October 25, 2009 12:00 am

Uncle Sam Pays You

A tax credit is a valuable write-off. It reduces your tax bill dollar for dollar. Now, there is a growing number of federal tax credits that you can use that will pay you money even if the credit is more than your tax bill. These credits are called “refundable.” Some credits are fully refundable, while others are partially refundable. Of course, you have to file a tax return to claim them, even if your income is less than the filing threshold; the refundable credits aren’t paid to you automatically.

American Opportunity Credit

You can receive a credit for certain costs that you pay for the first 4 years of higher education. The credit is 100% of the first $2,000 of eligible expenses, plus 25% of the next $2,000 of eligible expenses, for a top credit of $2,500. Eligible expenses include tuition, fees, and course materials, including books, whether or not purchased from the school, but not room and board. Forty percent of the credit, or $1,000, is refundable.

The credit has income limits. A full credit can be claimed only if modified adjusted gross income (MAGI) by a single individual is not more than $80,000 ($160,000 for married persons filing jointly). A partial deduction is allowed for singles with MAGI between $80,000 and $90,000 ($160,000 to $180,000 for joint filers).

Planning tip. If a parent’s MAGI is too high to qualify for the credit, but the parent’s child (the student) has taxable income, the parent may want to waive the dependency exemption so the child can claim the credit. The child can use the credit even if the parent, not the child, pays the eligible education costs. However, if the child is claiming the credit under these circumstances, no part is refundable; it can be used only to the extent of the child’s tax liability.

First-Time Homebuyer Credit

Those who purchase their first home or who have not owned a home within the past 3 years may qualify for a tax credit of 10% of the purchase price, up to a top credit of $8,000 if they make the purchase within the first 11 months of 2009. The credit phases out for singles with MAGI between $75,000 and $95,000 ($150,000 to $170,000 for joint filers). The credit for a purchase in 2009 can be claimed on a 2009 return or on an amended 2008 return. The credit is fully refundable.

Caution:  If the home stops being your principal residence within 36 months of purchase, you’ll have to “recapture” the credit. This means including the full amount of credit in your income in the year the home is no longer your principal residence. There are exceptions to this recapture for homes that are transferred in divorce, destroyed by a casualty event, or condemned, if the home is replaced within 2 years, and if the owner dies.

Alert: There are proposals in Congress to extend, and perhaps expand, the credit beyond November 2009, so check JKLasser.com for news.

Child Tax Credit

If you have dependents under the age of 17, you may claim a tax credit of $1,000 per eligible dependent. The credit phases out for singles with MAGI between $75,000 and $95,000 ($110,000 and $130,000 for joint filers). The credit a taxpayer is entitled to claim after the phase-out is fully refundable to the extent of 15% of earned income (including tax-free combat pay) in excess of $3,000 in 2009 and 2010. Those with 3 or more qualifying children may also be eligible for a refundable child tax credit; a different formula is used for them.

Earned Income Credit

Congress originally created the tax credit legislation in 1975 to offset the burden of Social Security taxes and to provide an incentive to work, and the credit has been called a “negative income tax.” Those with modest earnings may be entitled to a fully refundable tax credit. The amount of the credit depends on earned income, adjusted gross income, filing status, and the number, if any, of qualified children. 

Making Work pay credit

For 2009 and 2010, employees and self-employed individuals can qualify for a fully refundable tax credit of 6.2% of earned income, up to maximum credit of $400 ($800 for joint filers). The credit phases out for singles with MAGI between $75,000 and $95,000 ($150,000 and $190,000 for joint filers).

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Tax Glossary

Passive activity loss rules

Rules that limit the deduction of losses from passive activities to income from other passive activities. Passive activities include investment rental operations or businesses in which you do not materially participate.

More terms