Earned Income Credit

A Primer on Earned Income Credits in Maryland

Revised January 16, 2001

Tax Year 2001

An earned income credit is a tax credit for low-income, working taxpayers - mostly workers with children - that supplements their wages and offsets the impact of other taxes.

The federal government has offered an EIC for 25 years; it is now one of the nation's most important anti-poverty tools. Since 1987, working families in Maryland have been able to claim both the federal credit and a state credit, but until 1998 workers with incomes below the poverty line - the major beneficiaries of the federal credit - received little or no benefit from the state credit. In 1998, the state credit was expanded to benefit those workers as well.

The Federal Earned Income Credit

The federal earned income credit was originally passed in 1975 to offset payroll taxes for low-income workers. While some still view the primary role of the EIC as an offset to payroll taxes, the program also has become a way to reduce poverty among low-income, working families with children. The credit augments the wages of workers in low paying jobs, and thus is an important part of what is often called the "making work pay" strategy. Other reasons for the existence and expansion of the earned income credit are that it encourages the transition from welfare to work and that it offsets work-related costs such as child care, transportation, and clothing.

The federal credit was expanded in 1978, 1984, 1986, 1990, and 1993 -- each time increasing the size of the credit and the number of people who are eligible. The increases in 1990 and 1993 were substantial. In the debates around these more recent changes it was argued that the credit should help to ensure that working families are able to achieve at least poverty-level incomes.

The amount of a family's benefit under the EIC depends on the number of children and the family's earnings. At the lowest levels of earnings, the amount of the credit increases as earnings increase, until the maximum credit amount is achieved. As shown in both the chart and table below, the maximum credit is received for those with earnings within a narrow income range, after which the credit phases out as earnings increase.

For low-income childless workers, the credit offsets Social Security payroll taxes. In 2001, childless workers between the ages of 24 and 65 can receive a credit equal to 7.65 percent of their earnings up to $4,760, resulting in a maximum credit of $364. The maximum credit begins to phase-down at incomes over $5,950. The maximum credit is reduced by 7.65 percent for each additional dollar of earnings, resulting in no credit at earnings over $10,708.

Back to Top

The credit is more generous for families with children.

For taxpayers with one child, the credit amount increases by 34 cents for each dollar increase in earnings, up to a maximum credit of $2,428 for those with earnings between $7,140 and $13,090. The amount of the credit is reduced by 15.98 cents for every dollar increase in earnings above $13,090, resulting in no credit for families with one child and earnings over $28,281.

The credit is most generous for tax filers with two or more children. For these tax filers, the credit amount increases by 40 cents for each dollar increase in earnings, up to a maximum credit of $4,008 for those with earnings between $10,020 and $13,090. The credit begins to phase out for those with earnings above $13,090, when the credit is reduced by 21.06 cents for each dollar increase in earnings, resulting in no credit for families with income above $32,121.

Table 1

Federal Earned Income Credit Parameters

The federal credit is refundable. This means that the IRS will send a check to taxpayers whose credit is greater than the amount of income taxes paid or owed. Two examples are below:

Ms. Miller has no children. In 2001, she works part-time and earns $6,100. Because of her low earnings, she has no income tax taken out of her paycheck, and owes nothing to the IRS (although she does pay Social Security taxes). Her earnings entitle her to an EIC check of $353.

Mr. and Mrs. Gootman have two children. In 2001 they earn $23,000. Because of their low earnings, they have no income tax taken out of their paycheck, and owe nothing to the IRS (although the do pay Social Security taxes). Their earnings entitle them to an EIC check of $1,921.

Of note, Ms. Miller's EIC check is not enough to offset Social Security taxes. The $1,921 received by Mr. and Mrs. Gootman is $160 greater than their payroll taxes. Table 2 shows additional credit amounts.

Table 2

Federal EIC for Families By Income and Number of Children

Maryland Budget and Tax Policy Institute.

