As tax practitioners prepare to counsel clients about the loss of dependency exemptions on 2018 tax returns, there is good news to offer in the form of the enhanced child tax credit. The legislation known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, doubled the credit amount, increased the refundable portion, and expanded its scope to include dependents other than qualified children. In addition, the TCJA broadened the pool of taxpayers eligible for the credit by significantly increasing adjusted-gross-income (AGI) phaseout ranges.
New Sec. 24(h) contains eligibility requirements and other changes to the child tax credit effective for tax years 2018 through 2025.
HIGHER PHASEOUT RANGES
Under the TCJA, a taxpayer's potential credit amount begins to phase out at $400,000 of modified AGI (MAGI) for joint filers and $200,000 for all others. These amounts are not adjusted for inflation. Formerly, the credit began to phase out at $110,000 for joint filers, $55,000 for married filing separately, and $75,000 for all others. The distinction for married filing separately no longer exists, and the threshold for joint filers nearly quadrupled (for others, the threshold rose by 166%).
Under Sec. 24(b)(1) MAGI is the same as AGI unless a taxpayer is a resident of Puerto Rico, Guam, American Samoa, or the Northern Mariana Islands or has any foreign earned income and/or housing costs that he or she elected to exclude from gross income under Sec. 911. The credit amount decreases by $50 for every $1,000 (or fraction thereof) by which the taxpayer's MAGI exceeds the threshold amount.
HIGHER CREDIT AMOUNT
Though the TCJA eliminated dependency exemptions for tax years 2018 through 2025, the Sec. 152 definitions of dependents remain relevant for determining eligibility for the child tax credit. Sec. 24(h)(2) doubles the credit amount from $1,000 to $2,000 per "qualifying child." The credit amount is not adjusted for inflation. A qualifying child has the same definition as for dependency exemption purposes but must also be under age 17 (Sec. 24(c)(1)). In other words, a Sec. 24 qualifying child must meet the relationship, abode, and support tests from Sec. 152(c) while also being under age 17.
The relationship test requires the individual to be the taxpayer's (1) child or a descendant of the child, or (2) sibling or stepsibling or a descendant of the sibling or stepsibling. The abode test requires that the individual have the same principal place of abode as the taxpayer for more than half the year. The support test requires that the individual does not provide more than half of his or her own support for the calendar year in which the tax year of the taxpayer begins. As tax practitioners know, there are nuances to each of these tests. But the big picture is that taxpayers with MAGIs below the threshold will be able to claim a $2,000 credit for each qualifying child.
OTHER DEPENDENTS COVERED
Perhaps the most surprising change to the child tax credit is the addition of a $500 credit for each dependent who does not satisfy the Sec. 24(c) definition of a qualifying child. This $500 credit amount is not adjusted for inflation. Dependents eligible for the partial credit include "qualifying relatives" for dependency exemption purposes.
A qualifying relative must meet the relationship, gross income, and support tests from Sec. 152(d). The relationship test includes all individuals who meet the qualifying child relationship test, plus the taxpayer's lineal ancestors, stepparents, aunts, uncles, nieces, nephews, certain in-laws, and any individual who lives with the taxpayer and meets the other two tests.
The gross income test requires that the individual's gross income is less than the personal exemption amount. Though that amount becomes zero for tax years 2018 to 2025 for purposes of calculating taxable income, Sec. 151(d)(5)(B) retains the previous, inflation-adjusted exemption amount for purposes of the child tax credit. In October 2017, before passage of the TCJA, the IRS issued Rev. Proc. 2017-58 announcing an inflation-adjusted personal exemption of $4,150 for 2018 (up from $4,050 for 2017). However, the TCJA changed any inflation adjustments connected to Sec. 1(f)(3), including the personal exemption amount, from using the traditional consumer price index (CPI) to using the "chained" CPI. Any new figure will be in the same ballpark, rounded down to the nearest $50. Chained CPI generally reflects lower inflation than traditional CPI.
Finally, the support test requires that the taxpayer provides more than half of the individual's support.
The new $500 credit captures not only Sec. 152(d) qualifying relatives but also Sec. 152(c) qualifying children (for purposes of the dependency exemption) who are not eligible for the $2,000 credit because they are age 17 and over. These Sec. 152(c) qualifying children include those ages 17 and 18 (or up through age 23 for full-time students and any age for children who are totally and permanently disabled).
The TCJA raised the eligibility bar for qualifying children in one way: Where a taxpayer identification number (TIN) used to be sufficient, a qualifying child must now have a Social Security number (SSN) for the taxpayer to claim the $2,000 credit (Sec. 24(h)(7)). A taxpayer can claim a $500 credit for individuals without an SSN, as long as they have a TIN and meet the other dependency tests.
Of the $2,000 credit per qualifying child, up to $1,400 can be refundable. (No part of the $500 credit for other dependents is refundable.) The $1,400 refundable portion is adjusted annually for inflation after 2018, rounding down to the nearest $100. Interestingly, over time, assuming inflation continues, the refundable portion will get closer to the full $2,000 credit, which is not adjusted for inflation. Formerly, the entire maximum credit amount of $1,000 per child could be refundable under certain criteria.
The refundable portion of the credit only applies when the taxpayer is unable to fully use the $2,000 nonrefundable credit to offset his or her tax liability. Form 1040, U.S. Individual Income Tax Return, provides a specific order in which a taxpayer applies credits to reduce (or eliminate) tax liability.
Though the IRS has not yet published the 2018 Form 1040, one can assume that the mechanics for calculating the refundable credit, known as the "additional child tax credit," will be similar. On the 2017 Form 1040, the foreign tax credit, credit for child and dependent care expenses, education credits, and retirement savings credit came before the child tax credit in eliminating tax liability. The refundable credit equals 15% of a taxpayer's earned income above $2,500, up to a maximum of $1,400. In other words, a taxpayer with earned income of $11,833 or more is potentially eligible for the full $1,400 additional child tax credit. The $2,500 threshold is more favorable than the pre-TCJA threshold of $3,000.
NEW SIGNIFICANCE FOR MIDDLE-INCOME TAXPAYERS
In the past, tax practitioners whose client base consists of middle- to high-income taxpayers may have largely ignored the child tax credit. However, the TCJA expanded the credit, both in terms of eligible taxpayers and eligible dependents. In addition, the amount of the credit doubled and the refundable portion increased by 40%. Beginning with 2018 returns, the child tax credit takes on new significance, especially with the elimination of dependency exemptions.
Katherine M. Hetherington, J.D., LL.M., (email@example.com) is an assistant professor of accounting at San Francisco State University in San Francisco.
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