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CCH can assist you with stories, including interviews with CCH subject experts. Also, the 2010
CCH Whole Ball of Tax
is available in print. Please contact:
 
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
 
Neil Allen
(847) 267-2179
neil.allen@wolterskluwer.com

Visit the CCH Whole Ball of Tax site often as new releases and other updates will be posted throughout the tax season.

CCH provides special CCH Tax Briefings on key topics at: CCHGroup.com/Legislation/Briefings.

 
2010 CCH Whole Ball of Tax
Release (19) | Back to WBOT

2010 CCH Whole Ball of Tax

Contact:
Leslie Bonacum
, 847-267-7153, mediahelp@cch.com
Neil Allen, 847-267-2179, neil.allen@wolterskluwer.com

Child Tax Credit Offers Bigger Tax Break, But Who Claims Kids May Depend on Following New Rules

(RIVERWOODS, ILL., January 2010) – A few major changes affecting taxpayers raising children go into effect for income tax returns filed for 2009, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com). The refundable portion of the child tax credit has been increased significantly for 2009 and 2010 under the American Recovery and Reinvestment Act of 2009 (ARRA). Additionally, a clarification/revision of the definition of qualifying child and tie-breaker rules for determining who can claim the child tax credit go into effect. Finally, the IRS has finalized rules on dependency exemptions for children of divorced or separated taxpayers.

“There’s been a long history of people creatively applying tax code provisions related to children to their advantage, whether or not that was the intent of the tax law,” said CCH Senior Federal Tax Analyst John W. Roth, JD, LLM. “As a result, the rules have to be regularly reviewed to ensure they have the intended consequences.”

Below, CCH reviews the significant new tax rules, as well as provides charts highlighting other kid-friendly tax breaks.

Dependency Exemption

The IRS issued final regulations on the entitlement of divorced or separated parents, or parents who lived part at all times during the last six months of the year to claim a child as a dependent. The rules generally state that the custodial parent is allowed to claim the dependency deduction for the qualifying child and defines this parent as the one with whom the child resides with most nights of the year. If the child spends equal time with both parents, the parent with the higher adjusted gross income (AGI) is allowed to claim the child.

The only way that a child can be treated as a qualifying child to a noncustodial parent is for the custodial parent to release a claim to the exemption. Under the IRS’ final regulations, the only way this can be done is for the custodial parent to complete Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or a similar declaration conforming to the form (however, a court order or decree or a separation agreement can’t serve as the written declaration). They then need to provide a copy of this form to the noncustodial parent claiming the child who, in turn, must attach a copy of the revocation to their tax return for each year they claim the child as a dependent.

If the custodial parent later changes their mind, they use the same form to revoke the previous release and must attach a copy of the revocation to their tax return for each year they then claim the child as a dependent.

“Divorced parents who may have had an informal arrangement for who could claim the child will now have to formalize this, with the custodial parent completing Form 8332 if they are going to allow the noncustodial parent to claim the child,” said Roth. “A parent that is not eligible to claim a child but continues to do so may now face penalties for filing a false claim .”

Increasing Refundable Portion of Child Tax Credit

Under ARRA, the earned income base for the refundable child tax credit drops significantly from $8,500 to $3,000 for both 2009 and 2010. Reducing the income threshold increases the refundable portion of the credit that is available to return to qualifying taxpayers.

The refundable credit is equal to the lesser of either the unclaimed portion of the nonrefundable credit amount – $1,000 per child – or 15 percent of earned income over $3,000.This is the second time in two years that the income threshold under the child tax credit has been significantly lowered. In 2007, the income tax threshold was $12,050 before the Emergency Economic Stabilization Act of 2008 changed it to $8,050 for 2008; and ARRA now changed it to $3,000 for 2009 and 2010.

For low-income taxpayers with children, this can offer a significant tax benefit. For example, a taxpayer in 2009 has two children and an earned income of $10,000. She has no other income, is not subject to the alternative minimum tax and is only taking the child tax credit. She files as head of household, entitling her to a standard deduction of $8,100. She also is entitled to a personal exemption of $3,650 for each family member, or $10,950. As a result, she has no taxable income and no tax liability. Her nonrefundable child tax credit is $2,000 for the two children. However, because the nonrefundable credit is limited to the amount of taxes she owes, it’s zero.

Under the revised law, the nonrefundable credit equals the lesser of either the unclaimed portion of the nonrefundable credit amount, which in the above example is $2,000, or 15 percent of her earned income that exceeds $3,000, which would be $1,050 ($7,000 x 15 percent). So, she is entitled to a refundable amount of $1,050.

