The $500 child credit

The $500 child credit

Host : Great. You're starting to get me interested. But let's try to get a better understanding of our tax system by going over the changes brought about by the 1997 tax act.

What's one of the simplest and most beneficial parts about the new tax law?

David : I'd have to say the child credit. This is a credit, which is generally better than a deduction. A $500 credit cuts your total tax liability by $500, whereas a $500 deduction may only cut your taxes by $150.

Second, this $500 credit isn't worth $500, at least in 1998. It's only worth $400 in the first year of 1998. After 1998 you get the full $500 per child, regardless of the number of children, as long as your child is under age 17.

Host : So can every family take advantage of this?

David : No. If your income is so low you have no income tax liability, this won't help you. You may laugh, but the IRS literally gives away money through a refundable tax credit called the earned income credit.

The EIC started off as a good idea, but like many things, it got out of control. Presently the law imposes Social Security taxes on low-income workers, and then turns around and refunds these payroll taxes through the EIC.

Host : So on the one hand the government levies a Social Security tax, and then gives this tax back via the income tax's Earned Income Credit, right?

David : That's right, at least in theory. But your EIC refund doesn't depend solely on the Social Security tax you paid. It also depends on your income and number of children you have.

And the round trip involves a lot of waste, paperwork and an estimated $5 billion in fraud annually.

Much of the fraud arises because people pass dependents around -- at least on paper -- to friends to get a higher EIC. And since someone earning $9,000 annually can get an EIC of $3,500, we're not talking about spare change here.

To help reduce the fraud, the new tax law requires every new child's Social Security number be registered at birth. Taking the new child credit for low income families is complex, but it boils down to this.

If you have a low income and only one or two children, the $500 per child credit may not help you, simply because you have no income tax liability. However, if you have three or more children, the new child credit may help you -- if you can get through the paperwork.

Host : Wow. What about middle and upper income people?

David : Most middle income people get the full benefit of the $500 per child credit. However, the $500 benefit phases out for singles making more than $75,000 a year, and joint filers earning more than $110,000 a year.

Host : What do you mean by "phases out"?

David : A phase-out is supposed to improve the equity of the tax code by gradually denying a tax benefit to higher income people.

For example, with the child credit, if you have three kids, you get the full $1,500 on a joint return if your income is $110,000 or below, but you only get a total of $500 at $130,000. If your income is $140,000 or above, you get no benefit.

Most people won't argue with this definition of fairness, but phase-outs sure make the tax code more complicated.

Host : So does the new tax law complicate our income tax system?

David : Absolutely. It's funny that politicians who were denouncing the complexity of our tax code are the same ones who have given us a more complicated system. But these "targeted" cuts probably help them get re-elected, so at least the politicians are happy.