Credits

After you have figured your taxable income and tax liability, you can determine if you are entitled to any tax credits. Most tax credits do not have special rules for members of the Armed Forces. However, the rate reduction credit, the earned income credit, and the child tax credit may be of interest to you.

Rate Reduction Credit

Under new law, the IRS sent an advance payment check to you in 2001 if you paid tax in 2000. This payment reduced your tax and is not taxable income.

The amount of the 2001 advance payment was a maximum of:

• $300 if you filed single or married filing separately,
• $500 if you filed head of household, and
• $600 if you filed married filing jointly or you filed qualifying widow(er).

If you meet all of the rules below, complete the rate reduction worksheet in your tax forms instructions package to figure the amount of your credit.

You may be able to claim a rate reduction credit on your 2001 tax return if:

• Your advance payment was less than the maximum dollar amount for your filing status (explained above), up to the difference between your maximum amount and the advance payment you already received, or
• You had a tax liability for 2001 although you did not have one for 2000. (You must be otherwise eligible.)

The rate reduction credit is claimed on line 47, Form 1040; line 30, Form 1040A; or line 7, Form 1040EZ.

Example 1. Faye is single, not able to be claimed as a dependent by anyone, had a 2000 taxable income of $4,000, and claimed no tax credits. For 2000, she received an advance payment of $200 (5% of $4,000) in 2001. If her taxable income for 2001 rises to $6,000, she could claim a rate reduction credit of $100 in 2001 ($300 total maximum credit for a single filer minus $200 advance payment she received in 2001.)

For more information on the rate reduction credit, see the instructions for Forms 1040, 1040A, or 1040EZ.

Earned Income Credit

The earned income credit (EIC) is a special credit for certain persons who work. The credit reduces the amount of tax you owe (if any) and is intended to offset some of the increases in living expenses and social security taxes.

If you claim the EIC and it is later disallowed, you may have to complete an additional form if you want to claim the credit in a following year. See chapter 5 in Publication 596 for more information, including how to claim the EIC after disallowance.

Persons With a Qualifying Child

If you have a qualifying child, you must meet all the following rules to claim the earned income credit.

1. You must have earned income during 2001.
2. Your earned income and modified adjusted gross income (AGI) must each be less than:
1. $28,281 if you have one qualifying child, or
2. $32,121 if you have more than one qualifying child. If you do not have a qualifying child and earn less than $10,710, see Persons Without a Qualifying Child, later.
3. Your filing status cannot be married filing separate.
4. You (or your spouse, if filing a joint return) cannot be a qualifying child of another person.
5. Your qualifying child cannot be the qualifying child of another person with a higher modified AGI.
6. You cannot file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion, to exclude income earned in foreign countries, or to deduct or exclude a foreign housing amount. See Publication 54 for more information.
7. You must be a U.S. citizen or resident all year unless:
1. You are married to a U.S. citizen or a resident alien, and
2. You choose to be treated as a resident alien for the entire year. See Publication 519 for more information.
8. Your investment income must be $2,450 or less during the year. For most people, investment income is taxable interest and dividends, tax-exempt interest, and capital gain net income.
9. You must have a valid social security number for yourself, your spouse (if filing a joint return), and any qualifying child.

Qualifying child of more than one person. If you and someone else have the same qualifying child, the person with the higher modified AGI is the only one who may be able to claim the credit. The person with the lower modified AGI cannot claim the credit. This is true even if the person with the higher modified AGI does not claim the credit or does not meet all the rules to claim the credit.

Modified AGI for most people is the amount on line 34, Form 1040, or line 20, Form 1040A. See Publication 596 if you file Schedule E or you are claiming a loss from the rental of personal property not used in a trade or business.

Qualifying child of another person. If you are a qualifying child of another person, you cannot claim the credit--no matter how many qualifying children you have.

How to report. If you meet all these rules, fill out Schedule EIC and attach it to either Form 1040 or Form 1040A. Also complete the worksheet in the instructions for Form 1040 or Form 1040A to figure the amount of your credit. If you have a qualifying child, you cannot claim the credit on Form 1040EZ.

