Understanding the Earned Income Tax Credit

December 20th, 2011, by

Q: Please tell me the difference between increasing dependent deductions on my W-4 and asking my employer to sign me up for EITC. Which one will I get more money from on my monthly paycheck?

Columbia, SC

A: Before answering your question, I would like to explain how the W-4 form works.

When you get a job, your employer will ask you to fill out a W-4 or “Employee’s Withholding Allowance Certificate.” On this form, you report your marital status and the number of allowances you want to take. The information you supply allows your employer to calculate the amount of federal income tax to withhold from each paycheck.

You are entitled to take federal withholding allowances for yourself, your spouse and your dependents. Allowances reduce the amount of income that is subject to withholding. You can file a new Form W-4 at any time, and you can adjust the number of allowances you take. You can adjust your withholding at any time to increase your take-home pay by claiming allowances based on expected tax deductions and credits.

For example, if you itemize the interest you pay on your mortgage, you could boost the number of allowances you take so that you have more money in your paycheck. The more allowances you claim, the less money is withheld from your paycheck.

To figure out how many allowances to take, follow the instructions on the W-4. The form has a worksheet to help you figure this out, based on projected deductions and tax credits. However, just know that if you take too many allowances, you could owe the IRS, and you could be subject to a penalty for underpaying.

If you are having trouble doing the worksheet on the W-4 form, go to the IRS’ online “Withholding Calculator.”

Now, as to your question about the Earned Income Tax Credit (EITC), it is a refundable federal income tax credit that is intended to help low- to moderate-income working individuals and families. Your employer doesn’t sign you up for the EITC. To qualify, taxpayers must meet certain requirements and file a tax return, even if they do not have a filing requirement. To find out if you qualify for this great credit, go to the EITC Home Page of the IRS website.

In your question, I believe you are confusing the EITC with the AEITC or the Advance Earned Income Tax Credit program. The AEITC allowed people to get a portion of the Earned Income Tax Credit in their paychecks, instead of receiving all of it when filing their year-end tax return. The Education Jobs and Medicaid Assistance Act of 2010, signed into law in August 2010, repealed the Advance EITC. After December 31, 2010, workers could no longer get the benefits of this credit in their paychecks.

So, you should use the withholding calculator on the IRS site and find out if you are eligible for the EITC.

Last modified: December 20, 2011 at 4:28 am