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Refundable Tax Credits

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Refundable tax credits are a useful tool for increasing income and rewarding work for low- and middle-income families. Congress has the opportunity this year to promote work and parental responsibility by making permanent the improvements in several tax credits enacted as part of the American Recovery and Reinvestment Act of 2009. Several of the tax credits for working families are:

• An increase in the Child Tax Credit
• Marriage penalty relief in the Earned Income Tax Credit
• Additional Earned Income Tax Credit for families with three or more children
• The American Opportunity Tax Credit to make college more affordable

Child Tax Credit

Low- and middle-income working families with children are eligible for the Child Tax Credit. The credit is equal to 15 percent of the amount of a family’s earnings above the income threshold, which is $3,000 for tax years 2009 and 2010 in the Recovery Act—up to $1,000 per child. This tax credit is partially refundable, which means that families that work but have incomes too low to owe federal income tax can still receive the credit in the form of a refund. If no action is taken on these improvements, families will have to make more than $12,850 to qualify for this tax credit.

Example: A single parent working full time at minimum wage ($14,500 per year) with two children would receive a $1,750 Child Tax Credit in 2010. If the Recovery Act provision expires, the mother would receive only $248 in 2011. If she has one child, she would receive $1,000 under the current threshold, but would receive $248 in 2011 unless the improvements are continued. This illustrates how the CTC rewards parents who work hard to support their children.

Marriage penalty relief for EITC couples

The Earned Income Tax Credit was designed with single parents in mind. If two low-income workers who each receive the Earned Income Tax Credit get married, their EITC is likely to be reduced or even eliminated because their combined income likely exceeds the maximum allowed to receive the credit. Congress reduced this marriage penalty in 2001 by raising the income level at which the EITC begins to phase out for couples by $3,000 beyond the level at which it begins to phase out for single filers. The Recovery Act increased that amount to $5,000 for 2009 and 2010. But all marriage penalty relief under the EITC expires at the end of 2010.

Example: A single parent of two making $15,000 a year marries a man making $25,000 a year in 2011. Their combined EITC would be $5,156 if they are not married but only $1,332 if they are married under the current marriage penalty relief. If all marriage penalty relief expires, the couple’s EITC would fall to $279, a loss of $4,877. Providing relief from the marriage penalty is pro-marriage and pro-family.

EITC for families with three or more children

Increasing the EITC benefit for families with three or more children is another 2009 change that should be made permanent so that larger families can afford to continue to working. The American Recovery and Reinvestment Act added a third tier for the more than 3 million working families with three or more children for 2009 and 2010. The maximum benefit is $629 greater than that for families with two children. Families with three or more children will lose this additional benefit in 2011 unless the provision is made permanent.

Example: A married couple with three or more children making $30,000 per year will receive $3,705 in EITC benefits in 2009 and 2010, but $3,061 in 2011 unless Congress acts. This policy helps to ensure that parents with three or more children make more by working than they would receive from Temporary Assistance for Needy Families.

The American Opportunity Credit

Another Recovery Act change was to expand and rename the “Hope Credit” that helped to reduce college tuition costs for two years. The new American Opportunity Credit raised the maximum subsidy from $1,800 to $2,500 for 2009 and 2010. And it can be claimed for four years of qualifying education. The American Opportunity Credit is also 40 percent refundable up to $1,000, which means that lower-income families can now qualify.

Example: A family of four makes $21,000 a year while the mother works part time and attends college part time, at a cost of $6,000 a year. The mother receives a $4,000 Pell grant, leaving her to pay $2,000 a year to out of pocket for tuition and books. AOTC provides the family with $800 in benefits. But without the AOTC, the family must find the full $2,000 in its already squeezed budget. This credit makes college more affordable for working families who otherwise might not be able to help their children access higher education.

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