CRS Reports on EITC Changes for 2006

Qualifications for, and the amount of, the EITC depend on the amount of earned income, adjusted gross income (AGI), and whether the tax filer has a qualified child based on the definition for the personal exemption. In general, for the personal exemption for a dependent, an individual is either a qualifying relative or a qualifying child. A qualified child must meet the following three criteria:

• relationship -- the child must be a son, daughter, stepson, stepdaughter, or descendent of such a relative; a brother, sister, stepbrother, stepsister, or descendent of such a relative; an adopted child; or a foster child placed with the taxpayer;

• residence -- the child must live with the tax filer for more than half the year; and

• age -- the child must be under age 19 (or age 24, if a full- time student) or be permanently and totally disabled.

In general, the EITC amount increases with earnings up to a point (the maximum earned income amount), then remains unchanged (at the maximum credit) for a certain bracket of income, and then, beginning at the phase-out income level, gradually decreases to zero as earnings continue to increase. A family will be disqualified from receiving the earned income credit if investment income exceeds a specified level.

The maximum earned income amount, the phase-out income level, and the disqualifying investment income amount are indexed for inflation. For married couples filing a joint tax return, in tax years 2002 through 2004 the phase-out level was $1,000 higher than for other filers, and in tax years 2005 and 2006 the phase-out level is $2,000 higher.

To make it easier for tax filers to determine the correct amount of the credit, the tables for the earned income credit included in the income tax return instructions are in $50 increments of income. Table 1 shows the parameters for the EITC (credit rates, phase-out rates, maximum earned income amount, maximum credit, phase-out income level, and disqualifying investment income level) for tax years 2004, 2005 and 2006.

        Table 1. EITC Parameters for Tax Years 2004-2006

As shown in Table 1, between tax years 2005 and 2006, there are small increases in the maximum earned income, maximum credit, and phase-out income levels associated with indexing for inflation. The effect of the indexing is that the largest percentage increases in EITC between 2005 and 2006 will be for higher income EITC eligible tax filers. The effect of indexing on the EITC between 2005 and 2006 can be defined for four groups of tax filers:

• Tax filers below the 2005 maximum earned income level will have no increase in the EITC between 2005 and 2006.

• Tax filers above the 2005 maximum earned income amounts and below the 2006 maximum earned income level will have an increase in EITC equal to the change in the maximum credit amount (the credit rate times the change in the maximum earned income).

• Tax filers above the 2005 phase-out income amount but below the 2006 phase-out income amount, will have an increase in EITC equal to the change in the maximum credit plus the 2005 phase-out reduction in the EITC (the amount by which their 2005 income exceeded the 2005 phase-out income times the phase-out rate).

• Tax filers above the 2006 phase-out income level will have a change in the EITC that is fixed (approximately $13 for childless tax filers, $85 for a family with one child, $136 for a family with two children) at every income level until the end of the phase-out range. The fixed change reflects the change in the maximum credit.

                Table 2. EITC for 2005 and 2006,

Generally, to receive the EITC a married couple must file a joint return. However, by combining their incomes, the EITC will be reduced. EGTRRA increased the phaseout income levels for tax filers filing joint returns, to provide relief from this marriage penalty. Like the inflation adjustments, the largest percent change in the EITC from the marriage penalty relief are for higher income EITC eligible couples. This is because above the phase-out income level, like the inflation adjustments, the increase in EITC from marriage penalty relief is fixed (approximately $153 for childless couples, $319 for couples with one child, and $421 for couples with two children) for all income levels. The marriage penalty relief for couples above the phase-out income level is the change in the phase- out income level times the phase-out rate. For tax year s 2005 and 2006, the adjustment in the phase-out income level for married couples filing a joint tax return is $2,000. Table 3 shows the 2005 and 2006 EITC, the change in EITC, and the percent change in EITC at differing income levels for a married couple with two children.

                Table 3. EITC for 2005 and 2005,

The Working Families Tax Relief Act of 2004 (P.L. 108-311) created a more uniform definition of a child for several tax provisions used by families with children, including the EITC. P.L. 108-311 also provided that for tax years 2004 and 2005, taxpayers in the military have the option of including combat pay (which is generally nontaxable) in computing earned income for the EITC. The Gulf Opportunity Zone Act of 2005 (P.L. 109-135) extended the option of including combat pay for the EITC through tax year 2006. The Katrina Emergency Relief Act (P.L. 109-73) provided that taxpayers affected by Hurricane Katrina may use their tax year 2004 earned income to compute their 2005 EITC. P.L. 109-135 also extended the option of using 2004 income to compute 2005 EITC to taxpayers affected by Hurricane Rita and clarified that to use this election, the taxpayer's 2005 income had to be less than the taxpayer's 2004 income.