The Flawed Earned Income Credit

A single mom, whom we’ll call “Mary”, works hard without support from her ex to provide for her child, and makes about $35,000 per year.  Unfortunately, she makes too much money to qualify for the so called “Earned Income Tax Credit.”  During 2011, she lost her job due to company downsizing.  But, since she lost her job in October, her earnings for 2011 were still close to $30,000 – still too high to qualify for the EITC (with one child).  If she had lost her job in July or maybe August, her earnings would have been low enough to qualify.

Unfortunately, qualifying for the EITC has a lot to do with timing.

Mary is still unemployed and looking for a job.  It could be March or April before she lands a good job.  In other words, she could start working “just in time” to NOT qualify for the EITC again in 2012.  Even though she will have been out of work for 6 months, since those 6 months are split between 2011 and 2012, she doesn’t get the EITC for either year.  This is what you call a “wacky” system that only someone in D.C. could have come up with.

A single parent, claiming 3 dependents, can hit the “sweet spot” of EITC by earning between $12,750 and $16,650 during the year.  They can get EITC of up to $5,751 added on to their Income Tax Refund.  For 2 dependents the EITC is $5,112.

Another single mom that I know has supported 2 children on only about $17,000 per year for the past few years.  Unfortunately, last year she got a second job at a gas station and made an extra $5,000.  This extra income significantly decreased her EITC this year.  Only someone in D.C. could devise such a system that punishes a single mom for getting a second job.

The third situation is about two divorced parents living together with each having children of their own.  They each are providing for their own “household” and paying for each of their children’s expenses.  Thus, they both claim Head of Household and the EITC.  They each get $3,000 – $5,000 per year from EITC.  Then they get married.  Suddenly they no longer qualify for the EITC at all because together they make “too much money” to qualify for EITC.  Again, only a bureaucrat in D.C. could devise a system that encourages co-habitation and punishes married people.

All three of these situations are actual situations and I know all of these people personally.  The EITC is one of the many flaws in our current tax system that needs to be fixed.

Here is how it could be fixed:

1. If you’re going to have EITC at all, allow people to apply for EITC any time during the year using the past 12 months of income.  This could be done on an amended Form 1040X.  They would need to wait 12 months before applying again.

2. In order to not “punish” someone for getting a second job, allow people to take an average income over the past 3 years to determine their EITC.  Putting this in place would help those people who didn’t realize that they were going to be “punished” for working a second job and would allow them to decide going forward, after meeting with their tax professional, if they want to keep working the second job.  When you consider child care, social security and medicare taxes and the decrease in EITC it is hardly worth it for someone to work a second job.

3.  Allow married couples to file as “Single” if they so choose with only one being allowed to file as “Head of Household”.  And, no longer allow people living together to each file as “Head of Household”.  There should only be one “Head of Household” filing per physical address.