On
October 4, 2004,
President Bush signed the Working Families Tax Relief Act of 2004 (Family Tax
Act) into law. This $146 billion
tax bill extended more than ten income tax benefits that expired at the end of
2003 and eight tax benefits that were scheduled to expire during or after 2004.
In addition to the extension of these expiring tax benefits, the Act contains
several changes to the tax law as discussed below.
Exempt
Combat Pay Is Earned Income for Earned Income Credit Calculation.
Low-income workers can qualify for a refundable earned income credit (EIC).
The amount of the credit varies with the amount of their earned income. Prior to
the Family Tax Act, earned income for purposes of the EIC did not include tax
exempt combat pay for military personnel. For
tax years ending after October 4, 2004 and before January 1, 2006, military
personnel may elect to treat combat pay as earned income for EIC purposes.
Planning
Alert! If a taxpayer has
earned income from sources other than combat pay, electing to treat the combat
pay as earned income could actually cause the taxpayer to lose all or a portion
of his or her earned income credit. In that case, the election should not be
made.
Increased
Child Tax Credit. The $1,000 child tax credit was scheduled to drop from $1,000 to
$700 in 2005. The Family Tax Act
maintains the credit at $1,000 through 2010. Also, you may be entitled to a refund of your child tax credit
even if your credit exceeds your federal income tax liability.
Last year, you could have received a refundable credit to the extent of
10% of your earned income in excess of $10,500.
For years beginning after 2003, the Act increases the refundable
credit to 15% of your earned income in excess of $10,750.
Moreover, starting in 2004, the Act includes tax exempt combat pay in the
definition of earned income for purposes of the refundable child tax credit.
Tax Tip. Last
year, if you had one qualifying child, you had to earn at least $20,500 to be
entitled to a full refundable child tax credit of $1,000.
For 2004, you need earned income of only $17,417 to qualify for the full
$1,000 refundable credit.
Educators
Classroom Expense Deduction. The Family Tax
Act extends the above-the-line deduction for up to $250 for books, supplies,
computer equipment, etc. used in the classroom by elementary and secondary
school teachers through 2005. This deduction had been scheduled to sunset after 2003.
Uniform
Definition of Child for Tax Purposes. Before the
Family Tax Act, taxpayers with children could possibly qualify for five
different tax benefits: the
dependency exemption; the child tax credit; the earned income credit; the child
dependent care credit; and head-of-household filing status.
Each of these provisions had separate tests for determining whether the
child qualifies the taxpayer for the tax benefit. Starting in 2005, the Act establishes a uniform definition
of qualifying child that can be used for each of the above-listed tax benefits.
Planning
Alert.
The Act also contains new rules for divorced or separated parents. For example,
legal custody will not determine who is the custodial parent after 2004.
Instead, the custodial parent will be the parent with whom the child lived for
the greater portion of the year. As under current law, the custodial parent may
allow the non-custodial parent to claim the child as a dependent.