What's Earned Income Credit?

Question

What's a deduction? What are "allowances"? How come this stuff was not taught in high school?

Answer 1

Good question re high school - it should be, but rarely is.

An adjustment is something you subtract from your income. Examples are alimony paid, and student loan interest paid - there are others. They are subtracted before deductions are. They work a lot the same way, but the number after adjustments are subtracted and before deductions are is called your AGI (adjusted gross income), a number that gets used as a limit for eligiblilty for certain benefits. The IRS has a specific list of allowable adjustments.

Deductions are items that get subtracted off of your income also before your tax is calculated. Everyone gets a "standard deduction", an amount the IRS lets you subtract with no receipts or proof that you spent money on any particular thing. They have a list of allowable deductions - some are state and local taxes, some medical expenses, and charitable contributions. If you can prove that you spent more on deductible items than the standard deduction, then you "itemize", which means you file an extra form that lists your deductible expenses by category - if you do this, you take the amount of your "itemized deductions" off of your income instead of the standard deduction, before figuring your taxes.

There are a couple more important terms that you didn't ask about.

"filing status" - there are different rules for people who have different life situations. Common filing statuses are single, married filing joint (which means a married couple files one return together, showing all of their information for both of them), married filing separately (each on files a return, showing their own information, but they will have to follow somewhat different rules in figuring their tax than someone who is single), and head of household (maybe the most misunderstood status of all - the person must be single, and have a dependent who meets certain rules). There are a few other filing statuses, but those are the main ones that are used.

Dependent - there are too many rules for this to list here, but you can find them in the instructions for form 1040. Basically, it refers to your child who is below a certain age, or another person who doesn't have much income and you support. Please realize that this definition doesn't even come close to detailing all the rules.

Exemption - you can subtract $3300 from your income this year (the number usually goes up a little every year) for yourself, your spouse if filing a joint return, and each dependent.

When you get done with all this subtracting from your income, what you have left is your taxable income. If you had more to subtract than the income you had, then you have zero taxable income and don't owe any tax. There are formulas that you use from there to calculate your tax on your taxable income if you have any.

The tax code is set up that usually people with the least income pay little or no taxes, and people with more income pay at a higher rate depending on how high their income is. This is called a "progressive" tax rate. If everybody paid the same percent, it would be called a "flat tax".

The Earned Income credit is an amount the government gives to people who are working but not making a lot. If you don't have any dependent children, the limit to be eligible is well under $10,000. If you have one dependent child, it's a little over $36,000, and with two or more dependent children you can make as much as a little over $38,000 and still get a small EIC. There are tables in the 1040 instruction book for how much you get for EIC - it depends on your earned income (what you made from working), your filing status, and whether you have no childeren, one child, or two or more children - you don't get a bigger EIC for more children than two.

Sorry this is so long, but your question had a lot of pieces. I hope this explains what you wanted to know.

Good luck.

Answer 2

What Judy said.