I’ve been asked a lot of questions about the expanded Child Tax Credit under the new tax reform law. While we have a sense of how it should work under the existing rules for the Child Tax Credit, there are still some aspects of the new law that aren’t quite obvious. We’ll have to wait for the Regs for the details (typically once Congress passes a law, the Internal Revenue Service (IRS) issues Regulations which offer an interpretation of the statute) but here’s what you need to know.
Under tax reform, the Child Tax Credit may be worth as much as $2,000 per qualifying child depending upon your income – that’s twice as much as before. A qualifying child for this credit must meet all of the following criteria:
- The child must be under age 17 – age 16 or younger – at the end of the tax year.
- The child must either be your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes your grandchild, niece or nephew. An adopted child is always considered your own child.
- The child must not have provided more than half of their own support.
- You must claim the child as a dependent on your federal tax return.
- The child must be a U.S. citizen, U.S. national, or U.S. resident alien and you must provide a valid Social Security number (SSN) for the child by the tax return due date.
- The child must have lived with you for more than half of the tax year (some exceptions apply).
In prior years, the Child Tax Credit was nonrefundable which means that if the available tax credit exceeded your tax liability, your tax bill was simply reduced to zero. So even if you were able to claim the entire $1,000 per child (the maximum available credit for the 2016 tax year), if you didn’t have any tax liability, you couldn’t benefit from the credit. The credit would not carry forward to any future years, or back to any past years: it simply disappeared.
Under tax reform, part of the Child Tax Credit remains nonrefundable but the “old” Additional Child Tax Credit, which was refundable, has essentially been merged into the new credit. I know that sounds confusing but what it means is that the Child Tax Credit is just one credit worth up to $2,000 per child and includes a refundable piece of up to $1,400 per child. To be clear, the $1,400 refundable piece is included as part of the $2,000 Child Tax Credit and is not an additional credit (unlike before).
A refundable credit means that you can take advantage of the credit even if you do not owe any tax. Unlike with a nonrefundable credit, if you don’t have any tax liability, the “extra” credit is not lost but is instead refunded to you. To claim the refundable portion, you must have earned income (generally, wages, salary, tips, and net earnings from self-employment). For purposes of the new Child Tax Credit, the refundable portion is equal to 15% of your earned income which exceeds $2,500 up to the maximum credit.
Let’s do the math. Say your earned income is $10,000 and let’s assume that you are entitled to the entire $2,000 credit. However, at that income level, you likely don’t owe any tax. With a nonrefundable credit, that wouldn’t mean anything to you. However, with the refundable piece of the credit, you can pocket up to $1,125 since $10,000 (your earned income) less $2,500 x 15% = $1,125.
What if, instead, your earned income was $50,000 and your tax owed was $5,000? You would be entitled to the entire $2,000 nonrefundable credit – no need to do the math on the refundable piece. A nonrefundable credit reduces what you owe, it just can’t reduce your liability below zero. So after you apply the $2,000 credit, your tax liability is reduced to $3,000. Easy, right?
But what if you had already paid $5,000 as withholding? Do you lose the credit or the withholding? NO. Don’t read too much into the word “nonrefundable” – it only means you can’t reduce your tax burden below zero but it doesn’t negate an overpayment. Think of nonrefundable credits as tax reductions and refundable credits as payments – that’s more or less how they appear on your form 1040.
If you have three or more qualifying children, you can use an alternative formula to determine the refundable portion. Under the alternative formula, the refundable portion is equal to the amount by which your Social Security taxes (those taken out of your wages or paid out as self-employment taxes) exceed your earned income credit (sometimes called EIC or EITC).
The credit is limited if your modified adjusted gross income (MAGI) is above a certain amount. The amount at which this phase-out begins varies depending on your filing status. For married taxpayers filing a joint return, the phase-out begins at $400,000 and it is $200,000 for all other taxpayers (note there is no separate threshold for HOH). Phase-outs means that the credit is reduced as your income increases. In this case, the reduction is $50 for each $1,000 by which your MAGI exceeds the threshold amount.
Here’s a quick example of how the phase-outs would work. Let’s assume that as a single taxpayer, you are entitled to a credit of $2,000 but your income is above the $200,000 threshold: it’s $201,000. Your credit would be reduced by $50 (because you’re $1,000 over the threshold amount) so that your available credit is $1,950.
As your income climbs, the credit disappears completely. So, as a single taxpayer making income over $240,000, your credit is reduced by $2,000, bringing the available credit to zero (40 x $50 = $2,000).
Under tax reform, the child credit also includes a $500 non-refundable credit for qualifying dependents other than qualifying children. This has been referred to as a “family credit” and allows you to claim a credit for other dependents in your household that don’t meet the definition of qualifying child. The credit is clearly intended to make up for the fact that you no longer have the ability to claim other dependents like your parents on your tax return as personal exemptions since those have been eliminated. For purposes of the additional non-refundable “family” credit, the definition of dependent still generally applies but there is no requirement to provide an SSN (you’ll still need a taxpayer ID number).
And I know that this version of tax reform was supposed to be about simplification but not when it comes to the Child Tax Credit. In order to claim the credit, you must file a federal form 1040, federal form 1040A, or a federal form 1040NR. You cannot claim the child tax credit using form 1040-EZ.
The modified credit is slated to remain in place for the 2018 through 2025 tax years.