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Child Tax Credit

Back to Fall Tax Planning Guide Index * Back to Miscellaneous Itemized Deductions * Back to Itemized Deductions Topics * Adoption Credit and Exclusion * Forward to Education Tax Incentives

The real value of a dependency exemption decreased over the last 50 years by one-third. Instead of taking the simple approach of increasing the dependency exemption, Congress opted for a child tax credit. Code Section 24 has five qualifying criteria, the mother of all phaseouts, and a dual credit system of non-refundable and refundable credits. The Taxpayer Relief Act of 1997 allows a tax credit against the taxpayer's tax liability equal to $500 per qualifying child for 1999 and all subsequent years.

    To get the credit each dependent must meet all five of the following requirements:
  1. Name and valid Social Security number must be included on Form 1040, page 1.
  2. Taxpayer must be entitled to a dependency deduction of the child in the year claimed.
  3. Child must bear a relationship to the taxpayer (IRC 32), that is son or daughter or their descendants, a stepchild or eligible foster child.
  4. Child must be under the age of 17 as of the close of the calendar year.
  5. Child must be a U.S. citizen or resident alien.

The phaseout of the credit is based on modified adjusted income, filing status and number of qualifying children. Modified Adjusted Income is AGI plus any amount excluded from gross income under IRC 911, IRC 931 and IRC 933. Unless you are a U.S. citizen living abroad, you will use AGI to calculate the credit phaseout.

Credit starts to phase out for modified adjusted income over $110,000 (MFJ), $75,000 (Single & HDH) and $55,000 (MFS).

Generally, the credit is non-refundable which means the taxpayer must have a regular tax liability. A refundable credit may be available if the taxpayer has three or more qualifying children and has not been able to use the full non-refundable credit, and paid into Social Security. Form 8812 is used to calculate the additional child tax credit. The non-refundable child tax credit is reported on Form 1040, page 2, line 43, and refundable credit carries from Form 8812 to Form 1040, page 2, line 60.

Beware: The child tax credit may be eliminated by alternative minimum tax for all years after 1998. The credit only reduces regular income tax (reduced both regular and AMT in 1998) in 1999 and thereafter. Therefore, if the AMT is higher than the regular tax, the child tax credit will be of no benefit. Watch for any changes by the IRS for the 1999-filing season.

Adoption Credit and Exclusion

There are two tax benefits available to offset the expenses of adopting a child. Adoptive parents may be able to claim a credit against their federal tax for up to $5,000 of 'qualified adoption expenses' for each adopted child. That's a dollar-for-dollar reduction of tax. A maximum credit of up to $6,000 is available for the adoption of a child with special needs. Also, adoptive parents may be able to exclude from their gross income up to $5,000 of qualified adoption expenses ($6,000 in the case of a special needs child) paid by an employer under an adoption assistance program. Both the credit and the exclusion are ratably reduced (phased out) if the modified adjusted gross income of the parents exceeds $75,000.

Adoptive parents may claim both a credit and an exclusion for expenses of adopting a child. But they may not claim both a credit and an exclusion for the same expense.

After 2001, the adoption credit applies only to an adoption of a child with special needs. Also, the exclusion doesn't apply to any adoption assistance payments made by an employer after 2001.

Qualified Adoption Expenses. These are the reasonable and necessary adoption fees, court costs, attorney fees, travel expenses and other directly related expenses for the legal adoption of an eligible child.

Eligible child. An 'eligible child' is a child under the age of 18 at the time the qualified adoption expense is paid. If the child turned 18 during the year, the child is an eligible child for the part of the year he or she is under age 18. A person who is physically or mentally incapable of caring for himself is also eligible regardless of age.

Special needs child. This refers to a child who the state has determined cannot or should not be returned to his parents and who can't be reasonably placed with adoptive parents without assistance because of a specific factor or condition, e.g., ethnic background, age, membership in a minority group, medical condition, or handicap. Only a child who is a citizen or resident of the U.S. can qualify as having special needs.

Phase Out of Higher Income Taxpayers. Credit and exclusion are phased out for taxpayers with modified AGI between $75,000 and $115,000. This phaseout is applied only in the year the adoption credit is generated, and is not applied in future carryover years.

Maryland allows a subtraction modification of up to $3,000 (special needs child) or $2,000 (without special needs) of reasonable and necessary adoption fees, court costs, attorney fees and other expenses incurred by adoptive parents.

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