Sunday, December 31, 2006


The earned income credit was designed, as I understand it, to get people off welfare and encourage them to work, even at a low-paying job. It has both good points and bad points. If it is used, as it sometimes is, as a helping hand when someone is temporarily unable to earn an adequate income, it can be a good thing. One of my clients injured his back at work and was off work for almost a year. He got the EIC that year which seemed like something he was entitled to. As soon as his back got better he went back to work and no longer qualified for the EIC.

Another client who reports on a cash basis, and usually makes around $ 100,000 a year got an EIC one year, not because his business was bad, but because a lot of money due him did not get paid until early the next year when his income was higher than normal. It seems questionable to give it to someone under those circumstances, but since he qualified for it, I made sure I put it on his tax return.

However, some people get the EIC year after year under questionable circumstances. There is a lot of cheating. People earn more than they report, often working in the underground economy. Others are married, but both the husband and wife file as head of household, each claiming some of their children to get more EIC than the law would allow if they filed correctly. Another way to cheat is if you are self-employed and you underreport your income. Even if you get paid by check, you can cash a lot of checks and pay cash for all your living expenses and omit the hidden income from your tax return and get up to $ 4536 in Earned Income Credit.

The IRS spends a lot of time trying to catch the cheaters, but the time so spent is not cost productive. It is difficult to prove, in many cases, that the person is cheating. If a married couple both live together and both claim the EIC, and show the same address on their tax return, the IRS might catch them. In some cases the person really does have the low income and reports it correctly. An almost illiterate employee of one of my clients got an Earned Income credit. He qualified for it because he supported his grandchild, but was questioned. I had to help him provide all the supporting evidence requested by the IRS—and the IRS ended up being unable to disallow it. Meanwhile the IRS could have been finding big bucks auditing some large company that inadvertently underpaid their tax and would readily agree to the tax assessment if they were questioned.

In my own experience as an auditor, I always found the biggest dollars, not by auditing some small company that was cheating, but in auditing the big non-cheating corporations. Once I noticed a BTU report in which the percentage of one component in the gas, as reported by the buyer was off considerably from the preceding month and the following month. It seemed evident to me it was a misplaced decimal. The price of the gas was priced based the BTU content per cubic foot and the error caused a large pricing error. The buyer immediately agreed with my conclusion and paid my company the additional money. The error was completely accidental and unintentional. My time was more productively spent looking for that type error than in looking for deliberate fraud. (Gas is mostly methane -around 1000 BTU per cu ft, but the ethane content has a BTU of around 1700 and other components have even higher BTUs per cu ft.)

The earned income credit is even paid to people who have no tax withheld from their pay. If the person is self-employed, the credit is large enough to pay both his income tax and his social security tax. On a joint return you get the maximum credit of $ 4536 if you earn between $11,300 and $16,850 and have two children. And the credit does not completely phase out until income reaches $ 38,348.

This obviously requires the rest of us, who don’t get “refunds” of money we didn’t pay, to pay more taxes. For this reason, it seems that the EIC should have a time limit. A time limit would reduce cheating and place a smaller burden on the rest of us who have to pay taxes and might help people who really need help until they can get on their feet and become productive members of society.
Link to IRS forms and publications:

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

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