A Credit With Too Few Takers
Sunday, February 26, 2006
At an income level of less than about $38,000 a year, many taxpayers aren't really tax payers. To the contrary, there is a special provision of the tax law that is designed not only to wipe out any taxes they might otherwise owe, but to give them cash back even beyond that.
This provision is called the Earned Income Tax Credit, and today it is the government's largest program for aiding low-income working families. The EITC, as it is widely known, shells out about $40 billion a year to low-income earners and their dependents.
But the EITC is not a simple program. It involves phaseouts and dependency requirements, and other twists and turns that, while typical of today's tax laws, can be intimidating to people not accustomed to filling out forms.
Also, many low-income people are either unaware of the program or they underestimate its benefits, so they don't apply.
"This is a big problem. These households are such low income they don't owe taxes, and they know they don't owe, [so] they are not going to bother with the hassle," said Nicole Simpson, assistant professor of economics at Colgate University and coordinator of Volunteer Income Tax Assistance, which is based at the school. The nationwide assistance program is sponsored by the Internal Revenue Service and volunteers provide free tax preparation help.
Simpson said "it's very costly" to go to a commercial tax preparer for help. "They report paying over $150 on average for H&R Block," and they figure "it's risky to pay that much not knowing what they are going to get back."
The EITC is also prone to error because of its complexity, and to fraud because of its generosity, so it is one of the most heavily audited credits in the tax law.
But for many low-income working families -- and even singles, who can also be eligible -- the effort can be well worthwhile.
The average refund turned up by Simpson's volunteers is nearly $2,500, almost 20 percent of the $14,000 average annual income her group's clients report. "They have no idea" they could get that much, she said.
One reason the refunds are so large is that the EITC is both a credit and "refundable."
A credit reduces your taxes dollar for dollar. Thus, if you owe $3,000 in taxes and your situation entitles you to a credit of, say, $2,000, the credit wipes out $2,000 of your taxes, leaving you owing $1,000.
(This is in contrast to a deduction, which reduces your taxable income, and thus reduces your taxes indirectly. Deductions save you the taxes you would have paid on that income, so they are of greater benefit to people in higher brackets. A $1 deduction saves a taxpayer in the 35 percent bracket 35 cents; it saves a taxpayer in the 10 percent bracket 10 cents.)