What is the Earned Income Credit?

Q. What is the Earned Income Credit?

A. A common question from my tax preparation clients each year is “Why is my refund so big?”  Many of my clients can’t understand that they are getting a refund bigger than the total of the tax they had withheld from their check during the year.  One major reason for lower income clients is the Earned Income Credit.

What is It?

The Earned Income credit is a refundable credit that low or moderate income taxpayers are eligible for.  It acts like the child tax credit because those who are eligible receive a credit against their tax owed because of this credit.  According to the IRS website, it was originally designed to offset the amount of Social Security and Medicare taxes paid by people in this category.

How is it Calculated?

For 2011, the IRS offered the following chart to calculate the amount of EIC you may be eligible for:

Earned Income and adjusted gross income (AGI) must each be less than:

• $43,998 ($49,078 married filing jointly) with three or more qualifying children
• $40,964 ($46,044 married filing jointly) with two qualifying children
• $36,052 ($41,132 married filing jointly) with one qualifying child
• $13,660 ($18,740 married filing jointly) with no qualifying children

Tax Year 2011 maximum credit:

• $5,751 with three or more qualifying children
• $5,112 with two qualifying children
• $3,094 with one qualifying child
• $464 with no qualifying children

Investment income must be $3,150 or less for the year.

I thought this came in my paychecks throughout the year

This was called the Advanced Earned Income Credit or AEIC.  In the old days, taxpayers eligible for the EIC could get the money early throughout the year by submitting Form W-5 to their employer.  Effective January 1, 2011, because of the Education Jobs and Medicaid Assistance Act of 2010, this no longer happens.  The program was full of fraudulent payments and difficult to administer.  If a taxpayer was eligible in the beginning of the year and for some reason went above the threshold limit during the year and did not stop the payments, they could actually end up owing extra tax at the end of the year. I’m glad it’s gone.  Fortunately, this means taxpayers get a bigger refund if they fall into one of the categories listed above.

Tax software generally checks to make sure you are actually getting credits like this that you may be eligible for.  If you forget to include some of your income when preparing your own return and claim this credit by mistake, there could be some very serious penalties and interest in store for you.  For that reason, I always recommend a professional preparer no matter what level of income you receive.  The tax laws these days are just too complex to navigate alone. Visit my Tax Services page to learn more about how my firm can help with your tax preparation needs.

Stimulus Withholding Tables Released

I thought this news warranted a special release.  The new withholding tables related to the recently signed Stimulus package, called the “American Recovery and Reinvestment Act of 2009″ have been released. You can download a copy here.  These will ultimately be incorporated in Publication 15-T when that is released to the IRS website.  The significant changes include”

• increasing the amount at which withholding begins to $7,180 for single filers and $15,750 for married filers.
• changes to the income amounts for the 10%, 15%, 25% and 28% bracket
• changes to the calculation of the Earned Income Credit, but not the maximum amount of the credit.

There is no change to Social Security and Medicare withholding and no change to the value of an allowance.  The instructions indicate that employers should begin using the new withholding guidelines as soon as possible but no later than April 1, 2009.  This will increase the amount of take home pay in most paychecks by reducing withholding.  It should be interesting to see follow up comments on this issue.  The change was pushed through so quickly that there are bound to be problems with implementation and certain employers not being notified of the new rates.