EITC Awareness Day and Week Hopefully Also Can Focus on Needed Improvements

The Earned Income Tax Credit (EITC) was added to the law in 1975 (Tax Reduction Act of 1975 (P.L. 94-12, SEC. 204; 3/29/75). So, the first note I'd like to make is that March 29, 2025 will be the 50th anniversary of the EITC. The Congressional Research Service has a nice report on the history of the EITC (4/28/22 version).

There is a federal annual EITC Awareness Day, which was January 26, 2024 (IR-2024-22).

Employers have federal (and perhaps state) obligations to tell employees about the EITC. Law changes in California in 2023 require employers to notify employees of the EITC (and a few other items such as CalFile and VITA) twice per year rather than only once per year (SB 131, Chapter 55 (7/10/23)). AB 1355 (Chapter 277 (9/30/23)) allows the notification to be emailed to employees, within specified parameters. The California EDD provides information on the notification and sample language.

On January 27, 2024, California Governor Newsom issued a proclamation that January 26 to February 2, 2024 is CalEITC Awareness Week. 

For many reasons, it seems that a week is certainly needed for EITC awareness and better yet, some way to more frequently help taxpayers be aware of the EITC and the benefits to eligible taxpayers and their communities of making sure it is claimed. Data from the IRS indicates that about 24% of eligible workers do not claim the EITC. The IRS tracks this data by state and you can find it here. CA R&T §19851 states that "hundreds of millions of federal dollars go unclaimed by the working poor in California."

How does this happen? The Tax Policy Center notes that about 5 million eligible individuals do not claim the credit leaving about $7 billion of benefits unclaimed!  These funds certainly could help low-income workers. The Center suggests that reasons for not claiming the EITC include its complexity causing some to not be sure if they qualify, and having income below the filing threshold so they do not file. For the non-filers, perhaps they did not have federal or state income tax withholding, so they are not filing to get those taxes refunded. 

A good portion of the EITC represents a refund of employments taxes withheld or paid by the employer for the employees wages. This illustrates a fundamental problem with the credit in that it is making taxpayers pay taxes they don't owe and then having to file to get the refund and perhaps, depending on earned income and family size, getting an additional amount via the EITC. Why not design the system to not have the EITC-eligible worker not pay the tax in the first place (and that would also provide the benefit per paycheck rather than when the return is filed).

I had the opportunity to suggest such a change back in 2001 in a paper included in the JCT's Study of the Overall State of the Federal Tax System and Recommendations for Simplification, as required by the Tax Reform Act of 1986 (summary at page 7 and full text at page 205). I think others have made similar suggestions over the years. 

Basically, federal income tax withholding could be changed to only start once an employee has earned a certain amount of income. All employees could have, say the first $15,000 of wages not subject to Social Security taxes with an increase in the wage base to address this. Or the change could only be made for workers paid at minimum wage or perhaps 1.10% of minimum wage. 

There used to be an advanced EITC system where the worker applied and the employer would not withhold certain taxes. It was repealed several years ago because there was almost no one using it. Perhaps there is a way to bring that back with better use of technology to help low-income workers get the funds for sure and get them more evenly throughout the year. For example, use of the IRS website to help with the calculations and any form to be completed for the employer (as part of the W-4 for example).

Here is an excerpt of what I wrote over 20 years ago (and I had a lot of background info and data on the EITC in the report too, and I had forgotten that something I've been suggesting in more recent years, I suggested back in this 2001 report - moving to a return-free tax system!).  

    "The EITC could be restructured to be an immediate offset of payroll taxes in more than one way. For example, all employees could have an exemption from Social Security (FICA) and Medicare taxes (referred to in this paper as “payroll taxes”) on a specified amount of wages. Of course, to offset the reduction in tax collections, the tax rates and maximum amount of earned income subject to payroll taxes would need to be adjusted. Another alternative would be to have payroll taxes computed on a graduated rate basis tied to the worker’s wage base (similar to how federal income tax withholding is computed). Because the current EITC structure can result in refunds greater than the worker’s payroll tax amount, additional changes would be needed to maintain the current level of benefit provided by the EITC to taxpayers with one or more qualifying children. These changes might be achieved through increased dependency exemptions or child credits for individuals with specified amounts of earned income. 

