Child Tax Credit

No matter how bad a child is, he is still good for a tax credit. — Modification of an American Proverb

The child tax credit was enacted by Congress in 1997 to lower the tax burden on lower income Americans with children. The child tax credit is equal to $1,000 for each qualifying child under the age of 17 by the end of the tax year, who is a US citizen, resident, national, or an adopted child who lived with you during the tax year. Except for the fact that the child must be younger than 17, all other tests for a qualifying child under the dependency exemptions must be satisfied. The child tax credit can only be claimed for a 12-month tax year. The tax credit cannot be applied to a spouse's child, who is not the biological offspring of the claimant, unless the child is adopted by the spouse claiming the credit. Moreover, the adoption credit cannot be claimed for adopting the children of a spouse.

The credit is figured on the Child Tax Credit Worksheet in Publication 972, which is not attached to the return, but is simply used to calculate the credit. Because it is a nonrefundable credit, it is limited to your ordinary income tax liability, which may be reduced by other credits claimed earlier on Form 1040, such as the foreign tax credit, credit for child and dependent care expenses, education tax credits, and the retirement savings contribution credit. A nonrefundable credit does not offset payroll tax liability, i.e., Social Security and Medicare taxes.

A phaseout of the credit starts when your modified adjusted gross income (MAGI) exceeds the phaseout amount:

MAGI =  Adjusted Gross Income + foreign or American-possession earned income exclusions + foreign housing deductions

For most people, MAGI = adjusted gross income. The phaseout amount depends on filing status:

If your income is greater than the phaseout amount, then the credit is reduced by $50 for each $1,000, or fraction thereof, above the phaseout amount.

Example: Calculating the Child Tax Credit for Incomes Above the Phaseout Amount

Ava is a single parent with 2 dependent children and she earned $90,020 for the tax year. Because her income is $15,050 more than the phaseout amount of $75,000 for a head of household, she must reduce the $2,000 child tax credit that she would otherwise be entitled to by:

Note that although she only earned $20 more than $90,000, she must round her income up to $91,000, which is why the $50 is multiplied by 16 rather than 15.

Starting in 2018, under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, the child tax credit has been increased to $2,000 per child, with up to $1400 being refundable. However, the personal exemption has been eliminated, although a $500 credit can be claimed for dependents other than children. The income phaseout amount has also been increased to $400,000 married filing jointly, and $200,000 for everyone else. If a dependent does not qualify for the child tax credit, then they may qualify for a new credit of up to $500. The new law also requires that each child have a Social Security number before the due date of the return, including extensions, to qualify for the child tax credit. If the dependent child does not have a Social Security number, but has an ITIN, then the taxpayer may be able to claim the new dependent credit of up to $500 for that child.

Additional Child Tax Credit

The ordinary child tax credit, like most other credits and deductions, has an implicit work requirement, because it can only be used to offset ordinary income tax liability and for most people, especially poor people, that income tax liability comes from earning more than the total sum of the other tax credits and personal exemptions and deductions.

Although the child tax credit is generally limited to ordinary income tax liability or AMT liability, an additional refundable credit may be claimed on Form 8812, Additional Child Tax Credit if your earned income exceeded $3,000. Thus, the Additional Child Tax Credit has an explicit work requirement. However, if you have more than 2 children, then you can still claim a refundable credit even if your earned income is not over $3,000. The purpose of the earnings requirement is to promote work.

The Tax Cuts and Jobs Act has reduced the earnings threshold from $3000 to $2500, starting in 2018.

Poor people cannot use the traditional child tax credit, because it can only offset ordinary income tax liability: it cannot be used to offset employment and other taxes listed in the Payments section of Form 1040. Therefore, poor people receive most or all their benefit from the Additional Child Tax Credit, because it is refundable. For instance, in 2015, the personal exemption is $4000 and the standard deduction is $6300, so a parent with 1 child may claim 2 personal exemptions, worth $8000 plus the parent's own standard deduction, for a total of $14,300. Therefore, this parent would have no ordinary income tax liability if income does not exceed that. This is without even considering other possible deductions or tax credits that the parent may claim, such as a traditional IRA contribution. Therefore, the Additional Child Tax Credit provides most or all the tax savings for lower income taxpayers.

Richer taxpayers will probably have sufficient tax liability from ordinary earnings, so they can claim the entire $1000 by applying the regular child tax credit. Of course, the more children they have, the higher their income will need to be to rely only on the ordinary child tax credit.

Because it is refundable, the Additional Child Tax Credit can be used to reduce payroll tax liability. The refundable credit is limited to the lesser of the unclaimed portion of the nonrefundable credit amount or 15% of your earned income above $3,000. Combat zone pay, which is otherwise excludable, can be included in earned income when calculating the Additional Child Tax Credit.

Maximum Additional Child Tax Credit = Lesser of Unused Child Tax Credit or (Earned Income – $3000) × 15%

Examples: Calculating the Additional Child Tax Credit for Employees

Example: Amy, who had earned income of $20,000, could only claim a $1,500 child tax credit for her 2 children, since that was the extent of her ordinary income tax liability. Therefore:

Amy can claim the lesser amount of $500 for the additional child tax credit.

