Module 11: Earned Income Credit

Educational Standards

State and National Standards

Time Frame

One to three hours

Curriculum Area(s)

• Technology
• Civics/Government
• Family and Consumer Sciences
• History/Social Studies
• Economics

Purpose

To help students understand the earned income credit

Objectives

Students will be able to

• distinguish between a tax deduction and a tax credit.
• explain how the earned income credit affects the tax liability.
• apply the requirements to claim the earned income credit.
• describe the factors that determine the amount of the earned income credit.

Background

A tax deduction reduces the income subject to tax. A tax credit is a dollar-for-dollar reduction of the tax. The earned income credit is a refundable tax credit for people who work and whose earned income and adjusted gross income are under a specific limit. Many rules apply to the earned income credit, including a limit on the amount of investment income. Generally, the taxpayer's earned income, filing status, and number of qualifying children, if any, determine the credit. The earned income credit reduces the tax. Eligible taxpayers can receive the earned income credit even if their tax is zero. This makes it a refundable credit.

Key Terms

adjusted gross income

Gross income reduced by certain amounts, such a deductible IRA contribution or student loan interest.

earned income

Includes wages, salaries, tips, includible in gross income, and net earnings from self-employment earnings.

Earned Income Credit (EITC)

A tax credit for certain people who work and whose earned income and adjusted gross incomes are under a specified limit.

investment income

Includes taxable and tax-exempt interest, dividends, capital gains net income, certain rent and royalty income, and net passive activity income.

qualifying child

A qualifying child for the earned income credit meets relationship, age, and residency tests.

tax credit

A dollar-for-dollar reduction in the tax. Can be deducted directly from taxes owed.

tax deduction

An amount (often a personal or business expense) that reduces income subject to tax.

Opening the Lesson

Hand out Fact Sheet-Earned Income Credit. Use the following questions to prompt students to share what they know about the credit:

• Would you rather have a tax deduction or a tax credit for the same amount? (A tax credit; a tax deduction reduces the amount subject to tax, and a tax credit is a dollar-for-dollar reduction of the tax.)
• Why is there a tax credit for low-income workers? (The earned income credit encourages taxpayers to be employed; it supplements the income of workers who are not highly paid.)

Then, explain that this lesson covers the requirements to claim the earned income credit.

Note: Refer students who may want to work independently on this module to Student Lesson-Earned Income Credit.

Developing the Lesson

Direct students to Tax Tutorial-Earned Income Credit, and explain that this tax tutorial focuses on the earned income credit. Tell students they will learn (or review) the difference between a tax deduction and a tax credit and that they will learn about the requirements for claiming the earned income credit. Inform students that the earned income credit depends on the taxpayer's earned income, filing status, and the number of qualifying children, if any. The earned income credit reduces the tax. Eligible taxpayers can receive the earned income credit even if their tax is zero. Inform students that they will have an opportunity to see how the tax credit is reported on tax forms.

Concluding the Lesson

After the students have completed Tax Tutorial-Earned Income Credit, Simulation 11A-Claiming the Earned Income Credit without a Qualifying Child, and Simulation 11B-Claiming the Earned Income Credit with a Qualifying Child, ask them whether they have any questions about the earned income credit. To ensure that they understand the material, ask the following questions:

• At the same adjusted gross income level, which taxpayer has the higher earned income credit: a single worker with no qualifying children or a married couple with two qualifying children? (The earned income credit is larger for taxpayers with qualifying children.)
• Can a taxpayer with no earned income claim the earned income credit? (No; a taxpayer must have earned income to receive the earned income credit.)