Tax Credits for Working Families: Earned Income Tax Credit (EITC)

By Rochelle Finzel and Qiana Torres Flores
Updated January 2013

An earned income tax credit (EITC) is designed to help low-to-moderate-income, working people get ahead. The federal tax credit was enacted in 1975 and made permanent in 1978. Twenty-five states and the District of Columbia also have earned income tax credits. This report describes the federal and state earned income tax credits, answers common questions about them, and provides examples of how to help working people find and use free tax preparation services.

In This Report:

• What Is the Federal Earned Income Tax Credit?
• What Is a State Earned Income Tax Credit?
• Arguments For Earned Income Tax Credits
• Arguments Against Earned Income Tax Credits
• Refund Anticipation Loans
• Outreach: Providing Information about Free Earned Income Tax Credit Services
• Earned Income Tax Credit (EITC) Resources

What Is the Federal Earned Income Tax Credit?

The federal EITC for low-to-moderate-income working people  reduces the amount in taxes owed, and refunds the difference, if the credit is larger than the amount owed. The credit changes every year and is based on earnings, number of qualifying children and marital status.  To claim the earned income tax credit, a tax return must be filed with the Internal Revenue Service (IRS) that includes proper documentation.

The American Tax Payer Relief Act of 2013 extended the federal EITC for five years. The Act also specified that EITC refunds will not count as income or resources for 12 months after receipt when applying for benefits or assistance under any federal program or state program financed entirely or partially with federal funds.

For tax year 2012, a worker with no children who made less than $13,980 can receive up to $475. Single parents with three or more children who made less than $45,060 are eligible for $5,891. Married couples must file taxes jointly. Couples earning less than $19,190 qualify for a credit of $475. Those with three or more children qualify for $5,891 if they made less than $50,270. The IRS estimates that more than 26 million citizens received over $60 billion in federal, refundable credits in 2011.

Table 1. 2012 Federal EITC Income Maximum Limits

Source: Internal Revenue Service, EITC Income Limits, Maximum Credit Amounts and Tax Law Updates (Washington, D.C: IRS, January 2013).

Table 2. Federal EITC by State for Tax Year 2011

Source: Internal Revenue Service, EITC Statistics (Washington, D.C.: IRS, January 2012).

What Is a State Earned Income Tax Credit?

Twenty-five states and the District of Columbia have earned income tax credits. All states except Minnesota set their credits based on the federal credit; however, the percentages used vary greatly from state to state. Like the federal government, states require workers to file a proper tax return, and in 22 of the states, credits are fully refundable if the amount is greater than the taxes owed. In Delaware and Virginia, the EITC can only reduce a worker's tax liability, not provide a refund. And in Rhode Island, if the credit is larger than the amount owed in taxes, the taxpayer receives only a partial refund.

States determine eligibility for the credits based on the federal requirements. All of the states that offer credits, except Wisconsin, allow workers without qualifying children to be eligible for EITC.

Notes:
a—In 1999, Colorado offered a 10 percent refundable EITC, financed from required rebates under the state's Taxpayer’s Bill of Rights (TABOR) amendment. Due to a lack of funds, those rebates, and the EITC, were suspended in 2002.
b—Maryland also offers a 25 percent refundable or a 50 percent non-refundable EITC. Taxpayers can chose to claim either, but not both.
c—The Minnesota credit for families with children is calculated as a percentage of income. The credit for people with children can range from 25 percent to 45 percent of the federal credit; taxpayers with no children can receive a 25 percent credit.
d—In Rhode Island, if the credit exceeds the amount of taxes owned, 15 percent of the amount is refunded.  This means that 3.75 percent of the federal credit can be refunded.
e—Washington enacted a refundable credit of 5 percent of the federal EITC in TY 2009 and was scheduled to rise to 10 percent in 2010. Due to the budget shortfall, policymakers did not finance the credit for 2009 or 2010.

Source: Tax Policy Center, State Earned Income Tax Credit Based on Federal Earned Income Tax Credit Tax Year 2009 (Washington, D.C.: Urban Institute, Brookings Institution, July 2010); and Mandy Rafool and Todd Haggerty, State Tax Actions 2010: Special Fiscal Report and State Tax Actions 2011: Preliminary Report (Denver, Colo.: NCSL, February 2011 and August 2011).

