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Also, the 2011 CCH provides special CCH Tax Briefings on key topics at CCHGroup.com/Legislation.
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Child Tax Credits Hold Steady in New Tax LegislationPrevious Credits Extended Through 2012(RIVERWOODS, ILL., January 2011) – In the flurry of tax legislation activity by Congress in the closing months of last year, the child tax credit and its enhancements will continue for at least over the next two years. CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com), takes an in-depth look at the Child Tax Credit and other applicable rules. Child Tax Credit UpdateThe 2010 Tax Relief Act extends the $1,000 child tax credit for two years, through December 31, 2012. Also extended for two years are enhancements to the credit made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the 2009 Recovery Act and other bills. The 2010 Tax Relief Act also extends alternative minimum tax (AMT) benefits: the credit is allowed against the AMT and the refundable portion is not reduced by the AMT. However, the child tax credit continues to be phased out for taxpayers with adjusted gross income starting at $110,000 for joint filers ($75,000 for others). The qualifying child must be under age 17 at the close of the year and satisfy the relationship and residency tests, have not provided over one-half or their support, and not filed a joint return with their spouse. Barring further Congressional action, on January 1, 2013, the child credit is scheduled to revert to $500 per qualifying child. To the extent the child tax credit exceeds an individual’s tax liability, the taxpayer may be eligible for a refundable credit (the additional child tax credit) equal to 15 percent of earned income in excess of a threshold dollar amount. The threshold dollar amount of $3,000 continues through 2012. The threshold amount originally was $10,000 indexed for inflation. The 2009 Recovery Act reduced the threshold to $3,000 for 2009 and 2010. “Although many provisions of the child tax credit rules were unchanged and extended, taxpayers still need to make sure that their income levels allow for the tax breaks they believe they’re entitled to receive,” said CCH Senior Federal Tax Analyst John W. Roth, JD, LLM. “Some still try creative interpretations of tax code provisions to take advantage of child-related credits. Taxpayers should review the rules prior to completing and filing their income tax forms to avoid unnecessary complications.” Increasing Refundable Portion of Child Tax CreditThe earned income base for the refundable child tax credit, originally lowered in ARRA, stays at $3,000. 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. For low-income taxpayers with children, this can offer a significant tax benefit. For example, a taxpayer in 2010 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. However, the refundable 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). Thus, she is entitled to a refundable amount of $1,050. “Low income taxpayers were frequently 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 increased the potential for a greater portion of the child tax credit being refunded to individuals.” Dependency Exemption for Divorced or Separated ParentsThe general rule for divorced or separated parents, or parents who lived apart at all times during the last six months of the year, to claim a child as a dependent is that the custodial parent is allowed to claim the dependency deduction for the qualifying child. The custodial parent is 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 by signing Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or a similar declaration conforming to the form. A court order, decree or a separation agreement may no longer serve as the written declaration. The noncustodial parent needs to attach a copy of the form for each year he or she is claiming the child. If the custodial parent later changes his mind, he uses the same form to revoke the previous release and must attach a copy of the revocation to his tax return for each year he then claims 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. Applying the Tie-breaker Rule“There are many tax benefits when it comes to claiming a child for income tax purposes,” said Roth. “Because of this, many taxpayer who are not entitled to claim a child do to increase their income tax refund. This causes the IRS problems when the parent actually entitled to those tax benefits also makes a claim. This uses up scarce resources determining who is entitled to the tax benefits and collecting the wrongfully paid benefits.” Congress created the tie-breaker rules which 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 coincides with the IRS’s dependency rules,” Roth explained. “For example, when both parents, who are not living together, can qualify to claim a child, the dependency rules state that the parent with the highest income gets to the claim the child as a dependent. When neither parent claims a child under the tie-breaker rules, potentially a non-parent may claim the child but only if his or her AGI is higher than either of the parents,” “This can however 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. “Since neither parent qualifies, the dependency exemption goes unclaimed.” A Review of Credits/Exemptions for KidsIn the following, CCH outlines the basic child-related tax credits and exemptions available, as well as the rules for reporting kids’ income. Credit/Exemption
How Child’s Income Is Taxed
*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 businessCCH, 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). -- ### -- nb-11-21
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