The Earned Income Tax Credit (EITC) is one of the most effective anti-poverty programs in America. In 2017, the federal EITC pulled 5.7 million people above the poverty line and reduced the severity of poverty for another 19.5 million. In Oklahoma alone, 310,000 families filed for the EITC in 2019, bringing $808 million back into our state and their communities. Despite its effectiveness, one in four Oklahoma households eligible for the EITC do not claim the credit. The rules setting out who can claim the credit are extensive and challenging to understand, and as a result many people simply don’t bother. Unfortunately, that means these families are not getting the help they very much need to thrive. If Congress were to simplify the rules around the EITC, they could make this already effective anti-poverty tool even more effective.
Policymakers concerned with reducing EITC errors should focus on policies that improve the accuracy of returns.
Who qualifies for the EITC?
The EITC is targeted primarily at low-income working families. A household member must have earned income during the year and file a tax return in order to claim the credit. Childless workers are excluded from the credit once their earnings exceed $15,300 (if single) or $18,400 (if married). Because the income limits for single workers are so low, most people who claim the EITC are working parents.
This is the point at which things can get confusing. For a parent to claim the EITC, they must have earned income within the eligibility limits and have at least one qualifying child. However, simply having a child claimed as a dependent on a tax return does not mean the child meets EITC qualifications. The Internal Revenue Service (IRS) has four tests to determine a qualifying child under EITC rules: relationship, age, joint return, and residency. The residency test is where mistakes often occur, especially for divorced parents or individuals raising children who are not their biological son or daughter. The tax filer must be able to prove that the child lived in the household for at least six months of the year through supporting documents like school enrollment or daycare paperwork, doctor’s bills, or something else with the child’s name and the filer’s address.
EITC filers are often subject to extra review
Determining whether or not a tax filer can claim the EITC is complicated – the IRS’s instruction booklet alone was 40 pages long last year. The complexity of the EITC rules makes it easy for taxpayers, and even paid tax preparers, to make a mistake on tax returns. It is estimated that between 22 and 26 percent of EITC returns contain an error in calculating the credit, meaning that a family should have gotten a bigger or smaller credit, or the wrong taxpayer claimed the qualifying child (as can often happen when two parents share custody). Due in part to this high volume of errors, the IRS reviews EITC tax returns at a higher rate than it does the returns of middle to high-income taxpayers. In fact, a family making $20,000 a year is more likely to be audited than a family making $400,000 a year. However, it is important to remember that the majority of these errors are simple mistakes rather than tax fraud.
The best way to reduce the EITC error rate is to simplify the rules
Policymakers concerned with reducing EITC errors should focus on policies that improve the accuracy of returns. This can be achieved by simplifying the eligibility rules and ensuring commercial tax preparers have a thorough understanding of the rules and properly apply them to the families they serve. Approximately 52 percent of EITC returns are prepared by paid tax preparers. Most of these preparers are considered “unenrolled” preparers as opposed to “enrolled agents” who are federally-authorized tax practitioners, attorneys, or CPAs with technical expertise in taxation. Unenrolled preparers are not subject to professional oversight, and thus are most likely to make an error on a return. Improved oversight of these paid tax preparers would significantly improve the accuracy of tax returns.
The EITC is an effective poverty-fighting tool at both the federal and state levels. But too many people miss out on the benefit of this credit because the rules are simply too difficult to understand. Congress needs to simplify the rules so that families and tax preparers can follow them more easily. At the same time that Congress should address the complexity of the EITC rules, Oklahoma lawmakers could make the credit work better for their constituents by restoring EITC refundability, which the Legislature cut in 2016. A robust state EITC serves hard-working Oklahoma families, encourages work, reduces poverty, and improves the health of Oklahoma mothers and children. The EITC is an essential tax benefit that improves the lives of more than 200,000 Oklahoma families, and these changes would make it even more effective.