Enter "NO" directly to the right of line 61a (Form 1040) or line 39a (Form 1040A) if you cannot claim the credit because:

1. Your total taxable and nontaxable earned income was $28,281 or more if you have one qualifying child (or $32,121 or more if you have more than one qualifying child),
2. You were a qualifying child for another person in 2001,
3. Your qualifying child was also the qualifying child of another person whose modified AGI is higher than yours, or
4. You, your spouse, or qualifying child does not have a valid social security number.

Social security number. You must provide a correct and valid social security number (SSN) issued by the Social Security Administration for yourself, your spouse, and any qualifying child. If a social security card for you, your spouse, or your qualifying child says "Not valid for employment," you cannot get the credit.

If you need to get an SSN, file Form SS-5 with your local Social Security Administration office. It takes approximately two weeks to receive an SSN. If the filing deadline is approaching and you do not have an SSN, you can:

• Request an automatic extension to August 15 using Form 4868, or
• File the return on time without claiming the credit. After you receive the SSN, file an amended return (Form 1040X) claiming the credit and attach a filled-in Schedule EIC.

If an SSN for you, your spouse, or your qualifying child is missing from your tax return, or is incorrect, you may not get the credit.

Married persons. Married persons usually must file a joint return to claim the earned income credit. Even though you are married, you may file as head of household and claim the credit on your return if:

1. Your spouse did not live in your home at any time during the last 6 months of the year,
2. You paid more than half the cost to keep up your home for the entire year, and
3. You and your child lived in the same main home for more than half the year. You also must be entitled to claim an exemption for your child.

You will meet (3), even if you cannot claim your child, if:

• You gave that right to your child's other parent by filling out Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, or similar written statement, or
• There is a pre-1985 agreement (decree of divorce or separate maintenance or written agreement) granting the exemption to your child's other parent.

Qualifying Child

You have a qualifying child if your child meets three tests:

1. Relationship,
2. Residency, and
3. Age.

Relationship test. To meet the relationship test, the child must be your:

• Son, daughter, or adopted child (or a descendant of your son, daughter, or adopted child--for example, your grandchild),
• Stepson or stepdaughter, or
• Eligible foster child.

Married child. Generally, a married child can be your qualifying child only if you can claim an exemption for the child. If you cannot claim an exemption for your married child, he or she can still be your qualifying child if the only reason you cannot claim the exemption is one of the following.

• You gave the right to claim the child's exemption to your child's other parent by filling out Form 8332, or a similar written statement, or
• You gave the right to claim the child's exemption to your child's other parent in a pre-1985 agreement (such as a separation agreement or divorce decree).

If you need more information about either of these exceptions or when you can claim an exemption for your child, see Publication 501, or Publication 504, Divorced or Separated Individuals.

Residency test. To meet the residency test:

• A qualifying child must have lived in your home for more than half the year (for the whole year if your child is an eligible foster child), and
• The home must be in the United States. (U.S. military personnel stationed outside the United States on extended active duty are considered to be living in the United States.)

Birth or death of a child. The child is considered to have lived with you for all of 2001 if:

• The child was born or died during the year, and
• The child lived with you for the part of the year he or she was alive.

Temporary absences. Count time that you or the qualifying child is away from home on a temporary absence due to a special circumstance as time lived at home. Examples of special circumstances include:

• Illness,
• Attending school,
• Detention in a juvenile facility,
• Business,
• Vacation, or
• Military service.

You may be eligible for the earned income credit if you are absent temporarily only because of military service. To be eligible for the credit, you must plan to return to your main home where your qualifying child lives, at the end of your assignment. Service in a combat zone is a temporary absence.

Age test. The age test is met if your child is:

• Under age 19 at the end of the year,
• A full-time student under age 24 at the end of the year, or
• Permanently and totally disabled at any time during the tax year, regardless of age.

Persons Without a Qualifying Child

If you do not have a qualifying child, you can take the credit if you meet all of the following rules.

