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Thursday, March 12, 1998
Tax Q&A The New Child Tax Credit One of the changes in the recently enacted Taxpayer Relief Act of 1997 allows qualified taxpayers to claim a $400 tax credit in 1998 for each qualifying child under the age of 17. We will briefly look at this provision. How It Works If your modified adjusted gross income (AGI) is $110,000 or less for married people filing a joint return, $75,000 for single or head of household filers, or $55,000 for married separate filers, and you have a qualifying child in your household, you will be able to claim a $400 credit for this child in 1998. In order for a child to be deemed "qualifying," the child must have a tax identification number (normally a social security number) and must be:
So, if your modified AGI is below the limits noted above and you have a qualifying child, you will receive a $400 credit per child. Simple as that. No other computations will be required. Remember that this is a CREDIT against your tax -- a direct dollar-for-dollar reduction of your actual tax liability. It is not a deduction (which is much less valuable), but an actual credit. Example: Jack and Jill have modified AGI in 1998 of $65,000. They also have three qualifying children. When they compute their 1998 taxes, they determine that their total tax liability (before any credits) amounts to $7,200. From this tax liability, they take their child credit in the amount of $1,200 (3 times the $400 credit). Their net tax liability now amounts to $6,000. They also have federal withholding of $7,500. When they apply their withholding against their net tax liability, they'll receive a federal refund of $1,500. For Jack and Jill, the child credit reduced their tax liability by almost 17%. That's a pretty big reduction. The Phase Out Rules As with most tax laws, they wouldn't be any fun without some complex issues. The first of those issues is the phase out of the modified AGI. As noted above, if your modified AGI is below the levels noted (also called the "threshold amounts"), you don't have any problems. But what if your income is GREATER than the levels noted? Do you simply lose the credit entirely? Not exactly. The amount of the credit is reduced by $50 for each $1,000 (or fraction thereof) by which your modified AGI exceeds the threshold amounts noted above. Some simple math will tell you that if your are a head of household filer with one qualifying child, your full $400 child credit will be received when your modified AGI is $75,000 or less, and will be completely phased out when your modified AGI is more than $83,000. Example #1: Mary files as head of household, and she has one qualifying child. Mary's modified AGI for 1998 is $74,000. Mary will receive the benefit of the entire $400 credit for 1998. Example #2: Same facts as above, but assume that Mary's 1998 modified AGI amounts to $90,000. Mary will not receive ANY child credit. Her AGI exceeded the threshold amount by $15,000. Therefore, Mary's child credit must be reduced (but not below zero) by $50 for each $1,000 of AGI over the threshold amount. Mary's income is $15,000 over the threshold amount. $15,000 divided by $1,000 equals 15 multiplied by $50… or $750. Since the credit is only $400, Mary will lose the entire credit. Example #3: Same facts as above, but assume that Mary's 1998 modified AGI amounts to $78,000. Mary's AGI exceeds the threshold amount by $3,000. That means that she'll have to reduce her credit by $150. ($3,000 divided by 1,000 multiplied by $50). Mary's credit will amount to $250 ($400 less $150). Note that the amount of the credit is based upon the number of qualifying children, but the phase out is based upon the amount of the credit. So the more children you have, the greater your phase out range. Bottom line: If you have more qualifying kids, you'll also have a larger phase out range. By way of explanation, let's look at Mary's example #2 again, but add another qualifying child. Example: Mary, filing head of household, has TWO qualifying children and a modified AGI of $90,000. Mary is still $15,000 over the threshold and will STILL be required to reduce her child credit by the $750 computed above. But since Mary now has two children, see will start with a base credit of $800 (2 X $400 credit for each child), and will still receive the benefit of a $50 child credit. In effect, if Mary has one child, her phase out range is from $75,000 to $83,000. But if Mary has 2 children, her phase out range is from $75,000 to $91,000. And if Mary has 3 children, her phase out range is from $75,000 to $99,000. And so on… and so on… The computations work exactly the same for each filing status. Remember that the child credit rules do NOT take the place of any other credits that you may otherwise qualify for -- such as the earned income credit or the dependent care (i.e., child