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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Child Tax Credit

What it is:

The child tax credit is a tax-bill reduction given to people with qualifying children under 17 years old.

How it works (Example):

The Internal Revenue Service (IRS) allows taxpayers to reduce their federal income taxes by a fixed amount for each qualifying child. A qualifying child is a dependent under 17 who is a U.S. citizen or a resident alien. The child must be the taxpayer’s son, daughter, adopted child, grandchild, stepchild, eligible foster child, sibling, stepsibling, or descendant. The child must live with the taxpayer for more than one-half of the tax year. In many cases, divorced parents decide which parent receives the child credit.

The child tax credit is not a tax deduction, it is a credit. That means it is a dollar-for-dollar reduction in your tax bill rather than a reduction in your taxable income. As a result, the child tax credit is a very effective way to reduce a tax bill. The amount of the credit usually increases every year, and the income level at which the credit is phased out also changes every year.

In general, the more children a taxpayer has, the higher his or her tax credit is. For taxpayers with modified adjusted gross incomes (AGI) above a certain amount, the amount available from the tax credit is reduced. Taxpayers with a modified AGI over an even higher amount do not qualify for the tax credit at all (the income threshold varies with the number of children the taxpayer has). The amount of income or alternative minimum tax the taxpayer owes also limits the credit. For example, if you qualify for a $700 child tax credit but you only owe $200 in income tax, then your credit will probably be limited to $200.

Taxpayers claim the child tax credit on IRS Form 1040 or 1040A. Some taxpayers may also need to complete IRS Form 8812 if their tax credit is greater than their income tax liability.

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Why it Matters:

The child tax credit can substantially reduce a person’s tax bill or increase his tax refund. It is important to note that if the credit produces a large federal tax refund, the taxpayer should consider revising his or her federal withholding form (form W-4) to avoid letting the IRS hold the taxpayer’s money all year.

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