Making Sense Of The Child Tax Credit And Similar Sounding Tax Breaks

Kelly Phillips Erb, Forbes Staff Feb. 2, 2024 Forbes

The House has passed a bill to expand the child tax credit (CTC). The proposal would phase in a refundable portion of the CTC and increase the maximum refundable amount per child to $1,800 in the tax year 2023, $1,900 in the tax year 2024, and $2,000 in the tax year 2025. The provision would also allow for the same flexibility taxpayers had during Covid to use the current tax year or prior tax year earned income to calculate the credit. And finally, the value of the credit would be adjusted for inflation.

But with all the chatter, taxpayers appear to be confused about what the CTC actually is—and what it isn't. Here's a look at credits that taxpayers sometimes confuse with each other.

The Child Tax Credit (CTC)

The child tax credit helps families get a tax break of up to $2,000 per qualifying child.

A qualifying child for the 2023 tax year must meet all of the following criteria:

  • The child must be under age 17—16 or younger—at the end of the tax year (that means that a child who turns 17 on or before Dec. 31, 2023, would not qualify for the 2023 tax year).
  • The child must be your son, daughter, stepchild, eligible 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 child.
  • The child must have provided no more than half of their own support during the year.
  • You must claim the child as a dependent on your federal tax return. The child must not have filed a joint return with their spouse for the tax year or have filed it only to claim a refund of withheld income tax or estimated tax paid.
  • 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).

The child tax credit is income-dependent and subject to a phase-out. For married taxpayers filing a joint return, the phase-out begins at $400,000 —it’s $200,000 for all other taxpayers. Phase-outs mean that the credit is reduced as your income increases. In this case, the reduction is $50 for each $1,000 by which your modified adjusted gross income, or MAGI, exceeds the threshold amount.

Here's a quick example of how the phase-outs work under current law. 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 your available credit is $1,950.

As your income climbs, the credit disappears. So, as a single taxpayer with $240,000 in income will see a reduced credit of $2,000, bringing the available credit to zero (40 x $50 = $2,000).

There are a lot of moving parts. If you need help, the IRS has an Interactive Tax Assistant to check if you qualify .

Additional Child Tax Credit (ACTC)

Years ago, the child tax credit was nonrefundable, meaning if the available tax credit exceeded your tax liability, your tax bill was simply reduced to zero. So even if you could claim the entire $1,000 per child (the maximum available credit for the 2016 tax year), you couldn't benefit from the credit if you didn't have any tax liability. The credit would not carry forward to any future years, or back to any past years: it simply disappeared. However, if you qualified, you could also claim the additional child tax credit (ACTC), which was a refundable credit.

After the 2017 tax reform, the "old" additional child tax credit, which was refundable, merged into the revised version of the child tax credit. I know that sounds confusing, but it means that the child tax credit is essentially one credit worth up to $2,000 per child and includes a refundable piece—that refundable piece is referred to as the additional child tax credit.

A refundable credit means you can take advantage of the credit even if you do not owe any tax. Unlike 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). The refundable amount is equal to 15% of your earned income that exceeds $2,500 (up to the maximum credit).

Let's do the math. Say your earned income is $10,000, and let's assume you are entitled to the entire $2,000 credit under current law. However, you likely don't owe any tax at that income level. With a nonrefundable credit, that would mean the credit wasn’t useful 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—there’s no need to do the math on the refundable piece, since despite its name, it’s not an additional credit in this case. 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?

What if you had paid $5,000 in 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 since that's more or less how they appear on your Form 1040.

There's one more way that the ACTC impacts your refund. The law requires the IRS to hold refunds tied to the Earned Income Tax Credit (EITC) and the ACTC until mid-February. The rule applies to the entire refund—even the portion not associated with the EITC and ACTC. That means if you qualify for the refundable credit, you’ll have to wait until the IRS can release it. As a result, if you're an early EITC/ACTC filer, you should begin to see tax refunds on or after Feb. 27, 2024, if you chose direct deposit and there are no other issues with your tax return.

Credit For Other Dependents

Tax reform also introduced the credit for other dependents. It's a nonrefundable credit of up to $500 for qualifying dependents other than qualifying children. In other words, it’s intended to cover dependents who can't be claimed for the CTC. It is sometimes referred to as a "family credit."

As with the CTC, the credit begins to phase out when your income exceeds $200,000 ($400,000 for married couples filing a joint tax return).

Child And Dependent Care Credit

The child and dependent care credit is often confused with the child tax credit but is very different. It's a tax credit that may help you pay for the care of eligible children and other dependents while you work, look for work, or attend school.

Unlike the child tax credit, the child and dependent care credit is nonrefundable. This means you can claim credit up to—but not over—any taxes you owe.

The credit is figured based on expenses for a qualifying dependent. But pay attention to the definitions since a child may qualify as a dependent for the child tax credit and not be eligible for the child and dependent care credit.

The child and dependent care credit typically applies to a child under the age of 13, but exceptions apply to a person who is mentally or physically unable to care for themselves, who has lived with you for more than half the year, and whom you can claim on your return as a dependent. Notably, this can include a parent or grandparent. Your spouse may also qualify if they are mentally or physically unable to care for themselves and have lived with you for more than half of the year.

You must have qualifying expenses to claim the child and dependent care credit. Those include the obvious costs like nursery and preschool, child or adult care providers, and certain before and after school programs. It can also include not-so-obvious expenses like summer day camps (but not sleep-away camps or traditional summer school).

The amount of the credit is based on a percentage of work-related expenses and can be up to 35% of your costs. There are caps on the expenses for purposes of figuring the credit—those are $3,000 (for one qualifying dependent) or $6,000 (for two or more qualifying dependents). The result is that the maximum child and dependent care credit in a taxable year is $1,050 for one dependent (35% of $3,000) or $2,100 for two or more dependents (35% of $6,000).

Also, importantly, you—and ( not or) your spouse if you file a joint return—must have earned income during the year to claim the credit. If one spouse does not work outside of the home (meaning they are not employed for compensation), you will not qualify for the credit. Additionally, neither unemployment compensation nor workers' compensation count towards earned income for the credit. Earned income includes wages, salaries, tips, other taxable employee compensation, as well as net earnings from self-employment. And yes, this means reporting no income or reporting a loss on your Schedule C can disqualify you from claiming the credit—and a net loss from self-employment reduces earned income. (Special rules apply to students and those mentally or physically incapable of caring for themselves.)

For more information on the child and dependent care credit, check out IRS Pub. 503 .

Confused?

If this has you scratching your head, it’s with good reason: figuring out which credits you might qualify for can be tricky. Credits with similar names may have very different rules—they are not interchangeable. And, because no taxpayers are alike, your eligibility can be impacted by income phase-outs, exceptions, and special rules. If you need help, click over to irs.gov or check with your tax professional.

By Kelly Phillips Erb, Forbes Staff

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