For taxpayers with more than 2 children, an additional credit may be available by using the following generalized procedure:

  1. (Earned Income – $3,000) × .15
  2. Amount Taxpayer Paid in Social Security and Medicare Taxes as an Employee (listed in Boxes 4 and 6 of Form W-2) + 1/2 of any Self-Employment Taxes – Earned Income Credit
  3. Tentative Credit = Greater of #1 or #2
  4. Unclaimed Credit = Maximum Child Tax Credit – Claimed Portion of Credit
  5. Additional Child Tax Credit = Lesser of #3 or #4

Examples: Calculating the Additional Child Tax Credit for Taxpayers with Self-Employment Income

Case #1: Rachel, who had earned income of $20,000, could only claim a $1,500 child tax credit for her 3 children, since that was the extent of her ordinary income tax liability. Rachel earned $15,000 as an employee, paying $1,148 in social security taxes — her employer paid an equal amount, but only her portion can be used in the following calculation. She also earned $5,000 net profit from a cleaning business, for which she paid $765 in self-employment taxes. Rachel also claimed an earned income credit of $5,049. Therefore:

  1. 15% of earned income over $3,000 = ($20,000 – $3,000) × .15 = $2,550
  2. $1,148 + 1/2 × $765 – $5,049 = $1,530.50 – $5,049 = -$3,518.50
  3. Tentative Credit = Greater of #1 or #2 = $2,550
  4. Unclaimed portion of the nonrefundable credit amount = $3,000 – $1,500 = $1,500
  5. Additional Child Tax Credit = Lesser of #3 or #4 = $1,500

With the additional child tax credit of $1,500, Rachel can claim the full amount of the $3,000 (3 children × $1,000) that she could have claimed, but for her limited liability for ordinary income tax.

Case #2: Rachel earns all her income from self-employment.

  1. 15% of earned income over $3,000 = ($20,000 – $3,000) × .15 = $2,550
  2. $0 + 1/2 × $765 – $5,049 = $1,530.50 – $5,049 = -$4,666.50
  3. Tentative Credit = Greater of #1 or #2 = $2,550
  4. Unclaimed portion of the nonrefundable credit amount = $3,000 – $1,500 = $1,500
  5. Additional Child Tax Credit = Lesser of #3 or #4 = $1,500

It seems that Congress's intention was to limit the Additional Child Tax Credit to the lower of either the taxpayer's payroll tax liability or to the unused portion of the child tax credit, to limit any possible refund. 15% of earned income is very close to the 15.3% payroll tax on earned income that is assessed on employees, the employer paying ½ of that, so Steps 1 and 2 seem to be designed to limit the additional credit to slightly less than the full payroll tax liability on the earned income. So a self-employed taxpayer who had no earnings as an employee would always select Step 1, since that will always be greater than Step 2.

Note that Steps 2, 3, and 5 ensure that the child tax credit, unlike the earned income credit, will never be greater than the taxpayer's total tax liability. So although it is a refundable tax, in that it reduces payroll tax liability, it is not a negative tax. However, 2 other refundable credits after listed after the Additional Child Tax Credit in the Payments section of Form 1040:

If either of the above credits can be claimed, then those may lead to a greater tax refund or will at least reduce the payroll tax liability for the self-employed.

Also, Step 4 and Step 5, together, ensure that the following equation is always true:

Child Tax Credit + Additional Child Tax Credit ≤ Number of Children × $1,000

Tip: if you can claim the child tax credit or the additional child tax credit and you want to receive more take-home pay, then you should increase your withholding allowances by filing a new Form W-4 with your employer.

After 2017, the earnings exclusion for the Additional Child Tax Credit was scheduled to rise from $3000 to $14,600, thus eliminating or reducing the credit for many poor families, but The Protecting Americans from Tax Hikes Act, otherwise known as the PATH Act, (Division Q of P.L. 114-113) has made the change a permanent part of the tax code.

Longer Delays for Refunds for Taxpayers Claiming the Earned Income Tax Credit or the Additional Child Tax Credit

Starting in 2017, there will be a longer wait for refunds for people claiming the Additional Child Tax Credit and the Earned Income Tax Credit. The EITC is fully refundable, meaning that the taxpayer will receive a refund even if no taxes were paid. The ACTC is refundable, but only to the extent of paid taxes, including employment taxes. Because the regular child tax credit can only offset ordinary tax liability, most poor people mainly benefit from the ACTC. Most other tax credits cannot be used to lower employment tax liability. Other refundable tax credits, such as the Premium Tax Credit for healthcare coverage, are not subject to the delay. However, the whole refund will be delayed, not just the portion attributable to the EITC and the ACTC.

The IRS is required to delay the refunds until at least February 15 so that it has the chance to verify the claimed credits, because, previously, many refunds were paid erroneously because of errors in claiming the refund or from fraud. Therefore, there will be some delay regardless of when the tax return is filed, so taxpayers who want their money sooner should file as soon as possible. Because of the Presidents’ Day holiday, the refunds may be delayed even for early filers until the end of February.

