Tax Credits for Lower Income Taxpayers

Paying taxes is a painful ritual taxpayers must go through each year. However, the tax system is set up to take the sting out of paying taxes where lower income taxpayers are concerned.

Those with the lowest incomes are taxed at a rate of only 10 percent (as opposed to the top income tax rate of 35 percent). Also, starting in 2008, low and moderate income taxpayers in the 10 and 15 percent income tax brackets pay zero long-term capital gains taxes on investments.

In addition, there are a number of tax credits that are available only to lower income or disabled taxpayers. The following are three in particular you should know about.

Earned Income Tax Credit (EITC). If you or your spouse earned any taxable income for the year, you may be eligible for the Earned Income Tax Credit (EITC). The most appealing feature of the EITC is that it is a refundable tax credit. This means that if your credit amount is higher than your tax bill, you can actually get the unused part of the credit back as part of a tax refund.

The EITC is part of a federal tax program designed to help low income workers and families by offsetting the burden of Social Security taxes and providing an incentive to work. Even if you don’t earn enough to owe federal income taxes, you may get a refund from the IRS if you qualify for the EITC. If you qualify, it could be worth up to $4,716 for the 2007 tax year.

Even though it sounds too good to be true, it isn’t. In 2007, more than 22.4 million taxpayers received over $43.7 billion in earned income credits by filing their 2006 federal income tax returns. Unfortunately, the IRS estimates that approximately one in four people who could have been eligible failed to claim the EITC.

According to the IRS, the main reason people fail to claim this important tax credit is because they simply don’t know about it. To help solve this problem, here is what you need to know about the EITC.

If you or your spouse were employed for at least part of 2007, you may be eligible for the EITC based on these general requirements:

2007 EITC Eligibility

Maximum Earnings Qualifying Children Investment Income

Single Married Filing Jointly

$12,590 $14,590 None Maximum $2,900

$33,241 $35,241 One Maximum $2,900

$37,783 $39,783 Two or more Maximum $2,900

The amount of the EITC itself depends on your income and family size. For 2007, the maximum credit amounts are as follows:

2007 Maximum EITC Amounts

Number of Qualifying Children Maximum Credit

Two or more $4,716

One $2,853

None $428

Based on tables provided by the IRS, the maximum credit amounts are phased in from the first dollar earned. The EITC phases out completely when the earning levels mentioned earlier are reached.

When figuring out your EITC, benefits you receive under an employer's disability retirement plan (providing pensions to workers who lose their jobs because of disability) are considered earned income until you recach minimum retirement age. According to the IRS, the minimum retirement age is considered the earliest age at which you could have received a pension if you were not disabled. The taxable disability payments you claim on line 7 of either Form 1040 or Form 1040A count toward qualifying for the EITC.

However, you should be aware that benefits such as Social Security Disability Insurance (SSDI), SSI or military pensions are not considered earned income that qualify for the EITC. The same is true for payments you received from a disability insurance policy on which you paid the premiums. You or your spouse must have earned income to qualify for the EITC.

There are several ways to determine EITC eligibility and the actual amount of the credit. The hard way is to work through the worksheets and tables provided in the instructions to IRS Forms 1040, 1040A or 1040EZ. An easier way is to use the EITC Assistant tools provided by the IRS that walk you through the entire process. If you elect to do so on your tax return, the IRS can also figure out your EITC for you. If none of these choices work for you, seeking professional tax help is highly recommended because of complexities involved.

Saver’s Credit. For those struggling with the financial hardships caused by a permanent disability, putting away money for retirement may seem like a tough thing to do. However, the reality is that you will need money in later years as well (perhaps even more so then today).

The good news is that there is a way for the federal government to add to your private retirement nest egg through a special tax credit called the Saver’s Credit. This credit is available only to lower income taxpayers.

Based on the most recent information available, taxpayers claimed more than $900 million in Saver’s Credits on nearly 5.3 million individual income tax returns. The average savings for those filing jointly was $216.

