Parents of Young Children First in Line for Tax Breaks

One of the more generous and immediate tax breaks included in the big tax package President Bush signed into law last week is a boost in the child tax credit.

This credit, for parents with children 16 or younger, increases from $500 to $600 per child this year and eventually will rise to $1,000 per child.

But if you’re hoping for the full break, your children had better be young. By the time the full credit is phased in nine years from now, any child who turns 8 by the end of this year will be too old to qualify.

Moreover, the credit is linked to income thresholds and begins to decline over those levels.

Just what is the child tax credit, how is it changing and will you get to claim it? Here’s a look.

Question: What’s a tax credit?

Answer: A tax credit is arguably the best type of tax break because it reduces the tax you owe dollar for dollar. Tax deductions merely reduce the amount of income subject to tax, which, for instance, saves a taxpayer in the 30% bracket just 30 cents on the dollar.

Question: What is the child tax credit?

Answer: The child tax credit, instituted by President Clinton, ut taxes for parents of children. To claim the credit, you need to meet just one criterion: have a qualifying child.

Question: What makes a child “qualifying”?

Answer: He or she must be:

* your dependent child, stepchild, foster child or grandchild;

* a U.S. citizen or resident;

* younger than 17 at the end of the tax year for which you’re claiming the credit. (Thus, you can claim a 2001 child tax credit for a child who turns 17 on Jan. 1, 2002, but you can’t claim the credit if this child turns 17 on Dec. 31, 2001.)

Question: How do you claim the credit?

Answer: First, you figure your federal tax obligation by filling out a form 1040 or 1040A, adding up your income and subtracting your deductions. Then you’ll be directed to a work sheet and instructions to determine whether you can reduce that tax obligation with the child tax credit.

The simple version of the work sheet is this: Multiply the number of children who meet the above requirements by $600. (For example, two kids equal $1,200.)

If you’re a single filer and earn $75,000 or less, or married filing jointly and earn $110,000 or less, nothing more is required. You simply subtract the credit from the amount of tax you owe. If you earn more than that, you lose all or part of the credit.

Question: Are the income limitations based on total income, adjusted gross income or taxable income?

Answer: Great question.

Total income is all the income you earn--regardless of whether you saved some of it in a tax-deferred account.

Adjusted gross income is your income after subtracting contributions to certain retirement accounts--IRAs, 401(k)s, 403(b) plans, etc.--and after contributions to certain work-based savings programs, such as flexible spending accounts.

Taxable income is reduced further by deductions and personal exemption credits.

When claiming the child tax credit, there’s another type of income that’s taken into consideration: modified adjusted gross income. It’s adjusted gross income, plus any otherwise untaxed income that’s earned by a U.S. citizen in a foreign country or U.S. possession. If you don’t earn income from overseas work, you simply use adjusted gross income.

Question: What if my income exceeds the threshold?

Answer: More math is required. You must reduce the amount of your credit by $50 for each $1,000 (or fraction of $1,000) that your modified adjusted gross income exceeds the threshold. In other words, a couple with two children and $120,000 in income would exceed the threshold by $10,000, so they’d lose $500--10 times $50--of the $1,200 credit. They could claim the remaining $700. If this couple had just one child, they’d be able to claim only a $100 credit.

Question: What if my income exceeds the threshold by just $50? For instance, what if my husband and I earn $110,050?

Answer: Bad news. The phase-out causes you to lose $50 for even a fraction of $1,000 above the threshold. So even if your income exceeds the threshold by $1, you lose $50 of the credit.

Question: What if my tax obligation is negative, after subtracting the credit?

Answer: There’s even more math for you. The new law makes this credit refundable until it accounts for up to 10% of that portion of your earned income above $10,000 in 2001. (In 2005, this becomes more generous. You’ll be able to claim up to 15% of your income over $10,000.)

For example, if you earned $20,000 and had two children, you’d qualify for a $1,200 child tax credit. If, thanks to other deductions and credits, you owed no income tax, you would subtract $10,000 from your earned income of $20,000 to find your earned income over the threshold. You’d then multiply the result--$10,000--by 10% to find that you could get $1,000 of the child tax credit refunded.

Question: When does the credit amount increase?

Answer: It rises to $700 per child in 2005, to $800 in 2009 and to $1,000 in 2010.

Question: How does this differ from the “child and dependent-care” credit?

Answer: To qualify for the dependent-care credit, you must have children younger than 13 and you must pay someone--other than another one of your dependent children--to care for that child so you (and your spouse, if you’re married) can work, look for work or go to school. (If your spouse is disabled and unable to care for him or herself, he or she is considered to be working for purposes of this test.)

If you meet those tests, you get a credit that amounts to a percentage of the child-care expenses you pay, up to certain limits.

Currently, you can reduce your tax by an amount ranging from 20% to 30% of the child-care expenses you pay, up to $2,400 per child, to a maximum of $4,800 per household.

The percentage of the credit depends on how much you earn. Those earning $10,000 or less get the most, and those earning $28,000 or more get the minimum credit of 20% of their allowable costs.

In other words, a taxpayer earning $10,000 with $1,000 in child-care expenses annually gets a $300 dependent-care credit; a taxpayer earning $100,000 with $1,000 in allowable expenses would get a $200 credit.

Question: Does the dependent-care credit change under the new law?

Answer: Yes. Both the allowable expenses and the income levels that determine your credit percentage will become somewhat more generous, but not until 2003. At that point, the credit will be based on maximum allowable expenses of $3,000 per child, to a maximum of $6,000 per household.

And both the maximum credit amount and the income a taxpayer can earn and still claim the maximum credit will rise. Taxpayers earning up to $15,000 will get the maximum credit of 35% of their allowable dependent-care expenses. The minimum child-care credit will remain at 20% of allowable expenses and will apply to those earning $43,000 or more.

*

Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at https://wwwlatimes.com/perfin.

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Child Tax Credit at a Glance

What: A dollar-for-dollar reduction in income tax for parents of dependent children 16 or younger.

How much: $600 per child in 2001.

Who qualifies: U.S. citizens or residents.

Income limits: Credit begins to decline for single parents earning more than $75,000 and married couples earning more than $110,000.

Scheduled increases: Credit rises to $700 per child in 2005, $800 in 2009 and $1,000 in 2010.

Source: Times research