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Child Tax Credit

I. For tax years beginning in 1998, the Taxpayer's Relief Act of 1997 allows a tax credit against the taxpayer's income equal to $400 per qualifying child for the year 1998 and $500 per qualifying child for years after 1998. (Code Sec. 24)

A. To qualify as a dependent, the taxpayer must meet all five requirements.

1. Identification

a. The name and valid social security number of all qualified children must be included in the tax return

b. The tax year must include a full 12 month tax year except by reason of the taxpayer's death

2. Dependency

a. The taxpayer must be entitled to a dependency deduction for the child for the year claimed

b. The non-custodial parent can claim the dependency deduction with Form 8332

3. Relationship

a. The child must bear a relationship to the taxpayer as described in Code Sec. 32 (c)(3), that is a son or daughter, or their descendants; a stepson or stepdaughter, or an eligible foster child

4. Age

a. The child must be under the age of 17 as of the close of the calendar year in which the credit is claimed

5. Citizenship

a. The child must be a citizen or legal resident of the U.S.

B. Credit Phaseout

1. For one qualifying child, the credit is reduced by $50 for each $1,000, or fraction thereof, by which the taxpayer's modified adjusted gross income (MAGI) exceeds the following threshold amounts:

2. The Technical Correction in the IRS Restructuring and Reform Act of 1998 explains that the more qualifying children that a taxpayer has, the longer the phaseout range is

3. Making the phaseout in $50 increments means that for some taxpayers a $1 increase in MAGI within the phaseout range can trigger a $50 increase in tax liability

Example: Dee Kline was unmarried with 3 children, ages 14, 15, and 16 and MAGI of $75,001. Her credit is $1,050. Upon review of her tax return, she realized that her W-2 was accidentally rounded up by $1. She rounds down and creates a MAGI of $75,000. Her credit is now $1,200, a savings of $150 on a $1 change.

4. Planning opportunities abound by reducing MAGI when MAGI exceeds the initial phaseout threshold

Example: Dee and Duct Moore are married with 4 children, ages, 1, 5, 10 and 13 with MAGI of $117,001. Duct is a self-employed heating and cooling man with earned income of $60,000. By contributing $7,273 (the maximum allowed for a SEP-IRA), Duct reduces the MAGI to $109,728. The maximum child tax credit of $400 per child is now permitted. Assuming a 28% federal tax bracket, the Moore's receive a whopping federal tax savings of $3,636 (($7,273 X 28%) + ($400 X 4)).

Example: Dee Prishiashun is a single mother with 2 children, ages 6 and 9. Dee is a self-employed graphic designer with MAGI of $82,001. Dee bought computer equipment totaling $10,000. By electing Sec. 179 instead of 5 years MACRS. Dee was able to deduct $8,000 additional depreciation. Dee reduces the MAGI to $74,001 and she receives a child tax credit of $800 ($400 X 2).

C. Modified Adjusted Gross Income (MAGI) is AGI plus any amount excluded from gross income under:

1. Code Sec, 911, exclusion of income of U.S. citizens or residents living abroad

2. Code Sec. 931, exclusion of income for bonafide residents of Guam, American Samoa and the Northern Mariana Islands

3. Code Sec. 933, exclusion of income for residents of Puerto Rico

D. Non-Refundable Credit

a. Generally, the maximum amount of a taxpayer's child tax credit together with the other non-refundable personal credits is limited to regular tax liability (Tax Relief and Trade Extension Act of 1998)

E. Refundable Credit

1. Available if the taxpayer has 3 or more qualifying children

2. The credit allowed is increased by the lesser of:

a. Full Credit calculated less the amount of non-refundable credit calculated in paragraph D above, or

b. Regular tax liability

+ Employee's share of FICA

+ 50% of SE tax liability

- EIC (Code Section 32)

3. Refundable credit is not subject to alternative minimum tax

4. Credit stacking (ordering) rules for non-refundable credits

a. Non refundable personal credits

b. Other credits

c. Business credits

d. Investment tax credit

F. Supplemental Child Credit (SCC)

1. Part of the child tax credit may be treated as a supplemental child credit (i.e. provided under the EIC)

2. The SCC is in addition to the regular EIC (Code Sec. 32)

3. There is no change in the overall credit permitted

4. The SCC reduces the otherwise allowable non-refundable child tax credit dollar - for - dollar by the amount treated as a SCC

5. Calculated when EIC is allowed and taxpayer has any children

6. The credit is calculated as the lesser of:

a. The amount by which the taxpayer's total non-refundable personal credits are increased by reason of the child tax credit, or;

b. The negative tax liability of the taxpayer, defined as the excess of taxpayer's total tax credits, including the earned income credit, over the sum of the taxpayer's regular income taxes and social security taxes

g. Earned income phase out rules do not apply to the supplemental child credit