Bigger Tax Credits for Modest-Income Earners

Those with modest incomes are likely to get several pleasant surprises when they file this year’s income tax return.

Standard deductions, personal exemptions and tax credits for low-income families are more generous this year, making it far more likely that these individuals will get tax refunds.

But actually filing a return will be more complicated for some families because of recent changes in the earned income tax credit. The credit is a tax break designed solely for working parents with children under 19. (It can be claimed for older children who are disabled.)

Any family that earns less than $21,250 should investigate the credit, which can net you up to a $2,020 refund even if you paid no federal tax. That’s up from a maximum credit of $953 last year.

The credit is broken into three parts. The first is a basic credit available to anyone with income under $21,250 and qualifying children.

The second part gives a credit to those who pay health insurance premiums to cover their children. If you participate in an employer-sponsored plan covering your family, any co-payment you make qualifies for this credit even if the premium covers you and your spouse as well as your children.

The third part gives you an extra credit if you have a child who was born in 1991.

What’s the bottom line?

Consider a hypothetical family. John Smith is an auto mechanic who earns $19,000. His wife, Kathleen, stays home with their three children: John Jr., 5; Mary, 3, and Annette, 6 months.

They have no interest or dividend income and no significant deductions. They paid $600 in federal tax last year through employer withholding. And John pays $40 a month, or $480 a year, to his employer for a family health insurance policy.

When this family files their 1991 tax return, they’ll get a refund of $664.

Under the 1990 tax rules, their refund would have been only $226, assuming the same facts--income, number and ages of dependents and tax paid.

Why so much less? Primarily because of the earned income credit. This credit was only worth only $125 to the Smiths in 1990, but it was worth $448 in 1991.

However, some families are so intimidated by the tax forms that they either don’t file a tax return or they don’t claim the earned income credit. That’s a big mistake. If you’re cautious, filling out even the most lengthy 1040 Form is relatively simple.

To illustrate, let’s walk our hypothetical family through the 1040 Form.

They’ll check “married filing jointly” under filing status and enter the names of their dependent children. They must also include Social Security numbers for John Jr. and Mary.

They put $19,000 on Line 7, which asks for wages, salaries and tips. And since they have no other income and do not contribute to a retirement plan, they also put $19,000 on lines asking for total and adjusted gross income. (Lines 23, 31 and 32.)

On Line 34, they write in the standard deduction for a couple filing jointly, which is $5,700.

And they multiply their number of exemptions by the personal exemption amount on Line 36--five times $2,150--to come up with personal exemptions of $10,750.

The $10,750 and $5,700 are subtracted from their adjusted gross income of $19,000 to determine their taxable income is $2,550. By looking at the tax tables, they see their federal tax should amount to $384.

Since Kathleen is a stay-at-home spouse, they cannot claim credits for child and dependent care expenses. They have no additional credits or taxes, so they put $384 on Lines 40 and 46 as well.

Under the section titled “payments,” John puts in $600--the amount of federal tax that his employer withheld from his paychecks.

When they get to Line 56--the earned income credit--they need to refer to a separate form and set of tables.

The schedule EIC asks them to fill in the names and Social Security numbers of their two youngest qualifying children--Mary and Annette.

They look up their income on Table A--the basic credit--and find their first credit amounts to $274.

In the second part, John writes in his insurance premiums of $480 and looks up the health insurance credit in Table B, which amounts to $95. What John paid in premiums is more than the credit, so he gets the full health insurance credit of $95.

Finally, because Annette was born in 1991, the Smith’s get a third credit that amounts to $79.

They add the $274, $95 and $79 together to determine their full earned income credit of $448.

Back on the 1040 Form, they write $448 on Line 56. Then they add in the $600 that John has already paid in federal tax to come up with total payments made of $1,048.

They subtract the tax they owe--$384--from the tax they paid--$1,048--and find they are due a refund of $664.