     Beyond simplification, an additional potential benefit of an alternative structure and simplification of qualifying status requirements would be that it might make it easier to move to a return-free tax system. Structural changes as described above would also serve to provide the EITC benefit to low-income taxpayers in each paycheck without a need for individuals to apply to receive an advance EITC.  In addition, these structural changes could be implemented in a manner so as to reduce the current high marginal tax rates that result from the phase-out provision of the EITC."

This proposal reminds me of a similar suggestion that I and two SJSU econ professors wrote about a few years ago. To better target sales tax exemptions such as on food and infant diapers and to more easily have the sales tax apply to more types of personal consumption, convert the sales tax to a formula calculation (personal consumption = income less savings), because one benefit is that instead of providing a food exemption that primarily benefits higher income individuals because they spend more on food, you could exempt low-income individuals from all sales tax by exempting them from the calculation if their income is below a specified level. And the benefit could continue for income levels by use of a graduated rate structure based on income. I just note this because it is another example where it might be easier to just not collect a tax in the first place rather than structure a tax credit or use inequitable exemptions to help lower-income taxpayers. This sales tax paper can be found here and there are additional benefits of it in that businesses would no longer pay or have to collect sales tax (there would need to be a transition phase-in as revenues adjusted).

But back to the EITC ... perhaps the upcoming 50th anniversary calls for efforts to examine how it can be simplified and all eligible individuals can readily obtain its benefits.

What do you think?

Tax System Changes Can Help Reduce Poverty

Today I received information from the National Academies on their new report, Reducing Intergenerational Poverty, Sept 2023. It defines "intergenerational poverty," provides demographics of this poverty, describes education and health issues associated with continual poverty, and makes recommendations. 

The introduction reminds us of the relevance of this topic to us all (page 1):

"Capable and responsible adults are the foundation of any well-functioning and prosperous society. Yet low-income families struggle to offer their children the same advantages and necessities that better-off families can offer. As a result, throughout their childhoods children living in families with low incomes face an array of challenges that place them at much higher risk of experiencing poverty in adulthood as compared with other children."

"The costs of perpetuating this cycle of economic disadvantage fall not only on low-income individuals and families themselves, but also on society as a whole. Poverty reduces overall economic output and places increased burdens on the educational, criminal justice, and health care systems. Understanding the causes of intergenerational poverty and implementing programs and policies to reduce it would yield a high payoff for children and for the entire nation."

One of the recommendations is to increase and expand the Earned Income Tax Credit (EITC). Per the researchers: "The strongest direct evidence on the likely intergenerational effects for children is found for programs that increase both family income and parental employment during childhood and adolescence." [page 133]

IRS data reports that in 2020, 26 million filers claimed the EITC with the aggregate credit at $59.2 billion (Table A of Individual Income Tax Returns Complete Report 2020).

Where could the money come from to increase and expand the EITC? We can and should reduce various tax breaks that reduce the tax liability of high income individuals by far more than a taxpayer can currently claim as the EITC. The OMB reports that the "cost" of the exclusion for employer-provided health insurance is $224 billion per year. It is not uncommon for this exclusion to be about $10,000 (or even lots more) for one of the roughly 64% of employees who get this tax break (their employer pays all or a portion of their health insurance premiums). Assuming $10,000 of excluded income, this tax break is worth the following at each individual marginal tax rate as follows (the savings is similar to a tax credit of the amount listed below):

   10%     $1,000 tax savings
   12%     $1,200 tax savings
   22%     $2,200 tax savings
   24%     $2,400 tax savings
   32%     $3,200 tax savings
   35%     $3,500 tax savings
   37%     $3,700 tax savings

The average EITC for a taxpayer claiming it is, per the IRS, $2,043. Thinking of the above tax savings as similar to a tax credit, individuals with $10,000 of employer-provided health insurance who are at a 22% bracket or higher are getting a larger credit than the average EITC claimer.  And this is quite a tax savings because someone in these higher brackets can afford to pay their health insurance without the tax subsidy. Unlike the Premium Tax Credit, there is no income threshold or affordability limitations on claiming the exclusion for employer-provided health insurance (see blog post of 5/14/23).

