The earned income tax credit is one of the most complicated features of the U.S. tax code. But figuring it out can be well worth the effort, given the benefits that the credit can provide to lower-income taxpayers.
Just ask Roxanne Villa, a 25-year-old clerk-typist for the city of Los Angeles. The mother of two, who this year will claim the earned income credit for the fourth time, said using the credit has helped her pay off debts, put food on the table and buy some of the big-ticket items she previously couldn't afford.
"It has really made a difference for me," said Villa, who lives in L.A. "I was able to save and buy a car. I didn't have to live paycheck to paycheck."
Villa is far from alone. The credit, a lucrative tax break aimed at the working poor, has done more to pull children out of poverty than any other social program in the nation, including welfare, said Nancy Duff Campbell, co-president of the National Women's Law Center in Washington.
In 1999, the most recent year for which statistics are available, about 5 million people were lifted above the federal poverty line as a result of claiming the credit, she said.
"Even the people who aren't completely lifted out of poverty are getting a big boost from it," she said. "It is a very important program."
On returns for the 2002 tax year, the credit has been expanded to provide a bigger break to more people. Filers with two children can get a credit of as much as $4,140, up from a maximum of $4,008 last year. (Most tax deductions and credits simply reduce the amount of tax a person owes and are of scant value to low-income Americans who pay little or no income tax. But the earned income tax credit can put money in the pocket of a worker who pays no income tax.)
However, when Congress expanded the credit, it also created stiff penalties for claiming it improperly. That could be a problem, because it is among the most befuddling provisions in the U.S. tax code.
The Internal Revenue Service estimates that about one-third of those who claim the credit don't qualify for it. And a recent study by the General Accounting Office estimated that about 25% of those who qualify don't claim it. The nonparticipation rate is particularly high -- more than 50% -- among childless people.
"It is an incredibly complex provision," said Jim Seidel, senior tax analyst with RIA, a New York-based publisher of tax information and software. "You have to be very careful when you claim it because Congress put in some tough provisions to stem what were perceived as abuses of the system."
Those who claim the earned income credit "recklessly" or fraudulently now can be barred from claiming it again for a decade, Seidel said. They also could face prosecution for tax evasion, though the IRS typically goes after only the most egregious cases of fraud involving the earned income credit.
If the filer just made a mistake, perhaps claiming the credit for a child who did not meet all of the complicated eligibility criteria, he or she still could be barred from submitting earned income credit claims for two years.
"There are no like provisions for people who mistakenly claim business deductions," Seidel said. "Given that the people who are primarily eligible for the EITC may not be the ones who have access to good professional assistance, it seems like Congress may have gone a little overboard here. However, that's the law."
Myriad Eligibility Rules
The tax credit's complexity stems in part from its myriad qualification standards, which sometimes conflict with similar qualification standards in other parts of the tax code.
So-called dependency tests are one example.
A parent can claim a child as a dependent if he or she provides more than half of that child's support, regardless of where the child lives. But under the earned income tax credit qualification rules, the child also must live with the filer for more than half of the year, making it impossible for a non-custodial parent to claim the credit.
And that's just the start. The IRS put a quiz on its Internet site designed to help confused taxpayers determine whether they qualify for the earned income credit. The quiz is 15 pages and, at best, merely concludes that the person is "likely" to qualify for the credit if the answers to all the relevant questions are affirmative.
That conclusion is followed by a referral to an IRS booklet for further study and review.
Despite the challenges, taxpayers with adjusted gross income of less than $34,178 -- the most a married couple can earn and still qualify -- should find out whether they qualify for the earned income tax credit, Seidel said. The potential payoff is just too rich to ignore, he said.
Free Tax Help
An added bonus: Those likely to qualify for the credit also qualify for no-cost tax help through two programs -- the Volunteer Income Tax Assistance Program (VITA) and the IRS' fledgling electronic free-filing program.
To get information on a VITA program, which provides in-person assistance with tax preparation, call the IRS at (800) 829-1040. To link to the free IRS electronic filing program, go to www.irs.gov and click on "Free File -- Start Here."
The earned income quiz also can be accessed from the first page of the IRS site. Click on "Earned Income Tax Credit."
Times staff writer Kathy M. Kristof, author of "Investing 101" (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail firstname.lastname@example.org. For past Personal Finance columns visit The Times' Web site at www.latimes.com/perfin.