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The Earned Income Tax Credit (EITC) (Section 32), approved by Congress in 1975, was designed to help low income individuals and families. By providing this refundable tax credit, economically disadvantaged individuals are encouraged to join and stay in the workforce. Originally a modest credit ($400 max in 1975), the credit has grown to nearly $6,000, becoming a large percentage of many individuals' annual income.
While tax complexity generally increases with one's level of income, the earned income tax credit stands as an exception. Although designed to assist the working poor, navigating the EITC's provisions can be a daunting chore. Furthermore, the mechanics and practical effect of the credit computation can produce unintended consequences. Many tax professionals rarely encounter clients who qualify for this credit, but it may be relevant on occasion when preparing returns for family members of regular clients or when engaging in pro bono activities.
While the EITC has helped many poor families, a credit of this magnitude can invite fraud and other abuses. It may also induce socially undesirable behavior, as it can provide a disincentive to work and invest, discourages proper filing by spouses of undocumented aliens, and contributes to the "marriage penalty." These unintended consequences of the EITC are discussed below.
The earned income tax credit
Section 32(b)( 1 )( A) defines the EITC as a percentage of earned income: 7.65% for individuals without qualifying children, 34% for individuals with one qualifying child, and 40% for individuals with two or more qualifying children. A temporary provision for tax years 2009-2017 (Section 32(b)(3), as amended by the American Taxpayer Relief Act of 2012) increases the credit to 45% for individuals with three or more children. The credit increases with earned income up to a maximum ($5,89 1 , $5,236, $3, 1 69, or $475 for taxpayers with three or more, two, one, or no qualifying children, in 2012), plateaus, then begins to phase out when income exceeds a threshold (varies with the number of qualifying children, marital status, and tax year). For a married couple with three or more qualifying children in 2012, the credit does not completely phase out until earned income exceeds $50,270.
The significant increase in the amount of the credit in the presence of qualifying children...