Even if this one tax break for employer health insurance were cut in half to $112 billion per year, that would enable the EITC on average to be increased by about $4,000.  I note this example just to illustrate that there are tax breaks that can be reduced or eliminated, particularly where they provide a tax break much larger than a typical ETIC, but to people with far greater means for whom the tax break doesn't make a life-changing difference where it would improve the life of a low-income worker and improve economic conditions and living standards in the U.S. for everyone. There are over 100 other tax breaks that could be reduced, particularly where they provide significant subsidies and tax breaks to higher income individuals, whose well-being and that of our society is not improved much by them due to their income levels.

So, why don't we reduce some tax expenditures and use the funds in ways that will truly help people who need the assistance more and will benefit our society and economy as a whole?

What do you think?

New Required Preparer Due Diligence for AOTC and Child Tax Credit

The addition of these two credits to the required due diligence of paid preparers in preparing a return that claims either or both was made by the PATH Act (P.L. 114-113, 12/18/15). The statutory language added at §6695(g) implied that regulations were needed. The IRS released draft Form 8867 and instructions in summer 2016, but did not release the regulations until 12/5/16. [TD 9799 (12/5/16) and REG 102952-16 (12/5/16)]

The regulations note that Form 8867 must be completed “and such other information as may be prescribed by the” IRS. The preparer must include relevant worksheets and Form 8863 and instructions (AOTC), or “otherwise record in one or more documents in the tax return preparer’s paper or electronic files the tax return preparer’s computation of the credit or credits claimed on the return or claim for refund, including the method and information used to make the computations.”

The regulations also include this rule about knowledge (§1.6695-2(b)(3)):

“(3) Knowledge—(i) In general. The tax return preparer must not know, or have reason to know, that any information used by the tax return preparer in determining the taxpayer’s eligibility for, or the amount of, any credit described in paragraph (a) of this section and claimed on the return or claim for refund is incorrect. The tax return preparer may not ignore the implications of information furnished to, or known by, the tax return preparer, and must make reasonable inquiries if a reasonable and well-informed tax return preparer knowledgeable in the law would conclude that the information furnished to the tax return preparer appears to be incorrect, inconsistent, or incomplete. The tax return preparer must also contemporaneously document in the files any inquiries made and the responses to those inquiries.”

Form 8867, lines 3 and 4, address the “knowledge” requirement. The instructions for these lines provide:

“As a paid tax return preparer, when determining the taxpayer’s eligibility for, or the amount of, a credit claimed on a return or claim for refund, you must not use information that you know, or have reason to know, is incorrect. You may not ignore the implications of information provided to, or known by you, and you must make reasonable inquiries if the information provided to you appears to be incorrect, inconsistent, or incomplete. You must make reasonable inquiries if a reasonable and well-informed tax return preparer, knowledgeable in the tax law, would conclude that the information provided to you appears to be incorrect, inconsistent, or incomplete. You must also contemporaneously document in your files any reasonable inquiries made and the responses to these inquiries.

You must know the tax law for each credit claimed on a return or claim for refund you prepare and use that knowledge to ask your client the right questions to get all the relevant facts to determine your client’s eligibility for the credit(s) and the correct amount of the credit(s).”

Here are a few questions I’d suggest are appropriate for determining if someone is eligible for the child credit (not a complete list).

• How old are your children? When were they born?
• Where do they go to school? What grades are they in?
• For a single parent, where does the child live? If the child lived the majority of the time with the parent who is your client, ask if he/she signed a Form 8332 to allow the other parent to claim the child.
• If a client tells you they have a signed Form 8332 from the other parent, ask if it has been revoked (did they receive notice of revocation from the other parent)?

A few questions for someone who appears eligible to claim the AOTC for their dependent child and whose income is below the phase-out range (also see Form 8863 and instructions, along with IRC 25A and information on the IRS website (regulations addressing AOTC are still in proposed form - REG-131418-14 (8/2/16)):

• When did they start college?
• How many units did they take each semester? (student needs to be at least a half-time student for at least one semester; also see Box 8 of Form 1098-T)
• Please provide me the Form(s) 1098-T the child received. If it shows amount billed rather than amount paid (see boxes 1 and 2), ask when the tuition was paid. You should also verify that the 1098-T is correct. Be sure Box 9 is not checked (student is a graduate student, indicating they are likely no longer in their first four years of collect).
• How much is the tuition?
• Did your child receive any scholarships or grants?
• Do you have a 529 or 530 plan for the child? (If yes, was it used?) Is the taxpayer/child eligible for other education tax benefits that may be more beneficial? Did they receive any tax-free education assistance from his/her employer?