This delay was enacted as a provision under the Protecting Americans from Tax Hikes Act of 2015, often known by its much briefer moniker, the Path Act.

Tax preparers may offer the tax refund sooner, but they are really offering a loan, since the delay is required by law. These loans often have unfavorable terms, so they should be avoided.

The estimated time for refunds can be checked after February 15 using the IRS2Go mobile app, or by checking the Where's My Refund? - It's Quick, Easy and Secure page at irs.gov.

Source: Refund Timing for Earned Income Tax Credit and Additional Child Tax Credit Filers

A Tale of 2 Government Handouts

Some people consider the child tax credit to be a government handout, as evinced by the fact that the Additional Child Tax Credit has an explicit work requirement. I do not know if the Republicans have a unified view of the child tax credit, but since they oppose abortion, they should, at least, help people to afford those children. However, governments — federal, state, and local — put most of the tax burden on working people. Indeed, the Republicans do not want to tax investment income or gratuitous transfers at all! So that leaves taxing only work. They want working people to pay all the income taxes, so it is natural that they should espouse hard work, since somebody must pay for government. The Republicans just don't want it to be the rich. The tax burden on work is one reason why inequality is increasing, and why it is so difficult to move up in society by simply working for it.

In this light, it is interesting to compare the child tax credit with another very generous tax credit that benefits the wealthy: the unified tax credit, used to eliminate the estate tax on more than $5 million of gratuitous transfers, i.e., gifts and bequests.

The child tax credit:

By contrast, the unified tax credit:

The unified tax credit is very generous, indeed. For instance, the 2016 unified tax credit is worth more than most people are ever going to earn (adjusting for inflation) in their entire lives. A person who works for 40 years, averaging $50,000 a year, will only earn $2 million over his working lifetime, and would pay an enormous amount of taxes on that income over those years. On the other hand, a child receiving $10.9 million from his parents does not have to pay any federal tax at all on that income — and no! — he doesn't have to work for it.

Remember, too, that it seems that the tax code for the child tax credit has been carefully crafted to minimize any actual refund to low income taxpayers, by only allowing the credit to offset payroll taxes, so that the government's net credit to the taxpayer does not exceed what it has collected through payroll taxes. The Additional Child Tax Credit increases by 15% for each dollar over the $3000 minimum, which closely tracks the total payroll liability for an individual taxpayer. Of course, if the taxpayer also qualifies for the earned income credit or the premium tax credit or even the American Opportunity Credit, then the taxpayer's refund from these truly refundable credits will be increased by the child tax credit. Although this is a rather complicated explanation, it does explain why the calculation for the child tax credit is so complicated, and why the child tax credit is not simply a $1000 refundable credit per child. Moreover, not everyone can work! And if they had children? Too bad, I guess! This is just 1 illustration showing how the tax code strives to limit payments to the poor, while being very generous to the wealthy, as demonstrated by the inflation-adjusted unified tax credit of over $2 million!

If the government truly wants to promote work, it would be more successful by taxing it less, instead of taxing it the most, as it is now, especially considering the fact that the deadweight loss of taxation on employment is greatest while the deadweight loss on taxing gratuitous transfers is 0. States and municipalities also tax work more than other forms of income.

Under the tax code, as in other things in life, the rich really do have it better!

Note: As noted in the news item above, the new tax package doubled the maximum child tax credit to $2000, with $1400 of it being refundable. However, the only reason why this was added to a tax package immensely beneficial to the wealthy is because Marco Rubio insisted on it, and without his vote, the rich would not have gotten their big tax breaks. As for the wealthy, among the many other goodies that they have received, the unified tax credit has been doubled, so now the wealthy can pass $22 million to their heirs without any tax liability. But since the government costs so much money, if the wealthy don't pay their fair share in taxes, then they will have to increase taxes on everybody else! While the new tax package did lower taxes for many lower income Americans, it achieved this by greatly increasing the deficit, exactly at the time when taxes should be raised rather than lowered, since the economy is peaking right now. After all, what is the government going to do when the next recession arrives, as it always does, since the economy continually moves in cycles. Without government spending, the economy will sink lower than it would otherwise.

Eventually, these taxes will have to be paid back. For years, the Republicans have been screaming about the deficit, and now that they are in complete control of the government, they have greatly increased the deficit to benefit their political donors. What this means is that the Republicans were not really concerned about the deficit, only that not enough wealth was being transferred from the lower classes to the wealthy! Eventually, the Republicans will argue that taxes must be raised on everybody, mostly the poor and middle-class, and that so-called "entitlements" — Social Security and Medicare — needs to be reduced or even eliminated. Of course, working people have been paying heavy taxes for these entitlements all of their working lives, but the Republicans still call them entitlements. On the other hand, the unified tax credit is a free gift to the wealthy, and unlike the child tax credit, has no onerous requirements!