If you were voting for the most misunderstood part of the U.S. tax code, a strong candidate would be the Earned Income Tax Credit. The EITC (as professionals call it) represents a refundable federal income tax credit for low- to moderate-income workers.
Since it was installed in the tax code way back in 1975, it has helped offset the burden of Social Security taxes on people for whom the payroll taxes are most (or all) of their tax bite, and it also provides an incentive to work. Taxpayers who are eligible to claim the EITC may be entitled to a refund from the government even if they would otherwise owe no federal taxes.
Sounds pretty straightforward, right? But there’s a swirl of misinformation around the EITC. You might have heard that the EITC is a welfare system for people who don’t work, but in fact only people with earned income are eligible for the credit—and passive income like interest and dividends doesn’t count.
Have you heard that only families with children qualify? Not true. The amount of your tax credit is dependent on your income and the number of your “qualifying” children. Natural or adopted children under age 19, or under age 24 and a full-time student, qualify.
Nor, as some have alleged, can undocumented aliens qualify for the credit. You must be a U.S. citizen with a valid Social Security number or a resident alien for the entire year to claim the EITC.
It’s not always easy to know whether any particular person qualifies for the credit. If you have more than $3,500 of investment income in the tax year, you don’t qualify. You don’t qualify if your taxable income is over $55,952, or if you are reporting foreign earned income. Special rules apply to members of the military, members of the clergy, anyone receiving disability benefits and people impacted by disasters. You don’t qualify unless you file a tax return, even if you don’t otherwise owe federal taxes.
But many do qualify, and the EITC can be a welcome relief for people who are just barely making it financially. Last year, 25 million taxpayers received over $61 billion in tax credits under the EITC program, for an average of $2,504 in tax relief. The tax credit may be misunderstood, but it also seems to somehow be working.