ACCY 312 Chap.8 Tax Credits, Prepayments and Penalties
Tax Credits, Prepayments and Penalties
How credits differ from deductions
A credit reduces tax dollar for dollar, so its value is its full amount rather than its amount times a rate. Credits fall into three groups. Nonrefundable personal credits can reduce the tax to zero but not below. Refundable personal credits can take the tax below zero and be paid out.
Business credits pursue policy aims, as the research credit encourages innovation, while the child and dependent care credit helps parents work.
Child-related credits
The child tax credit is $2,200 for each qualifying child under 17 at year-end who is claimed as a dependent, and $500 for each other dependent, such as a qualifying child aged 17 or over or a qualifying relative.
Part of the child amount is refundable, capped at 15% of earned income above $2,500 or $1,700 per child, whichever is smaller. The credit phases out by $50 for every $1,000, or part of $1,000, of AGI above $400,000 for joint filers and $200,000 for everyone else.
The child and dependent care credit covers care for a dependent under 13: qualifying expenses are the least of actual costs, a cap of $3,000 (one qualifying person) or $6,000 (two or more), and earned income, multiplied by a rate that falls from 35% to 20% as AGI rises.
Education credits
The American opportunity tax credit covers the first four years of postsecondary education per student: the full first $2,000 spent on eligible costs plus a quarter of the next $2,000, so at most $2,500, of which 40% is refundable.
It phases out proportionally between $80,000 and $90,000 of AGI for a single filer and between $160,000 and $180,000 for joint filers. The lifetime learning credit is 20% of up to $10,000 of expenses per taxpayer, so at most $2,000, and extends to graduate and continuing education.
Both cannot be claimed for the same student and expenses in one year.
The earned income credit
A refundable credit aimed at lower-income workers, the earned income credit is sometimes called a negative income tax. Its amount depends on the number of qualifying children and on earned income, and it phases out above a threshold.
A worker needs earned income and either a qualifying child or an age of 25 to 64 without being someone else's dependent.
Paying as you go
Tax is paid through the year by withholding, treated as paid evenly, and by estimated payments due January 15 (for the prior year), then April 15, June 15 and September 15. Underpaying costs interest at the federal short-term rate plus three points, unless a safe harbour is met: 90% of this year's tax, or 100% of last year's (110% when AGI exceeds $150,000).
Filing late costs 5% of the unpaid tax per month to a maximum of 25%; paying late costs 0.5% per month, also capped at 25%.
What this chapter covers
- 01
Nonrefundable, refundable and business credits
- 02
Child tax credit and its phase-out
- 03
Child and dependent care credit
- 04
American opportunity tax credit
- 05
Lifetime learning credit
- 06
Earned income credit
- 07
Withholding and estimated payments
- 08
Underpayment, late filing and late payment penalties
Worked example · free
Credits for a family with a child and a college freshman
- 2Child tax credit: $2,200 for the son under 17 plus $500 for the daughter as another dependent is $2,700; AGI is far below $400,000, so no phase-out.
- 2AOTC before phase-out: 100% of $2,000 plus 25% of the next $2,000 is $2,500.
- 2Phase-out: ($168,000 less $160,000) over $20,000 is 40%, so $1,000 is lost and the AOTC is $1,500.
Key terms
- Nonrefundable Credit
- A credit that can reduce tax to zero but cannot create a refund.
- Child Tax Credit
- A credit of $2,200 per qualifying child under 17, partly refundable and phased out at high AGI.
- American Opportunity Tax Credit
- An education credit worth up to $2,500 per student for the first four years of postsecondary study.
- Lifetime Learning Credit
- An education credit of 20% of up to $10,000 of expenses per taxpayer.
- Earned Income Credit
- A refundable credit for lower-income workers that rises with earnings and then phases out.
- Safe Harbor
- A payment level that avoids the underpayment penalty even if more tax turns out to be due.
Tax Credits, Prepayments and Penalties FAQ
How is the child tax credit phase-out rounded?
The credit falls by $50 for each $1,000 of AGI over the threshold, and any part of $1,000 counts as a full step. So $15,500 of excess AGI is 16 steps, a reduction of $800, not $775.
Can I claim both education credits for the same student?
Not for the same student and the same expenses in the same year. The American opportunity credit is per student and limited to four years, while the lifetime learning credit is per taxpayer and covers graduate and continuing study.
What is the safe harbour for estimated tax payments?
Paying at least 90% of the current year's tax, or 100% of the prior year's tax, in quarterly instalments avoids the underpayment penalty. The prior-year figure rises to 110% when AGI is above $150,000.
Exam move
Make a credit grid with columns for amount, who it is per, refundable or not and phase-out, and fill it from memory each week. Then work one family case that needs three credits at once.
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