Here are some tougher questions for the AOTC:

• Did you child receive academic credit for at least one semester of the tax year? This is a tough one as parents might not know the answer, particularly if the child dropped out after the refund period. Box 8 on Form 1098-T asks if the student was at least a half-time student. Perhaps that being checked is sufficient. Also, if not enrolled per how that term is defined at the university, a 1098-T likely should not have been issued. So, this might be a tough question if there is no 1098-T and the parent insists the child was in college during the year.
• Does the student have a felony conviction for possession or distribution of a controlled substance?

Perhaps it would be best to put these questions on a checklist for the client to complete and sign. It should include the reason why the question is asked.  You might want to refer clients to the AOTC information and flowcharts in Publication 970 and FAQs.  Also see IRS Pub 4687 with tips on due diligence for these three refundable credits.

The AOTC includes amount paid for books and related materials that are required by the university, even if not paid to the university. Before making any effort to determine these amount, see if the tuition paid for the year is high enough to max out the AOTC. In most cases, it will be (unless the student attends a community college in California). You max out the AOTC with $4,000 of tuition paid for the year (the credit is 100% of the first $2,000 and 25% of the next $2,000 for a maximum credit of $2,500).

The questions asked by the paid preparer and the answers/documents received from the client must be kept for three years after the return is filed. The Form 8867 is attached to the client’s return to avoid a $510 penalty to the preparer. Do note that even with the attached form, a preparer can still be subject to the penalty for not doing the required due diligence. This reminder is in the “what’s new” section of the Form 8867 instructions (although this is not new):

“Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return.”

I think the Form 8867 will help improve compliance with the child credit and AOTC as it will likely lead many preparers to review these credits in more detail and some may find that there were parts that they were not aware of before (such as that the AOTC is only for the first four years of college, even if that is only the first fall semester, if the student was at least half-time, that is a year of college). If a student attended a California community college for the first two years of college, parents might feel cheated because the tuition paid is not enough to max out the AOTC for those years (although books and other required materials, perhaps even a computer will help – see FAQ7). So, they might want to use the AOTC when the child transfers to a more expensive university, but it doesn’t work that way. The AOTC is only for the first four years of college. So, that parent (or student) doesn’t max out the AOTC, but they also aren’t paying a lot of tuition!

On a policy note, if a state university or college isn’t charging enough tuition to max out the credit, the California Legislative Analyst described this as the state giving a reverse subsidy to the federal government (that is, to students in other states). [See LAO’s February 1998 report]

Should the Form 8867 due diligence documentation requirement to avoid a penalty be expanded to other complex items claimed on a tax return? I don’t’ think so. Preparers already have required due diligence requirements such as the preparer penalty of §6694. Many preparers are also subject to licensing rules and those of professional organizations they belong to, as well as Treasury’s Circular 230. Congress likely expanded the §6695(g) penalty to these additional credits due to errors in claiming them. But, there are other solutions to address tax law complexity: (1) simplification, (2) required continuing education for all preparers (to address those not covered by licensing requirements for continuing education), (3) some assurance that paid preparers have adequate training including research skills and access to resources beyond IRS pubs and form instructions, and (4) due diligence checklists from the IRS to help preparers (and the IRS).

The PATH Act also requires the Treasury Department “to conduct a study evaluating the effectiveness of tax return preparer due diligence requirements for the EITC, child tax credit and AOTC. The study with respect to the EITC shall be completed one year from the date of enactment (December 18, 2015), and the study regarding the child credit and the AOTC shall be due two years from the date of enactment.” [JCT Bluebook to 2015 legislation, page 231]

The only study I find (at 12/24/16; 6 days after the 12/18/16 due date for the EITC report) is a 27-page report issued by Treasury in July 2016.  It addresses preparer due diligence, but doesn’t reference the PATH Act (only House Report 114-194). Per H. Rpt 114-194, the July report is tied to this request: “The Committee directs the Office of Tax Policy (OTP) and the IRS Office Research,  Analysis and Statistics to conduct data-driven analysis to  improve EITC compliance in collaboration with the tax  preparation community. Successful analysis will identify solutions effective for both paid preparers and self-preparers, ensure ease of taxpayer understanding. The Committee directs OTP and IRS to submit a report to the Committees on Appropriations in the House and Senate not later than six months after enactment of this Act on meeting this goal.” The report explains various initiatives the IRS used to improve EITC compliance (a subject for a future blog or article – looks interesting). So, it seems that we are still waiting for the §6695(g) EITC report due 12/18/16.

