TITLE: Tax Credits vs. Tax Deductions
SOURCE: CCH, Federal Tax Audio Advisor
Bulletin, Issue 2001-5
DATE POSTED: 11/28/01
Tax Credits vs. Tax Deductions
Tax credits are more valuable than
tax deductions because they reduce your taxes on a dollar-for-dollar basis.
Recent tax changes created new tax credits and liberalized the rules for
certain other tax credits. You may be able to benefit from these changes.
Rate reduction credit. Did you receive an advance refund check of up to $300 if single ($500 if a head of household, or $600 if married and filing jointly) reflecting the new 10% tax bracket? You may not have received this check-if you didn't file your 2000 return by April 17, 2001. However, you can still receive the benefit of the new 10% tax bracket when you file your 2001 return. You can claim a rate reduction credit-which applies only for 2001. Starting next year, the 10% bracket will be built into the tax tables so there'll be no need for a separate credit.
Caution: Someone who can be claimed as a dependent on another taxpayer's return is not eligible for the 10% tax bracket in 2001. Thus, for example, your dependent child won't get an advance refund or be able to claim the credit.
Credit for retirement plan contributions. Starting in 2002, those who make elective deferrals to 40 I (k), 403(b) or other salary reduction arrangements or contributions to IRAs-both traditional or Roth-may claim al tax Credit. However, this special credit, which runs only through 2005, has strict income limitations.
Important: The credit is in addition to other tax benefits for the contributions-tax-free treatment for elective deferrals or a deduction for traditional IRA contributions.
Child tax credit. If you have a child who is under the age of 17 by the end of the year, you may be eligible for a credit of $600 (up from $500 in 2000). This credit applies for each eligible child. The credit is scheduled to increase to $700 in 2005, $800 in 2009, and to $1,000 in 2010.
Caution: If your modified adjusted gross income exceeds a certain amount ($75,000 for singles or $110,000 on a joint return), you start to lose the benefit of the credit. The credit is reduced by $50 for each $1,000 of modified income over the threshold amount.
Important: A portion of the credit may be refundable-payable even though it exceeds your tax liability. The refundable portion for 2001 generally is 10% of earned income in excess of $10,000, but special tax rules may create a different refundable amount.
Child and dependent care credit. If you pay expenses for the care of a child or other dependent so you can work, you may be eligible for another child-related credit. For 2001, the credit is based on expenses up to $2,400 for one dependent and $4,800 for two or more dependents. The amount of the credit depends on your adjusted gross income. It scales down from a top credit of 30% of eligible expenses, to a minimum credit of 20% of eligible expenses.
Starting in 2003, the credit
increases in several ways. The amount of eligible expenses rises to $3,000 for
one dependent and $6,000 for two or more dependents. The credit percentage
increases to a maximum of 35%. Additionally, the adjusted gross income point at
which the maximum credit applies rises to $15,000 (up from $10,000).
Adoption credit. If you pay expenses to adopt a child, you may be eligible for a credit. In 200 I, the top credit is $5,000 for a child without special needs and $6,000 for a child with special
needs.
Starting in 2002, the credit rises to $10,000 for both a special needs and a nonspecial needs child. Starting in 2003, the $10,000 credit may be claimed for a special needs child without regard to your actual payments-you receive the credit for making the adoption.
We want to point out that eligibility for certain tax credits may be affected by employer-provided benefits-for example, employer-paid child care. There are a number of other limitations on these tax credits. Please feel free to discuss with us whether any of these credit opportunities apply to you.
If you would like to discuss any of the issues raised in this summary