Back to Top

The Maryland Earned Income Credit

The earned income credit is used by some state governments to augment the incomes of the working poor and to offset the impact of state and local taxes. This latter point is particularly important in Maryland. In 1995, the poorest 20 percent of families in Maryland had a state and local tax burden that was greater than any other income group.(1)

As of November 2000, 15 states offered earned income credits. Ten states follow the federal practice of making the credit refundable. Five other states offer non-refundable credits that limit the amount of the credit to a family's income tax liability. Maryland's EIC is modeled after the federal EIC, and has both a refundable and non-refundable component.

Maryland's non-refundable EIC is calculated as 50 percent of the federal credit. However, because it is not refundable, the actual size of the credit that a family can claim cannot exceed the family's income tax liability.

For families whose incomes are so low that they had little or no state income tax liability to begin with -- and thus for whom the non-refundable EIC provides little or no benefit -- the state in 1998 enacted a refundable EIC. The state provides a modest refund to taxpayers whose credit is greater than the amount of taxes paid or owed. Effective beginning tax year 2000, the state's refundable EIC is equal to 15 percent of the federal credit for eligible families with children, minus any pre-credit income tax liability. Maryland's refundable credit is not available to taxpayers without qualifying children.

Maryland's refundable and non-refundable credits work in concert. The refundable credit provides modest refunds to families with income approaching the poverty level. The actual credit amount varies based on family size and income. The non-refundable credit ensures that families with incomes slightly above poverty have little or no income tax liability.

Three examples of Maryland's credit are below:

Ms. Miller has no children. In 2001, she works part-time and earns $6,100. Because of her low earnings, she had no state income tax taken out of her paycheck, and owes nothing in state taxes. Her earnings entitle her to a federal EIC check of $353. However, because Maryland's refundable EIC is available only to families with children, Ms. Ahern does not receive a state EIC.

Ms. Appleton has one child. In 2001, she works full-time, full-year at the minimum wage of $5.15 per hour, and earns $10,300. Ms. Gootman's earnings entitle her to a federal credit of $2,428. Her state tax liability, before calculating the EIC, is $95. With the EIC, her state tax liability is eliminated. Moreover, because 15 percent of her federal credit ($364) exceeds her pre-credit liability ($95) by $269, she receives a refund of $269.

Mr. and Mrs. Gootman have two children. In 2001 they earn $23,000. They are eligible for a federal earned income credit of $1,921. The Appletons' state income tax liability is $481. Fifty percent of the federal credit is $960. Because the non-refundable credit can only be used to offset state income taxes, the Appleton's will receive a state EIC of $481, all of which is used to eliminate their income tax liability. They do not receive a refund because 15 percent of their federal credit ($288) does not exceed their state income tax liability.

Table 3 shows the impact of the federal and state earned income credits for different family sizes at various earnings levels. Figures in ( ) show the state refund returned to the taxpayer.

Not shown in the table are the local incomes taxes levied in all Maryland counties and in Baltimore City, and the impact of Maryland's state earned income credits on local income tax liability. Historically, Maryland's non-refundable credit implicitly applied to local income taxes. Local income taxes were based upon state tax liability after consideration of the non-refundable EIC. Thus, if the state's non-refundable EIC eliminated state tax liability, then it also eliminated local income tax liability.

In 1999, legislation "decoupling" the local taxes from the state taxes was enacted in order to simplify state tax calculations. Among other provisions, this legislation explicitly created a non-refundable EIC to offset all or part of local income tax liability for eligible taxpayers. The local EIC equals the local tax rate times ten, multiplied by the federal credit. For example, a taxpayer in a county with a local income tax rate of 3 percent may claim a local EIC equal to 30 percent of the federal credit. The amount of the county credit, however, may not exceed local income tax liability. The "decoupling" legislation was structured so that it would have little or no impact on families' net tax liability while simplifying the calculation of local tax liability.

In addition to the federal and state EICs, Montgomery County also offers a local refundable EIC that is equal to the state credit. Montgomery County is the only local jurisdiction in the United States that offers an earned income credit.

Table 3

State EIC Amounts in Maryland in Tax Year 2001

Maryland Budget and Tax Policy Institute.

Back to Top

Notes:

1. Michael Ettlinger, et.al., Who Pays: A Distributional Analysis of the Tax Systems in All 50 States, Citizens for Tax Justice and The Institute on Taxation and Economic Policy, June 1996.