1. You must have earned income during 2001.
2. Your earned income and modified adjusted gross income must each be less than $10,710.
3. Your filing status cannot be married filing separate return.
4. You (or your spouse, if filing a joint return) cannot be a qualifying child of another person. See Qualifying child of another person, earlier.
5. You (or your spouse if filing a joint return) must be at least age 25 but under age 65 at the end of your tax year.
6. No one else is able to claim an exemption for you as a dependent on his or her return.
7. Your main home must be in the United States for more than half the year. (U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States.)
8. You cannot file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion.
9. You must be a U.S. citizen or resident alien all year unless:
1. You are married to a U.S. citizen or a resident alien, and
2. You choose to be treated as a resident alien for the entire year.
10. Your investment income must be $2,450 or less during the year. For most people, investment income is taxable interest and dividends, tax-exempt interest, and capital gain net income.
11. You (and your spouse, if filing a joint return) must have a valid SSN. In either case, you can use only a valid SSN issued by the Social Security Administration. If a social security card for you or your spouse says, "Not valid for employment," you cannot get the credit.

How to report. If you meet all of these rules, fill out the worksheet in your tax forms instructions for EIC to figure the amount of your credit.

Enter "No" directly to the right of line 61a (Form 1040), next to line 39a (Form 1040A), or on line 9a (Form 1040EZ) if you cannot claim the credit because:

1. Your total taxable and nontaxable earned income was $10,710 or more,
2. You (and your spouse if filing a joint return) were under age 25 or age 65 or more,
3. Your home was not in the United States for more than half the year,
4. You were a qualifying child of another person in 2001, or
5. You or your spouse did not have a valid SSN.

Earned Income

For purposes of the earned income credit, earned income includes:

• Wages, salaries, and tips,
• Long-term disability benefits you received before minimum retirement age,
• Salary deferrals and reductions,
• Housing and subsistence allowances and in kind equivalents received by military members,
• Combat zone excluded pay (box 12, code Q of your Form W-2),
• Net earnings from self-employment, and
• Anything else of value, even if not taxable, that you received for providing services.

For purposes of the earned income credit, the term housing and subsistence allowances means the Basic Allowance for Housing (BAH) and the Basic Allowance for Subsistence (BAS) received by military personnel (with respect to grade and status) and the value of meals and lodging furnished in kind to military personnel residing on military bases. To calculate the value of meals and lodging furnished in kind, you may assume that the value is equal to the combined BAH and BAS that the military member would have received had he or she been entitled to the allowance. Earned income that is not taxable, such as combat pay, BAH, BAS, and certain in kind equivalents, is reported in box 12, Code Q, of Form W-2.

Earned income does not include:

• Interest and dividends,
• Social security and railroad retirement payments,
• Certain workfare payments,
• Pensions or annuities,
• Veterans' benefits (including VA rehabilitation payments),
• Workers' compensation,
• Unemployment compensation, or
• Alimony and child support.

Example 1. Corporal John Andrews and his wife Doris will file a joint return for 2001. They have two children--Mark who is age 3 and Connie who was born in May of 2001. Their total earned income is $23,650 (basic pay $16,104, BAH $4,896, BAS $2,650). John and Doris qualify for the earned income credit.

Example 2. Staff Sergeant Brad Wilson and his wife Judy will file a joint return for 2001. They have two children--Angela who is 6 years old and Eric who is 4 years old. Their total earned income is $34,054 (basic pay $25,140, which includes $7,780 nontaxable pay for service in a combat zone, plus BAH $6,264 and BAS $2,650). Even though the Wilsons' modified AGI is $17,360, they do not qualify for the earned income credit because their total earned income is not less than $32,121.

Military members should receive a Leave and Earnings Statement at the end of the year that includes some of the pertinent allowance information. You should refer to that statement or your Form W-2 when determining earned income for EIC purposes. You can also contact your legal assistance office or unit tax advisor if you need additional help.

Advance Earned Income Credit

You must meet all the following rules to qualify for the advance earned income credit in 2002. You must:

• Work and expect that your earned income and AGI will each be less than a certain amount. The amount in 2001 was $28,281. The amount for 2002 will be higher. See Form W-5, Earned Income Credit Advance Payment Certificate, for the 2002 amount.
• Have a qualifying child.
• Meet all the rules explained in the instructions for Form W-5.

