Congress Extends Tax Cut to Lower-Income Families

Lower-income families that didn’t get a tax rebate check this summer could still get a break from this year’s big tax cut, thanks to a recent action by lawmakers.

Congress instructed the Internal Revenue Service to make changes in the standard 1040 tax form that will extend the immediate benefit from the new 10% tax bracket further down the economic ladder.

“This is really great news because we thought this group of taxpayers was not going to get any benefit from the tax act this year,” said Brenda Schafer, senior tax research coordinator at H&R; Block in Kansas City, Mo. “This makes the 10% tax bracket available to a lot more people.”

The immediate benefits of the new 10% bracket already have been distributed to most workers in the form of the tax rebate checks the Treasury has been sending out since July.

However, for a variety of technical reasons, some low- and moderate-income taxpayers won’t see the tax break until they file their 2001 tax returns next spring. Even then it took the changes ordered by Congress to ensure that these taxpayers would get to take full advantage of the lower tax rate.

The change that’s likely to have the biggest effect involves simply moving a line on the 1040 tax form. To understand why, you first need to know the difference between a “refundable” and “nonrefundable” tax credit. A nonrefundable tax credit--such as education tax credits, dependent-care credits and the credit for the new 10% tax rate--can reduce a tax bill to zero, but not below.

A refundable tax credit, such as the earned-income tax credit, can reduce a tax bill below zero. In other words, not only are no taxes paid, but the federal government sends the taxpayer a check, effectively increasing his or her income.

About 40% of the nation’s households have adjusted gross incomes of $25,000 or less. That makes them prime candidates to benefit from refundable tax credits, which clearly are intended to help the working poor.

However, on the latest version of the 1040 form, taxpayers had to claim the child tax credit before the credit for the 10% tax rate. The child tax credit is refundable. The 10% rate credit is not. Using the child tax credit first could make a lower-income family ineligible for the nonrefundable tax credits further down the form. The result: They would pay no tax, but neither would they get a check from Uncle Sam.

Consider a couple with three young children and income of $30,000. Assuming this family claims the standard deduction and five personal exemption credits, its taxable income would amount to just $7,900, with a tax bill of $1,185.

However, the family qualifies for three credits: the credit for the new 10% bracket, which should save $600; the child tax credit, which provides a $600 tax reduction for each child, for a total of $1,800; and the earned-income tax credit, which would save this family $447.

The way each of these credits works is slightly, but significantly, different:

* The earned-income tax credit is fully refundable.

* The child tax credit is partially refundable.

* The credit for the new 10% tax bracket is nonrefundable.

The way the 1040 form for this year was structured, this family would have first subtracted the child tax credit, which would have reduced its federal income tax obligation to zero. The credit for the 10% tax rate, which is nonrefundable, would then be wasted because it can’t be used to reduce the family’s tax bill below zero.

The net result: This family would get a $1,062 refund from claiming the earned-income tax credit and the refundable portion of the child tax credit.

The new version of the 1040 form moves the credit for the 10% tax rate ahead of the child tax credit. Thus, this family would receive the $600 credit from the 10% tax rate. That would boost its total refund to $1,662.

New instructions for claiming the tax rate credit and new draft copies of the 1040 forms for this year were posted on the IRS Web site (https://www.irs.gov) last week, said IRS spokesman Don Roberts.

Why did the IRS originally figure it the more-restrictive way? Because that’s the formula Congress set when it wrote the law. However, Treasury Department officials suspected that what Congress said was not what it meant. Consequently, the Treasury asked for a clarification. Congress came back Sept. 14 with a letter stating that it did, indeed, mean for more people to get the tax cut.

“We recognize that the language of the Act may not be technically consistent with this intended result,” legislators wrote in their official response to the Treasury.

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at http://161.35.110.226/perfin.