What do you think? (about the expanded due diligence for preparers for 2016 returns, preparer obligations in general, complexity, or anything else in this post)

Employer EITC Notice to Employees - New California Requirement!

Several states require employers to notify employees that they may be eligible for the federal (and perhaps also state) Earned Income Tax Credit (EITC). This year, California law was changed to require employers to also notify employees about the California EITC recently added to the law.

AB 1847 (Chapter 294, 9/12/16) – Expands the current employee notification requirement for the federal EITC to also include the California EITC, effective after 2016. Per the introduction to AB 1847: “This bill would require those same employers currently required to notify employees who may be eligible for the federal earned income tax credit to also notify these employees that they may be eligible for the California Earned Income Tax Credit under the same conditions.”

Amends R&T 19853, including as follows:

 (a) An employer shall notify all employees that they may be eligible for the federal and the California EITC within one week before or after, or at the same time, that the employer provides an annual wage summary, including, but not limited to, a Form W-2 or a Form 1099, to any employee. …

R&T 19854:

 (a) The notice furnished to employees regarding the availability of the federal and the California EITC shall state as follows:

BASED ON YOUR ANNUAL EARNINGS, YOU MAY BE ELIGIBLE TO RECEIVE THE EARNED INCOME TAX CREDIT FROM THE FEDERAL GOVERNMENT (FEDERAL EITC). THE FEDERAL EITC IS A REFUNDABLE FEDERAL INCOME TAX CREDIT FOR LOW-INCOME WORKING INDIVIDUALS AND FAMILIES. THE FEDERAL EITC HAS NO EFFECT ON CERTAIN WELFARE BENEFITS. IN MOST CASES, FEDERAL EITC PAYMENTS WILL NOT BE USED TO DETERMINE ELIGIBILITY FOR MEDICAID, SUPPLEMENTAL SECURITY INCOME, FOOD STAMPS, LOW-INCOME HOUSING, OR MOST TEMPORARY ASSISTANCE FOR NEEDY FAMILIES PAYMENTS. EVEN IF YOU DO NOT OWE FEDERAL TAXES, YOU MUST FILE A FEDERAL TAX RETURN TO RECEIVE THE FEDERAL EITC. BE SURE TO FILL OUT THE FEDERAL EITC FORM IN THE FEDERAL INCOME TAX RETURN BOOKLET. FOR INFORMATION REGARDING YOUR ELIGIBILITY TO RECEIVE THE FEDERAL EITC, INCLUDING INFORMATION ON HOW TO OBTAIN THE IRS NOTICE 797 OR ANY OTHER NECESSARY FORMS AND INSTRUCTIONS, CONTACT THE INTERNAL REVENUE SERVICE BY CALLING 1-800-829-3676 OR THROUGH ITS WEB SITE AT WWW.IRS.GOV.

YOU ALSO MAY BE ELIGIBLE TO RECEIVE THE CALIFORNIA EARNED INCOME TAX CREDIT (CALIFORNIA EITC) STARTING WITH THE CALENDAR YEAR 2015 TAX YEAR. THE CALIFORNIA EITC IS A REFUNDABLE STATE INCOME TAX CREDIT FOR LOW-INCOME WORKING INDIVIDUALS AND FAMILIES. THE CALIFORNIA EITC IS TREATED IN THE SAME MANNER AS THE FEDERAL EITC AND GENERALLY WILL NOT BE USED TO DETERMINE ELIGIBILITY FOR WELFARE BENEFITS UNDER CALIFORNIA LAW. TO CLAIM THE CALIFORNIA EITC, EVEN IF YOU DO NOT OWE CALIFORNIA TAXES, YOU MUST FILE A CALIFORNIA INCOME TAX RETURN AND COMPLETE AND ATTACH THE CALIFORNIA EITC FORM (FTB 3514). FOR INFORMATION ON THE AVAILABILITY OF THE CREDIT, ELIGIBILITY REQUIREMENTS, AND HOW TO OBTAIN THE NECESSARY CALIFORNIA FORMS AND GET HELP FILING, CONTACT THE FRANCHISE TAX BOARD AT 1-800-852-5711 OR THROUGH ITS WEB SITE AT WWW.FTB.CA.GOV.

