a credit amount that is a fixed percentage of their income, which is accumulated from the first dollar of income until it reaches a certain maximum value.
When the credit gets to the maximum limit, it is paid at the maximum until the income equals a particular level. Subsequently, the credit amount reduces with each extra dollar of earning until there is no credit available.
The credit rate and maximum credit value depend on the family size – a larger credit is provided to families with more children. EIC benefits only working families.
Working families with one child currently receive a maximum credit of $3,584, whereas the maximum credit for families with three or more children is $6,660. On the contrary, childless workers receive a maximum credit of only $538.
The credit amount claimed by a tax filer depends on the number of their qualified dependents he/she and their annual income for that tax year.
According to the Internal Revenue Service (IRS), a qualified dependent is a child related to the tax filer by birth, fostering, or adoption. The age of a qualified dependent should not be more than 19, or 24 if he/she is a full-time student.
The dependent child may also be a sibling of the taxpayer or the child of the taxpayer’s sibling. The tax filer must be older than the dependent child, excluding the cases involving permanently disabled dependents.
Eligibility for Earned Income Credit (EIC)
- Earned income credit (EIC) is only applicable for working people who are earning qualifying income.
- Taxpayers should either file as individuals if single or jointly if married.
- If the taxpayer is married, the taxpayer, spouse, and qualifying children must possess valid Social Security numbers.
- The taxpayer’s age must be at least 25 but less than 65. The age restriction only applies to childless workers.
- The taxpayer should be a citizen or resident of the U.S.
- Tax filers, regardless of having qualifying children, should have lived in the U.S. for at least half of the tax year.
Retirement income, child support income, alimony, benefits from social security, and unemployment benefits do not qualify for the earned income credit. Self-employed workers are eligible for EIC.
All working families should evaluate their eligibility for earned income credit for each tax year, as tax situations and laws can change. Furthermore, a tax filer can be disqualified from accessing EIC if his/her income from investments – including earnings from rental properties and stock dividends – exceeds a certain limit.
Impact of Earned Income Credit (EIC)
1. Encourages work
Earned income credit grows with each extra dollar of income that the worker receives until it reaches a maximum value. It acts as an incentive for the existing low-income workers to work additional hours.
It also encourages many parents to become a part of the labor force, particularly during a strong labor market. According to a study, EIC is considered the most important factor for increased employment among single mothers during the 1990s.
2. Decreases poverty
In 2018, over 5.6 million people – comprising three million children – were lifted out of poverty by the earned income credit EIC benefit. Without it, the number of underprivileged children would have been 25% higher.
EIC also reduced the poverty intensity for over 16.5 million people, out of which 6.1 million were children. It decreases poverty by rewarding work and boosting the earnings of low-income workers.
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