Low-income tax filers, particularly those with larger household sizes, may not be able to claim some of their children as dependents because of a new wrinkle in the tax code.
The new rules create the possibility that children who receive Social Security benefits will be classified as self-supporting, thus making them ineligible to be claimed as a dependent.
The change will reduce tax refunds for filers who would have claimed those children as dependents to get the Earned Income Credit (“EIC”).
“People who have a lower income that may have multiple dependents,” said a tax preparer, “have the most trouble. That test is starting to knock kids out of dependency status for those parents.”
About the Earned Income Credit
The EIC is a means-tested refundable tax credit. People receive their EIC benefit through their tax refund. The seamless nature of the distribution of the funds makes the EIC was one of the most cost-effective anti-poverty mechanisms. For the low-income people who receive the credit, it becomes the high-water financial event of their year.
The arrival of those funds in low-income neighborhoods triggers a lot of economic activity. Caseworkers and non-profit groups use the moment to encourage savings. For the companies that sell goods and services, it’s also a boon. People catch up on rent and pay off loans. The low-dollar used car market booms.
For anyone who relies on the EIC to catch up, the loss of even a fraction of their refund hurts.
The result will be felt later this month, as the IRS intends to delay the payment of any refund for any return that claims either the EIC or the Child Tax Credit (“CTC”) until at least the end of February owing to concerns about fraud.
How the New Rule Works
The test will disqualify a child for dependency status if the disability benefit received by that person is more than the estimated cost of caring for that child. The test divides the overall cost of running a household by the number of people living there. If the product is less than the amount of the disability benefit, then the person cannot be considered to be a dependent for the purpose of collecting the EIC.
The test works like this:
1. To find the cost of supporting a person, a preparer should divide all earned income by the number of residents in the household.
2. If that number is less than the amount of the federal benefit (excluding permanent benefits) received for the child, then the child cannot be claimed as a
If per-person support cost is greater than Social Security income received for that child, the child is considered a dependent for the purposes of the EIC. If not, then the child is not considered a dependent and cannot be used for qualifying for the EIC. If a filer has a child who receives a Social Security disability benefit, then those funds are included in the support test.
I can illustrate the way it works through a real-life example.
Recently, our tax site served a woman with three children who had approximately $15,000 in earned income. One of her children was born prematurely and as a result, received a monthly benefit of $500.
Her contribution to running the household (15,000/4 = $3,750), on a per-person basis, fell below the amount received from the child’s Social Security benefit ($6,000). As a result, the child cannot be claimed as a dependent.
EITC calculators predict that the loss of one dependent should have reduced her refund by $716.
The end result is actually counter-intuitive to the purpose of the EIC, because the households most likely to be harmed are the ones with the most dependents. Larger households will see their earned income divided into smaller pies, thus increasing the chance that a recipient of disability payments will be disqualified.
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