Thus, AB 1847 modifies the required notice about the federal EITC and adds the information about the California EITC.

Effective 1/1/17.

Also see:

• EDD information on notice (not updated for AB 1847 (as of 12/12/16).
•  FTB website about the EITC with link to brochure and poster.
• FTB FAQs on EITC.
• FTB Analysis of AB 1847.
• California EITC brochure.
• IRS Notice 797 on EITC.

x  What do you think?

California AB 509, EITC and Notice of Refund

The Assembly Revenue & Taxation Committee will discuss AB 509 at its May 2, 2011 hearing. AB 509 would require state agencies to do the same as is required of other employers - to notify workers that they may be eligible for the federal Earned Income Tax Credit (EITC), a refundable credit available to low-income workers. (See EDD information about this employer requirement - here.)

This is a good idea - if other employers are required to do it, why not California employers as well? Also, not everyone entitled to the EITC claims it. Per a memo from CA Board of Equalization member Betty Yee, the IRS estimates that 20% 20 25% of eligible individuals fail to claim the EITC. I'd guess this is due to the fact that the individual is below the filing threshold and does not know about the EITC and that they must file to get it. Or perhaps some people who prepare their own return don't look up the instructions when they get to the EITC line or some preparers overlook it. Here are ten reasons suggested by Hawaii Tax Help as to why some people fail to claim the EITC.

One more item overlooked (based on my anecdotal evidence of talking to students) is the need to file a return to get your overpaid tax withholding back. For example, a student told me recently (not an MST student) that she asked someone if her income level required that she file. That person (not sure if it was a paid preparer) looked it up on the IRS website and said no without asking her if she had wage withholding. She was quite puzzled when I told her she needed to file if she wanted to get her federal income tax withholding back that she had overpaid. I'm guessing this is not an unusual occurrence.

So, why not modify California law, as part of AB 509, to required all employers to not only provide the information (such as on the worker's pay stub) about the EITC, but also of the need to file to have overpaid federal and state income tax withholding refunded? The worker can be referred to the IRS interactive website that asks lots of questions to determine if there is any reason you should file including just to get your withholding refunded (here). Even better information for workers would be to give them one URL where they can go to determine if they need to file federal and California returns, or refer them to a VITA site to help them, and why they should take these actions.

What do you think?

Continuing EITC Problems Contribute to Tax Gap

On February 9, the Treasury Inspector General for Tax Administration (TIGTA) released a report on EITC compliance problems. Per TIGTA:

"The Internal Revenue Service (IRS) has made little improvement in reducing improper Earned Income Tax Credit (EITC) payments since 2002, when it was first required to report estimates of these payments to Congress, ... The IRS estimates that 23 to 28 percent of EITC payments are issued improperly each year, which equated to $11 billion to $13 billion in EITC improper payments in Fiscal Year (FY) 2009."

TIGTA's recommendations mostly sound to me like "try harder." I think part of the problem is due to complexity (the EITC eligibility and calculation are some of the more difficult provisions in the law). Some of it may also be due to the EITC built-in incentive to try to claim a high credit, including increasing your taxable income to generate the largest credit amount. For an example of some of the EITC complexity, take a look at this IRS website on the EITC - it seems a bit daunting to me.

Why no better solution? Is the EITC just fundamentally flawed as a way to deliver benefits to low-income workers? Well, it does work for the majority of filers, but a 25% error rate is too high.

Back in 2001, I had an EITC proposal included in the Joint Committee on Taxation's simplification study for Congress (here - summary of page 7 and full text on page 205). It called for a mechanism to get the benefit to workers through reduced or zero Social Security withholding. Part of the concept would have been similar to the Advanced EITC which was repealed recently. I also noted that if we ever went to a return-free system for a majority of individuals, EITC reform would be helpful.

What do you think would reduce the tax gap resulting from EITC errors?