In 1975, Congress introduced the Earned Income Tax Credit (EITC) as an incentive for folks to go to work and to help relieve the burden of Social Security taxes. This tax credit is designed for low-income workers, especially those with children. The amount of credit one can receive is on a sliding scale depending on the amount of earned income received and the number of children the taxpayer claims as dependents.

For 2012, the maximum credit is as follows:

  1. $5,891 with three or more qualifying children
  2. $5,236 with two qualifying children
  3. $3,169 with one qualifying child
  4. $475 with no qualifying children

The nice thing about the EITC is that it’s refundable, which means that if your tax liability is only $30 and the credit you are allowed is $5,030, you may receive a refund check for $5,000. This is how it got its nickname from some politicians as a “Reverse Welfare System.”

According to the IRS, in order to qualify for the credit, you must meet the following requirements:

  1. Have a valid Social Security number
  2. Have earned income from employment, self-employment, farming, some disability plans, or another source
  3. Dividend, interest and capital gain income or other income from investments does not qualify as earned income and must be less than $3,200 for the year
  4. Don’t use the married, filing separate filing status
  5. Be a U.S. citizen or resident alien all year or a nonresident alien married to a U.S. citizen or resident alien and choose to file a joint return and be treated as a resident alien
  6. Cannot be the qualifying child of another person
  7. Cannot file Form 2555 or 2555-EZ (related to foreign earned income)
  8. Your Adjusted Gross Income and earned income must meet the limits shown on the Income Limits, Maximum Credit Amounts and Tax Law Updates Page.  

To qualify, your earned income and adjusted gross income for the 2012 year must be less than $45,060 ($50,270 married filing jointly) with three or more qualifying children, $41,952 ($47,162 married filing jointly), with two qualifying children, $36,920 ($42,130 married filing jointly) with one qualifying child, $13,980 ($19,190 married filing jointly) with no qualifying children.

Qualifying children are those who have valid Social Security numbers, under age 19 at year end, your child, stepchild, adopted child, grandchild, brother, sister, or other blood relation as described in the IRS code. Children also must have lived with you for more than half the year and if married, can’t have filed a joint return except to claim a refund without having a filing requirement.

For more detailed information, check out Qualifying Child Rules on the IRS website.

Because there has been so much fraud and abuse associated with the EITC, the IRS requires preparers to submit Form 8867 – a due diligence questionnaire – along with the taxpayer’s income tax return. If you self-prepare your income taxes, be sure to include this form with your tax return. Otherwise you will likely be audited or simply disallowed all or part of the credit. A number of individuals have written to me telling me of their nightmares in dealing with the IRS over this issue in order to get their tax refunds.

Bonnie Lee is an enrolled agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter and on Facebook.