Provided you or your spouse have any earned income, the Saver’s Credit helps offset part of the first $2,000 workers voluntarily contribute to IRAs and to 401(k) plans and similar workplace retirement programs. This credit can be claimed by:

•   Married couples filing jointly with incomes up to $52,000 in 2007 or $53,000 in 2008;
•   Heads of Household with incomes up to $39,000 in 2007 or $39,750 in 2008; and
•   Married individuals filing separately and singles with incomes up to $26,000 in 2007 or $26,500 in 2008.

The maximum Saver’s Credit is half of the first $2,000 saved in a retirement account. This means a tax savings up to $1,000 for a single taxpayer earning $15,500 in 2007 and up to $2,000 for married couples earning $31,000 or less. This savings is in addition to any other tax savings for contributing towards retirement.

It is important to note that the Saver's Credit amount decreases when earnings are above $15,500 for single taxpayers and $31,000 for married couples. This credit is phased out completely above the income levels listed earlier (e.g. $52,000 for married couples in 2007).

To see how this works, take a look at the following example.

Example

Jack and Jill Hill are married and file jointly. Jack is permanently disabled after a fall and had no earned income or disability income yet in 2007. Jill is employed and earned $29,000 in 2007. Jill also contributed $2,000 to an individual retirement account for the year.

After doing the number crunching on IRS Form 1040, Jill’s IRA contribution results in the following tax savings for the couple:

Their combined taxable income is reduced by $2,000 resulting in a tax savings of $205.
After taking the standard deduction and tax exemption amounts, their tax bill comes to $953.
Their Saver’s Credit comes to $1,000 (half of $2,000).
Since their taxes are less than the Saver’s Credit, their taxes owed falls from $953 to zero.
Their total savings for contributing $2,000 towards their retirement savings is $1,158.

Based on the above example, the couple essentially gets back almost 58% of the amount they set aside for retirement. Although the idea of parting with $2,000 may be hard to take and your results may vary depending on your income and deductions, where else can you get a deal like that?

To figure out and claim the Saver’s Credit, use IRS Form 8880, Credit for Qualified Retirement Savings Contributions.

Credit for the disabled. If you receive taxable disability income through your former employer's accident, health or pension plan, the Credit for the Elderly or the Disabled may reduce the amount of taxes you owe on it. You may be able to take this credit if your 2007 adjusted gross income is under:

$17,500 if filing single
$20,000 if filing jointly and only one spouse is eligible for the credit
$25,000 if filing jointly and both spouses are eligible
$12,500 if married filing separately

To qualify for this credit, the taxable disability income must meet both of the following requirements:

It must be paid under your former employer's accident, health or pension plan; and
It must be included in your income as wages during your absence from work due to a permanent and total disability.

The maximum amount of the potential credit depends on your filing status. For those on permanent and total disability, the maximum credit amounts are as follows:

Maximum Disabled Credit

Filing as single, head of household or qualifying widow(er)
$5,000

Married filing jointly with one spouse under 65 and retired on permanent and total disability
$5,000

Married filing jointly with both spouses under 65 and retired on permanent and total disability
$7,500

Married filing a separate return
$3,750

Please note that amount of the credit cannot be more than your taxable disability income. Also, be aware that the non-taxable part of your Social Security benefits factors into your credit calculation.

Calculating this credit is not easy. To figure out and claim the credit for the disabled, use IRS Schedule R (Form 1040), Credit for the Elderly or the Disabled, or IRS Schedule 3 (Form 1040A).

However, you can choose to have the IRS figure this credit for you. Just follow the instructions on the forms as to how to do this.

Other tax breaks for low income taxpayers. Depending on your particular situation, there may be many more tax breaks that can take the sting out of filing your taxes and even help your financial situation in the end. To take full advantage of these tax breaks, consider seeking out professional tax assistance.