Child Tax Credit and the Credit for Other Dependents

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

2022-01-18The child tax credit was enacted by Congress in 1997 to lower the tax burden on lower income Americans with children. The child tax credit (CTC) can be up to $2,000 for each qualifying child under age 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. Children who qualify include a natural child, stepchild, grandchild, great-grandchild, brother, sister, or step- or half-siblings or any of their descendents. The child tax credit can only be claimed for a 12-month tax year.

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

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

• Married Filing Jointly: $400,000
• All Other Filing Statuses: $200,000

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

The $500 nonrefundable Credit for Other Dependents can be claimed for dependents who do not qualify for the child tax credit. Qualifying dependents include qualifying relatives who are US citizens, US nationals, or US resident alien, but not residents of Canada or Mexico who could otherwise qualify as a qualifying relative. A qualifying dependent needs to have a Social Security number, an Individual Taxpayer Identification Number (ITIN),  if the resident alien is not eligible for a Social Security number, or an Adoption Taxpayer Identification Number (ATIN), which is a temporary identification number for children in the process of being adopted. The same MAGI limits that apply to the child tax credit ($200,000 or $400,000 if married filing jointly) also applies to the credit for other dependents.

The child tax credit and the credit for other dependents are figured on Form 8812, Credits for Qualifying Children and Other Dependents. Because they are nonrefundable credits, they are limited by your ordinary income tax liability, which may be reduced by other claimed credits, 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.

Additional Child Tax Credit

For tax year 2021 only, the Additional Child Tax Credit is not applicable for qualifying children since the entire amount of the child tax credit is refundable, but the old law will apply in 2022 and thereafter. However, the Additional Child Tax Credit can be claimed by taxpayers in 2021 if they did not qualify for the refundable child tax credit because of residency requirements. An alternative way of calculating the Additional Child Tax Credit can be found in Part II-B of Form 8812, Credits for Qualifying Children and Other Dependents if the taxpayer has 3 or more children and paid Social Security and Medicare taxes exceeding their earned income 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 deductions.

Because $600 of the child tax credit is nonrefundable, families with little or no tax liability will not be able to benefit from the child tax credit. And since the standard deduction has been greatly increased for head of household status and for married filing jointly, many families will not be able to benefit from the child tax credit. At the same time, a single parent who makes less than $10,000 will not only not benefit from the regular child tax credit, but they will not even get much of the Additional Child Tax Credit. Even though the Additional Child Tax Credit is refundable, the refundable amount is limited by earnings.

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, Credits for Qualifying Children and Other Dependents if your earned income exceeded $2,500. 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 $2,500. The purpose of the earnings requirement is to promote work.

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 certain other taxes. Therefore, poor people receive most or all their benefit from the Additional Child Tax Credit, because it is refundable. For instance, in 2018, the standard deduction is $18,000 for a head of household, so a parent with 1 child may claim the parent's own standard deduction of $18,000. 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 have sufficient tax liability from ordinary earnings to claim the entire $2000 as the regular child tax credit. More children requires a higher income 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 $2,500. 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 − $2500) × 15%

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

1. (Earned Income − $2,500) × .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

Note that Steps 2, 3, and 5 ensure that the child tax credit, unlike the earned income credit, will never exceed 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:

• 40% of the American Opportunity Tax Credit
• net Premium Tax Credit, which is the Obamacare tax credit for lower income taxpayers

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 × $2,000

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 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.