As state lawmakers consider FY 2014 appropriations, many are examining the impact—both good and bad—that earned income tax credits have on state budgets. From 2011 to 2012, seven state legislatures passed EITC-related laws, although one was vetoed by the governor. Two states decreased the credit amount, one state increased the credit amount, one state created an EITC, and three others focused on outreach efforts. Only two bills regarding EITC were enacted in 2012.

2012

•  Iowa, HB 649, appropriates $195,678 for tax preparation and EITC outreach.
•  Illinois, SB 400, increases the state ETIC from 5% for 2012, to 7.5% for 2013, then to 10% of the federal tax credit after 2013.

2011

• Connecticut, SB 1239, established an EITC equal to 30 percent of the federal credit.
• Iowa, SF 209, increased the state EITC from 7 percent to 10 percent of the federal credit but was vetoed by the governor.
• Michigan, HB 4361, decreased the credit from 20 percent to 6 percent of the federal credit.
• Maryland, HB 632, requires the comptroller and employers of eligible workers to notify workers of their eligibility for the state credit.
• Virginia, HB 1500, appropriated $185,725 for two years to the state Community Action Partnership to support the Earned Income Tax Coalition, providing grants to local organizations for outreach to and tax preparation services for citizens who may be eligible for the federal EITC.
• Wisconsin, AB 40, decreased the credit from 14 percent to 11 percent for two children and from 43 percent to 34 percent for three children.

Recipients choose how to spend or save their refund. Research shows that refunds are commonly used for rent, child care, school loans, groceries, or put aside in savings accounts. A study on the knowledge and use of EITC found that 74.7 percent of recipients spent their entire refund.²  Of those, 49 percent paid bills.  Similar results were reported from a survey of rural families; 44 percent used the tax credit refunds to pay bills.³

Arguments For Earned Income Tax Credits:

Fiscal Stimulus to the State 
Some proponents believe the refundable nature of EITCs pumps new money into the economy.  This may provide both immediate and long-term economic stimulus to state budgets, according to the Brookings Institute.

Work Incentive
EITC financially rewards low-to-moderate-income individuals and families who work. The credit increases as earnings increase up to a specified limit.

Child Care
People who receive tax credits often use the funds to pay for child care. Credits, such as EITC, also free up resources for child care expenses by decreasing the amount of taxes owed. Research on single, working mothers suggests that EITCs can significantly reduce the risks of living in poverty by helping working mothers pay for child care, a key support to getting and maintaining a job.⁴

Financial Assets and Savings
EITC refunds can boost financial assets and savings, which can help working families avoid future financial setbacks. Nonprofit and community-based organizations that work with free tax preparation sites also promote financial education and counseling and connect EITC recipients to checking and savings accounts.  The IRS provides the option to deposit tax refunds into a savings or checking account or to purchase a U.S. savings bond to anyone who receives a refund, including those who get an EITC.

Arguments Against Earned Income Tax Credits: 

Spending More, Collecting Less
A report from the Heritage Foundation states that the consequence of offering refundable taxes, including EITCs, is that the government pays out more money than what it collects in taxes. 

Overpayments due to Error
Some argue that EITCs result in foregone federal and state revenues by not collecting taxes and overpayment as a result of error.  The IRS estimates that the error rate in issuing the tax credit is between 23 and 28 percent.  The Government Accountability Office (GAO) reported that $15.2 billion in federal EITC overpayments were dispensed to recipients in 2011.⁵  The primary causes of overpayments are due to fraudulent claims and unintended errors in taxpayer-provided information such as in income reporting on the W2 form and confusion about IRS requirements for qualifying children.  These errors are attributed to the complex process of applying and determining eligibility for the credit. 

One of the ways states try to guard against overpayment in EITCs is to issue only non-refundable credits.  However, states that offer a non-refundable credit, like Delaware, report that their rate of error is close to that of the federal government’s.⁶

Rethinking Spending in Tight Budget Times
Overall states are reconsidering their expenditures, including their appropriations to EITCs, to address growing deficits.  In 2011, Michigan and Wisconsin reduced their state earned income tax credit in addition to making other cuts due to financial constraints.