care) credit. But the rules get even more complex when you have more child credits than you have income tax liability. In many cases, those excess credits will be refundable to you in the form of a tax refund. But those rules get REALLY complex, and since we don't have to deal with these child credit issues in detail until next year, we can save that discussion for another time. And, speaking about next year, remember that the child credit is increased in 1999 to $500 per child. So why, you might ask yourself, is this tax goofball talking about something that is still a year away? Does extra cash in your pocket NOW sound like a good reason? Think about it. It's never a good idea to have Uncle Sammy hold on to your money all year long. Sammy doesn't pay you any interest on those big federal tax refunds. So if you were close to "break even" in 1997 and you will qualify for the 1998 child credit, you might want to consider revising your federal withholding form for 1998 NOW. If you anticipate a larger refund this time next year due to the child credit, change your W-4 form NOW and get that extra cash in your pocket right away. An $800 child care credit for 1998 can increase your monthly take home pay almost $100 from now until the end of the year. And I'm just sure that you can put that money to better use than Uncle Sam. The payroll department at your place of employment will be able to supply you with a W-4 form that you can use to revise your federal withholding. And make sure that you get the FULL W-4 form, the one with the worksheets, so that you can make the proper computations. If your employer doesn't have the correct forms, you can download them at the IRS website (http://www.irs.ustreas.gov). ============= Message Board Q&A And now, a few posts from the Tax Strategies message folder. 1. Smdesai asks… Q: I donated clothes (shirts, trousers, suits and furniture) to the Salvation Army. How does one determine the value of these donations? A: The IRS is looking for the fair market value on these items. You can use FMV, or the appraisal method, or the thrift shop value method, or even the comparable sales method. This is a difficult procedure... trying to figure out the value of used underwear. If you have a list of the clothing (which you should in order to take the deduction), take the list to the local Salvation Army and see if they can tell you what they would sell them for. Or do the same at your local thrift shop. If you donated a BUNCH of stuff, you might want to visit http://www.taxsave.com. For a fee (I think it is still $15), you can get a listing of commonly donated property and the associated FMV based upon their research. This is the guide that I use in my personal tax practice. For additional information, see IRS Form 8283 and instructions. 2. And jpandes asks a number of questions… Q: I feel like such a bonehead asking this but here goes. Are the management and advisors and advertising fees that mutual funds indirectly charge shareholders tax deductible? A: The KEY word here is "indirectly." As you point out, these fees are "buried" in the mutual fund share price. This being the case, they are NOT deductible per se. Just like stock broker commissions that you pay when you buy an individual stock, those "fees" will stay with the mutual fund shares purchased. Q: I asked my accountant this question and she looked at me like I was from the moon. A: Don't feel bad... it's just that time of the year. Your accountant may have been working on only a few hours sleep. Or, it could have been that you forgot to wear your hat to hide that horn on the top of your head (sorry... just kidding). But don't consider it a bonehead question. It shows good critical thinking skills. Unfortunately, not much critical thinking goes into creating the tax laws. Q: But it seems to me that if a directly charged broker's commission or margin interest is tax deductible as an investment expense, these indirect fees ought to be deductible as well. A: Broker commissions are also not deductible, but are an addition or reduction to the purchase/sale price of the stock. Margin interest is different, and MAY be deductible as investment interest if you qualify for the deduction under the investment interest rules, but it certainly AIN'T automatic. And, as stated before, the indirect fees are NOT deductible. Q: After all, aren't they also expenses associated with investment? Can anyone straighten me out on this? A: These are expenses associated with the purchase and sale of the investment, which means that they are added to the cost of the shares. For additional information regarding the tax issues surrounding mutual funds, check out IRS Publications 550 and 564 at the IRS website. Please note that Roy cannot answer individual questions in e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!
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