Had the income threshold not been lowered from $8,500 to $3,000, she would have received just $225 on an income of $10,000; further, under the 2007 income threshold of $12,050, she would have received nothing with an earned income of $10,000. Taxpayers with three or more children also can use an alternative formula for determining the refundable amount.

“People with low incomes and eligible for several credits were often unable to claim any or very little of the child tax credit because they would exhaust their tax liability before claiming this credit,” Roth said. “The reduced income threshold increases the potential for a greater portion of the child tax credit being refunded to individuals.”

Applying the Tie-breaker Rule

Effective for income tax returns starting with 2009, the tax code adds further detail to clarify the definition of a qualifying child for purposes of claiming the child tax credit. In addition to the existing definition, a qualifying child must be younger than the taxpayer and can’t file a joint return with a spouse. The law also seeks to map out in greater detail who is eligible to claim a qualifying child under tie-breaker rules.

“There are a number of tax benefits related to claiming a child for income tax purposes,” said Roth. “The challenge for the IRS is to make sure the appropriate individuals receive these benefits without being in the position of running interference between the parties or trying to recover tax benefits taken by a taxpayer that they did not deserve.”

The tie-breaker rules now apply whenever two or more taxpayers can claim a child as a qualifying child, regardless of whether they actually do so. Additionally, if the parents can claim an individual as a qualifying child, but neither does, another eligible individual can claim the child as a qualifying child. To do so, however, that person’s AGI must be higher than the highest AGI of either of the parents.

“The tie-breaker rules work with the dependency rules. For example, when both parents not living together are equally qualified to claim a child, the dependency rules state that the parent with the highest income gets to claim the child. When neither parent claims a child under the tie-breaker rules, a non-parent can only claim the child if their AGI is higher than either of the parents,” said Roth.

“However, this can have a significant impact on the finances of extended families. For example, a grandmother raising a child with a lower income than either of the child’s parents would not be able to claim the credit,” said Roth.

A Review of Credits/Exemptions for Kids

In the following, CCH outlines the basic child-related tax credits and exemptions available as well as the rules for reporting kids’ income.

Credit/Exemption

 

Applies to

Amounts for 2009 Taxes

Child Credit

Individuals/joint filers with dependents under age 17.

$1,000 per child, phasing out when AGI exceeds $75,000 for single filers and $110,000 for joint filers. Phases out at a rate of $50 of credit loss per $1,000 of AGI beyond the above incomes, with the upper phase-out range depending on the number of children claimed.

Personal Exemption

Individuals/joint filers with dependent children under age 19 or, if full-time student, under age 24.

Maximum exemption parent(s) can claim on return is $3,650 ($3,650 in 2010). For divorced parents filing separately, generally the exemption goes to the parent who has custody for the greater part of the year.

Childcare Tax Credit

Individuals/joint filers with childcare expenses for children up to age 13, or older children if they are physically or mentally incapable of caring for themselves.

Credit taken against maximum qualifying expenses of $3,000 for one qualifying dependent and $6,000 for two or more. Credit equals 35 percent of qualifying expenses for taxpayers with AGI up to $15,000 and decreases with income to 20 percent of allowable expenses for AGI of $43,000 or more.

Adoption Credit

Individuals/joint filers adopting children under age 18.

Maximum credit of $12,150 for a regular adoption, with credit amounts phased out at incomes between $182,180 and $222,180 for both single filers and joint filers. For a special-needs adoption, the credit is figured without regard to the actual expenses paid or incurred in the year the adoption becomes final.

How Child’s Income is Taxed

 

Applies to

Amounts for 2009 Taxes

Filing – tied to Standard Deduction

All dependents.

Must file a tax return if they have more than $950 in unearned income, or earned income over $5,700 – or if their total income was more than the larger of $950 or their earned income (up to $5,400) plus $300.

Earned Income – paid by an employer

All dependents.

The standard amount of earned income exempt from income taxes is $5,700. Anything above this is taxed at the child’s income bracket. Although a return is not required with income below $5,700, a child with less income may want to file to obtain a refund of withheld taxes.

Earned Income – self-employed

All dependents.

The standard amount of earned income exempt from income taxes is $5,700. However, the child must pay self-employment tax for Social Security and Medicare on any self-employment income greater than $400.

Unearned Income – interest, dividends, capital gains

Varies based on age of dependent.*

Certain children with unearned income exceeding $1,900 must be taxed at their parent’s marginal income tax rate.

*Parents can elect to include the unearned income of a dependent child under the age of 19 whose income is less than $9,500 on their return by filing IRS Form 8814 along with the parents’ return. However, while combining the child’s income with the parents eliminates the need for the child to file his own tax return, it will increase the parents’ adjusted gross income and, therefore, possibly reduce the parents’ deductions or other potential tax breaks.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands (www.wolterskluwer.com).

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