The amount of the credit first increases as earnings increase, reaches a plateau, and then falls as earnings increase. The credit phases out at a rate of The child tax credit had broad bipartisan support. However, the value of dependent exemptions in is approximately what it was in when the latter is adjusted for inflation. The credit is partially refundable the refundable portion is called the additional child tax credit.
Unlike the EITC, the child tax credit is not targeted to just lower-income taxpayers. In fact, the limits on the additional child tax credit cap the refundable portion of the credit for the lowest-income taxpayers, but usually not for middle-income taxpayers. In addition, the CTC is a fixed per child amount and thus does not take into consideration economies of scale within the family.
Historically, the federal income tax system has related tax liability to family size. Other major family-related tax provisions are:. These provisions are available to taxpayers at all income levels, but the benefits of some may be limited for the highest-income taxpayers by other tax provisions.
The first three provisions are considered part of the normal income tax system and, therefore, are not considered tax expenditures. The last provision, the child and dependent care tax credit, is contingent on employment and earnings, and is considered a tax expenditure. Exemptions for the taxpayer have been in the tax code since the beginning of the individual income tax. Exemptions do not affect tax liability in the same way that tax credits do.
Since , working taxpayers have been able to claim a nonrefundable tax credit for employment-related care expenses for children and other dependents. The credit rate is reduced as AGI rises the minimum credit rate is 20 percent. Most taxpayers claiming the credit receive less than the maximum amount of the credit. Since this credit is nonrefundable, working taxpayers with no tax liability cannot claim the credit.
The first is simplicity and convenience—the provision should be clearly stated, not arbitrary, and minimize the inconvenience of filing the tax return. The second criterion is efficiency—the extent to which the provision adds or removes economic distortions. Whether or not a tax incentive achieves its objective, such as increasing work effort, can be considered a question of efficiency.
Lastly, a provision should be judged on equity—how the benefit or burden of the provision is distributed among taxpayers, and how it changes the distribution of the overall tax burden. As Congress has increasingly used the tax code to pursue policy goals, tax returns have become longer and more complex. A taxpayer claiming the EITC must file the six-line Schedule EIC providing information on the qualifying children with her tax return and calculate the amount of the credit using a six-line worksheet.
Claiming the CTC involves filing the line Schedule for the additional child tax credit and calculating the credit using a line worksheet.
This paperwork burden entailed in claiming the EITC and the CTC is mitigated somewhat by the use of paid tax preparers or volunteer tax preparers, and electronic tax return filing. Almost 80 percent of taxpayers filing the or A filed electronically in , and 60 percent used a paid or volunteer tax preparer IRS Earlier studies have estimated similar improper payment percentages for example, IRS However, EITC noncompliance studies have shown that the most common errors leading to overpayments involve unintentional misreporting of qualifying children McCubbin ; IRS Furthermore, the noncompliance studies do not take into account underpayments.
It is easy to understand how these unintentional errors occur. The criteria for qualifying children vary among different tax provisions. The IRS has prepared a three-page table listing the qualifying child criteria for the EITC, CTC, dependent exemption, head of household filing status, and the child and dependent care credit.
Most taxpayers with children take advantage of two or more of these tax provisions, and confusion is unavoidable when a child may be a qualifying child under one provision but not another. Taxes and tax provisions can change taxpayer behavior by introducing incentives or disincentives. By affecting the after-tax wage rate, these tax credits can affect labor supply or work effort, although the effect is theoretically ambiguous.
A higher after-tax wage due to, say, a tax reduction increases the price of leisure. This would lead an individual to take or purchase less leisure, or work more. This is known as the substitution effect. This is known as the income effect. Consequently, the total effect is ambiguous. The after-tax wage rate for working one more hour is the hourly wage multiplied by one minus the marginal tax rate. For most workers, the marginal income tax rate is either 10 percent, 15 percent, or 25 percent.
Figure A shows the marginal tax rate of married workers with two children as annual earnings increase. The marginal tax rate varies from minus 55 percent as the tax credits phase in to plus 36 percent as the EITC phases out.
In the phase-in range, the after-tax wage is 55 percent higher than the before-tax wage rate, which provides an incentive to increase labor supply either to begin working or work more hours. In the phase-out range, the after-tax wage rate is 36 percent lower than the before-tax wage rate and provides an incentive to work less that is, reduce labor supply. Since its inception, numerous studies have examined the labor supply effects of the earned income tax credit reviewed in Hotz and Scholz ; Eissa and Hoynes a; and Meyer Most studies focus on single mothers and find that the EITC increases labor force participation that is, induces single mothers to find a job.
But for those already working, there is mixed evidence that the EITC significantly affects the number of hours worked. Chetty, Friedman, and Saez forthcoming find that workers with children increase their hours of work in the EITC phase-in range, but do not substantially change their hours in the phase-out range. This suggests that the high marginal tax rates associated with the EITC phase out have limited work disincentive effects.
A few studies examine the EITC and the labor supply of married taxpayers. Overall, this research indicates that the EITC has a positive labor supply effect; it increases labor force participation with little or no effect on hours worked.
The high marginal tax rate in the EITC phase-out range has no apparent effect on labor supply. Most research that has examined the tax effects on marriage conclude that the tax credits have not affected marriage patterns reviewed in Hotz and Scholz Evidence suggests that the tax credits, however, may have small positive incentive effects on fertility reviewed in Hotz and Scholz Visit www.
The IRS works with national partners, community-based coalitions and thousands of local partners and governments. These partnerships provide free EITC tax return preparation and tax help and tax education. You should choose a tax preparer carefully.
You are responsible for the accuracy of your own return. Find out what you should know if you pay someone to do your taxes. Since many low-income workers are not required to file a return, they often miss out on the full value of refundable credits. In response, several states have implemented measures to increase the awareness of EITCs.
Iowa and Maine are among states that require beneficiaries of certain assistance programs to be informed of the benefits of EITCs. Oregon requires its Bureau of Labor and Industries commissioner to adopt rules requiring employers to share information about state and federal EITCs with their employees. In addition, several states - including Iowa , Oklahoma, Texas and Virginia - appropriate funds or implement measures to help state and federal EITC-eligible families prepare their tax filings.
California uses different income levels and phase out calculations than the federal EITC. Create Account. Earned Income Tax Credit Overview. Kemberley Washington. Forbes Advisor Staff. Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations. Compare the best tax software of See our picks. Was this article helpful? Share your feedback. Send feedback to the editorial team.
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