Refund Anticipation Loans

A refund anticipation loan is offered by many commercial tax preparation services. These loans expedite the refund process making the credit available an average of 10 to 14 days sooner. Nearly 63 percent of those that file for EITC take a refund anticipation loan, at costs that range from $65 to more than $115. The loan is paid for directly from the credit.⁷

The IRS maintains a list of refund application loan costs and the tax centers that promote such services. It also maintains a list of more than 4,000 Volunteer Income Tax Assistance sites established to provide low-cost refund anticipation loan alternatives. These sites help to reduce the number of refund application loans taken out by EITC recipients.⁸

Outreach About Free Earned Income Tax Credit Services

The IRS estimates that 20 percent of eligible workers do not claim EITC.  Outreach campaigns to increase the number of people who claim the earned income tax credit focus on increasing workers’ knowledge about the federal and state credits and promoting the use of Volunteer Income Tax Assistance (VITA) sites, and other free tax preparation services. VITA sites offer free tax preparation services to low-to-moderate-income working people and are staffed by volunteers certified by the IRS.  Some campaigns target groups, such as those who receive Temporary Assistance for Needy Families benefits, while others reach out to the entire community.

Residents of large cities are more likely to claim the credits because it’s easier for them to find free tax assistance services. Outreach to rural areas has increased, targeting those who have limited or no free tax preparation services. The Rural Family Economic Success program conducts EITC outreach in these areas. The program focuses on earning income, maintaining financial assets and growing wealth in rural America.

Elected officials, state, local and federal government agencies, private companies, philanthropic foundations, and nonprofit organizations all provide outreach campaigns. Delaware, along with the District of Columbia, and Boston, have used social networking sites like Facebook.com to publicize information and recruit volunteers. Outreach materials and toolkits are available from The National Community Tax Coalition, the National League of Cities, and the IRS.
 

Conclusion

Federal and state earned income tax credits can support low-to-moderate-income, working people. The earned income tax credit may provide incentives to work and can be a tool to build workers’ financial stability. VITA sites and outreach campaigns promote free tax preparation services, provide low-cost alternatives to RALs, and ultimately increase the number of people who claim the tax credit. But in times of tight budgets, foregone state revenue from the tax credits can be difficult to justify, causing some state lawmakers to reconsider or even decrease funding for EITCs.   

Earned Income Tax Credit (EITC) Resources

Internal Revenue Service (www.irs.gov)

• Find a VITA site
• 1-800-906-9887

• EITC Advocacy Toolkit

National Conference of State Legislatures  (www.ncsl.org)

• Working Families Overview: A Legislator’s Tool Kit

Notes

¹ Kansas Department of Revenue. Tax Expenditure Report: Calendar Year 2011. Topeka, 2012; http://www.ksrevenue.org/pdf/taxexpreport.pdf.

² Timothy M Smeeding, Katherin Ross Phillips, and Michael O’Conner, “The EITC: Expectation, Knowledge, Use, and Economic and Social Mobility,” National Tax Journal 53, no. 4 (December 2000): 1188; http://surface.syr.edu/cpr/147/.

³ Sheila Mammen and Frances C. Lawrence, “How Rural Working Families Use the Earned Income Tax Credit: A Mixed Methods Analysis Financial Counseling and Planning,” Association for Financial Counseling and Planning Education 17, no. 1 (2006): 51-63; http://6aa7f5c4a9901a3e1a1682793cd11f5a6b732d29.gripelements.com/pdf/vol1715.pdf.

⁴ Peter Cattan, “Child-care problems: an obstacle to work,” Monthly Labor Review Online, 114, no. 10 (October 1991); http://www.bls.gov/mlr/1995/08/art1full.pdf.

⁵ Beryl H. Davis, Improper Payments: Moving Forward with Governmentwide Reduction Strategies (Washington, D.C. United States Government Accountability Office, February 7, 2012); http://www.gao.gov/products/GAO-12-405T.

⁶ Division of Revenue, State of Delaware Tax Preference Report, 2011 Edition, FY11-FY12 (Delaware Department of Finance, January 2012); http://finance.delaware.gov/publications/tax_prefer/exec_smy.pdf.

⁷ Chi Chi Wu and Jean Ann Fox, “Major Changes in the Quick Tax Refund Loan Industry: The NCLC/CFA 2010 Refund Anticipation Loan Report” (Boston: National Consumer Law Center and Consumer Federation of America, February 2010); http://www.nclc.org/images/pdf/high_cost_small_loans/report-ral-2010.pdf.

⁸ Alan Berube et al. The Price of Paying Taxes: How Tax Preparation and Refund Loan Fees Erode the Benefits of the EITC, (Washington, D.C.: Brookings Institution, May 2002); http://www.brookings.edu/reports/2002/05taxes_eitc.aspx.