If you expect to qualify for the earned income credit for 2002, you can choose to get part of the credit in advance by giving a completed 2002 Form W-5 to your appropriate finance office. The credit will be included regularly in your pay.

If you received advance earned income credit payments in 2001, you must file either Form 1040 or Form 1040A for 2001 to report the payments.

IRS Will Figure Your Credit for You

There are certain instructions you must follow before the IRS can figure the credit for you. See Publication 967, The IRS Will Figure Your Tax.

Child Tax Credit

The child tax credit reduces your tax. If you have children, you may be able to take a child tax credit on your tax return for each of your qualifying children.

The child tax credit is not the same as the credit for child and dependent care expenses. See Publication 503 for more information on the credit for child and dependent care expenses.

Qualifying Child

A qualifying child for purposes of the child tax credit must be all of the following.

1. Under age 17 at the end of 2001.
2. A citizen or resident alien of the United States.
3. Claimed as your dependent.
4. Your:
1. Son or daughter,
2. Stepson or stepdaughter,
3. Adopted child,
4. Grandchild, or
5. Eligible foster child.

Adopted child. A child placed with you by an authorized placement agency for legal adoption is an adopted child even if the adoption is not final.

Grandchild. A grandchild is any descendant of your son, daughter, or adopted child and includes your great-grandchild, great-great-grandchild, etc.

Eligible foster child. An eligible foster child is any child you cared for as your own and who:

• Is (1) your brother, sister, stepbrother, or stepsister; (2) a descendant (such as a child) of your brother, sister, stepbrother, or stepsister; or (3) a child placed with you by an authorized placement agency, and
• Lived with you for all of 2001. A child who was born or died in 2001 is considered to have lived with you for all of 2001 if your home was the child's home for the entire time he or she was alive during 2001.

Amount of Credit

The maximum credit that you can claim is $600 for each qualifying child.

Limits on the credit. You must reduce your child tax credit if either (1) or (2), below, applies.

1. The amount on line 42 (Form 1040) or line 26 (Form 1040A) is less than the credit. If the amount is zero, you cannot take this credit because there is no tax to reduce. But you may be able to take the additional child tax credit. See Additional Child Tax Credit, later.
2. Your modified adjusted gross income (AGI) is above the amount shown below for your filing status.

• Married filing jointly -- $110,000
• Single, head of household, or qualifying widow(er) -- $75,000
• Married filing separately -- $55,000

Modified AGI. For purposes of the child tax credit, your modified AGI is your AGI plus the following amounts that may apply to you.

• Any amount excluded from income because of the exclusion of income from Puerto Rico.
• Any amount on lines 43 and 48 of Form 2555, Foreign Earned Income.
• Any amount on line 18 of Form 2555-EZ, Foreign Earned Income Exclusion.
• Any amount on line 15 of Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa.

If you do not have any of the above, modified AGI is the AGI amount on line 34 (Form 1040) or line 20 (Form 1040A).

Claiming the Credit

To claim the child tax credit, you must file Form 1040 or Form 1040A. You must provide the name and identification number (usually a social security number) on your tax return for each qualifying child.

Answer the Questions in your form instructions for line 48 ( Form 1040) or line 31 ( Form 1040A) to find out which child tax credit worksheet you can use to compute the credit.

If you answer Yes to question 1, 2, or 3 in your Form 1040 instructions or question 1 or 2 in your Form 1040A instructions, you must complete the Child Tax Credit Worksheet in Publication 972, Child Tax Credit.

For more information on the child tax credit, see the instructions for Form 1040 or Form 1040A.

Additional Child Tax Credit

This credit is for certain individuals who get less than the full amount of the child tax credit. The additional child tax credit may give you a refund even if you do not owe any tax.

How to claim the additional child tax credit. To claim the additional child tax credit, follow the steps below.

• Make sure you figured the amount, if any, of your child tax credit. See Claiming the Credit, earlier.
• Use Form 8812, Additional Child Tax Credit, to see if you can take the additional child tax credit only if you answered Yes on line 4 or line 5 of the Child Tax Credit Worksheet.
• If you have an additional child tax credit on line 13 of Form 8812, carry it to line 63 (Form 1040) or line 40 (Form 1040A).

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