Amended California EITC: Fiscal impact and effects on taxpayers

By Glen Quon, CPA, M.S., Irvine, Calif.

Editor: Mark G. Cook, CPA, CGMA

The California earned income tax credit (CalEITC) provides a refundable credit for qualified low-to-moderate-income working Californians. Like the federal earned income tax credit (EITC), its goals are to boost income of the poorest while simultaneously encouraging work.

For example, in its report on the EITC's effect, the Urban Institute and Brookings Institution's Tax Policy Center determined that the EITC encourages single people and primary earners in married couples to work (see Maag, "Earned Income Tax Credit in the United States," 22-1Journal of Social Security Law 20 (2015)). At the federal level, IRC Sec. 32 allows an EITC for qualified individuals filing a federal income tax return. At the state level, states must decide individually whether they wish to also enact a version of the EITC in their respective income tax rules and regulations. California adopted its own version of the EITC in 2015.

The original CalEITC has been criticized as a program that primarily benefits only the poorest Californians earning less than $10,000 per year. In response, earlier this year, Gov. Gavin Newsom signed into law California Assembly Bill (A.B.) 91, the Loophole Closure and Small Business and Working Families Tax Relief Act of 2019, which significantly expands the dollar benefits, the amount paid out per family, and the estimated number of households who qualify.

This discussion summarizes both versions of the CalEITC and how the 2019 amendments affect the calculation and the credit's desired effects.

Credit summary

Under the CalEITC rules:

  • The taxpayer must have earned wage income that is subject to California withholding.
  • Like the federal credit, the CalEITC has income limitations. In 2018, both the taxpayer's earned income and federal adjusted gross income (AGI) must be less than $24,951 to qualify for the California credit.
  • The taxpayer may elect to include all of his or her nontaxable military combat pay in earned income for California purposes regardless of his or her election for federal income tax purposes.
  • In 2018, the taxpayer's total interest, dividends, capital gain net income, income from passive activities, rental income from personal property, and investment income cannot exceed $3,699.
  • The taxpayer's credit depends in part on how many qualifying children (if any) the taxpayer has, although a taxpayer does not have to have a qualifying child to receive the CalEITC. For purposes of the credit, a "qualifying child" includes a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half-brother, half-sister, or a descendant of any of them; the child must be under 19 at the end of the tax year and younger than the taxpayer; and the child must be under 24 at the end of the tax year and younger than the taxpayer if the child is a student. Also, the child qualifies at any age if permanently and totally disabled. Other requirements include that (1) the child is not filing his or her own joint return; (2) the child must have lived with the taxpayer in California for over half of the tax year; and (3) the child cannot be a qualified child for another taxpayer.
  • As is the case with federal income tax, California qualified taxpayers must file as single, head of household, or married filing jointly; i.e., they cannot file as married filing separately (see instructions to California Form 3514, California Earned Income Tax Credit).

For processing purposes, Californians must complete Form 3514 as part of their tax return to qualify for the credit. Just as the IRS does with the federal EITC, California assesses penalties on those who claim the CalEITC even though they know they are not eligible. California imposes on preparers a $500 penalty for not complying with CalEITC requirements (Cal. Rev. & Tax Code §19167(a)(5); IRC Sec. 6695(g)(2)).

Credit calculation

Taxpayers must determine wages, salaries, tips, and other employee compensation subject to California withholding. California taxpayers should be aware that the following items are included toward calculating California earned income: in-home supportive supplementary payments that are nontaxable for federal income tax purposes; prison inmate wages; a pension or annuity from a nonqualified deferred compensation plan or a nongovernmental IRC Sec. 457 plan; nontaxable combat pay; and net earnings from self-employment (instructions to California Form 3514, California Earned Income Tax Credit).

Taxpayers then determine the amount of the CalEITC credit corresponding to qualified income and the number of qualifying children according to the Earned Income Tax Credit Table. If California earned income is different from federal AGI, the taxpayer compares the CalEITC corresponding to AGI to the CalEITC corresponding to California qualified income. The resulting CalEITC is the lower of the two numbers.

So, what is new?

Under A.B. 91, the following amendments are now in effect:

  • The maximum income for California is raised from $24,951 to $30,000. This expands the number of Californians eligible for the CalEITC and more gradually decreases the eligible credit as income increases by widening the qualified income range.
  • The annual income recomputation floor rises from 3.1% to 3.5%. This increase makes it more likely that taxpayers who qualify for the CalEITC will be able to qualify in succeeding years.
  • A $1,000 refundable tax credit is provided for each young child (under 6 years old) for those who earn a minimum of $1 of income. According to Newsom, the goal is to spread the benefit to as many people as possible, especially young children. By keeping the minimum earned income at $1, California is giving qualified children a $1,000 tax benefit each if their parents make even a minimal effort to earn income.

According to the California Department of Community Services and Development, estimated net annual expenditure under A.B. 91 increased from $400 million to $1.2 billion, and the estimated number of households that qualified increased from 1.9 million to 3 million (California Department of Finance, 2019-2020 Revenue Estimates, May 2019 revision, available at www.ebudget.ca.gov).

Long-term effect of the changes

While the Urban Institute and Brookings Institution's Tax Policy Center findings offer a positive long-term outlook on the EITC's benefits at the federal level, the federal EITC does have its limitations. The biggest criticism of the EITC is that it provides almost no support for families without custodial children (Maag, "Earned Income Tax Credit in the United States," above). The CalEITC does provide tax credits to those without custodial children, and the new California law seeks to expand the tax credit to benefit more low- and lower-income households with a greater amount per household regardless of whether they have custodial children. Only time will tell whether the changes will positively affect poverty rates for low-income families generally and, more specifically, for those without custodial children.

EditorNotes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.

All contributors are members of SingerLewak LLP.

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