Partners, Volume 13, Number 1, 2003

Earned Income Tax Credit: Maximizing the Benefit
By Jessica LeVeen

The Earned Income Tax Credit (EITC) is one of the U.S. government’s largest and most effective anti-poverty policies. In 2000, 19 million people obtained approximately $31 billion in EITCs, and each year the program lifts an average of 5 million families above the poverty line. Unfortunately, some individuals and families aren’t reaping the full benefit of the tax credit. Government, business and community groups are working together to help maximize the impact of EITC.

Qualifying for the EITC

Enacted by Congress in 1975, the EITC is a refundable tax credit that reduces the tax burden on low- and moderate-income workers, particularly those raising children. The credit not only reduces a worker’s income taxes, but also any amount remaining beyond the tax liability is refunded to the taxpayer.

Individuals and families are eligible to claim the EITC if their income is less than twice the federal poverty limit. Both income and family size determine the credit the taxpayer will receive. For example, in tax year 2002, a family with two or more children earning income up to $33,178 would be eligible for an EITC up to $4,400. Individuals with no children would be eligible for a much lower EITC. The average EITC recipient this year will earn a credit of $1,700.

Benefits and concerns

The benefits of the EITC are significant: not only does the tax credit help reduce poverty, but it also offers an incentive to work. The EITC has slowed the rising income inequality between the working poor and high-income workers during the past decade. In addition, it can help low-income families build assets.

Despite these benefits, not all eligible filers claim the EITC. A Government Accounting Office study of 1999 data found that 86 percent of eligible families with children claimed the EITC, but only 45 percent of workers without children claimed the credit. The Internal Revenue Service (IRS) is currently working to increase the participation rate of eligible EITC filers.

Unfortunately, the benefits of the EITC to low-income workers are often diminished by the use of paid tax preparers and refund anticipation loans (RALs). A recent study by the Brookings Institution found that nationwide, 68 percent of EITC filers used a paid tax preparer. Tax preparation services are often concentrated in low-income neighborhoods and heavily marketed to low-income filers. EITC filers can pay $100 or more in fees for these services.

In addition to costly tax preparation services, low-income taxpayers are increasingly using RALs to obtain their refunds more quickly. Filers using RALs receive an advance on their anticipated refund about 7 to 10 days more quickly than if they received refunds via direct deposit into their bank accounts. Nationwide, 39 percent of EITC returns were claimed using RALs. In some Sixth District communities, more than 60 percent of EITC returns were filed with RALs.

The fees associated with RALs — $100 for the RAL and an average fee of $100 for tax preparation — substantially reduce an EITC filer’s refund. In 1999 an estimated $1.75 billion in EITC funds were diverted from low-income workers to tax preparation services.

Coalitions increase EITC awareness

Broad-based coalitions have formed to increase the amount of the EITC captured and retained by low-income workers. The IRS has partnered with community organizations, financial institutions and local governments to increase EITC awareness and to promote free tax preparation services.

The IRS and community partners promote this service through Volunteer Income Tax Assistance (VITA) sites, where trained volunteers prepare federal tax returns without charge. The sites provide an important alternative to high-cost tax preparation services.

Some VITA sites offer additional services to promote financial stability, including financial education, assistance in opening bank accounts and asset-building tools such as Individual Development Accounts (IDAs). These services not only enable low-income workers to maximize the benefit of EITC, but also provide them with opportunities to improve their overall economic well-being.

Spotlight on New Orleans:
The Central City Asset-Building Coalition

New Orleans' Central City Asset-Building Coalition recently initiated an EITC program focused on the city's central area, identified by the Casey Foundation as having one of the lowest EITC participation rates in the nation.

The partnership, which includes the IRS, Tulane-Xavier National Center for the Urban Community, Entergy Corporation and the Annie E. Casey Foundation, as well as other nonprofit groups, has set up three permanent sites and a mobile income tax preparation unit over the last two years to help low-income clients with their taxes.

Clients are referred to Hibernia National Bank for free checking accounts and are encouraged to enroll in financial education classes taught by Consumer Credit Counseling Services and Neighborhood Housing Services of New Orleans. Eligible clients are also referred to the Individual Development Account (IDA) Collaborative of Louisiana to participate in an asset-building IDA program.

Last year the centers helped prepare 249 tax returns that saved participants a total of $64,750. By taking a comprehensive approach to improving EITC participation, the coalition has contributed significantly to long-term strategies to alleviate poverty.

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