Tax credits are more valuable to taxpayers than deductions because they reduce tax payments dollar for dollar; their value is not dependent on the taxpayer's tax bracket. In the past several years, Congress has used tax credits to effectuate administration policies, such as encouraging the purchase of homes to stimulate the poor housing market, and for businesses, hiring new employees and paying for employee health care. Moreover, an ever-growing number of credits are now fully or partially refundable so that they form a "negative income tax" (payments are made to taxpayers in excess of the taxes they owe).
There are now dozens of tax credits for individuals and businesses. Many of the credits for individuals have income limitations that bar their use by high-income taxpayers. Here are some of the new credits for 2010, as well as those that represent "last chance" opportunities because they are set to expire this year.
Making Work Pay Credit
This tax credit, created under the American Recovery and Reinvestment Act of 2009 (P.L. 111-5), was designed to help jump-start the economy by putting more money in the hands of workers by increasing their take-home pay. The making work pay credit began in 2009 and applies to both employees and self-employed individuals but will only run through 2010 unless Congress extends it (Code Sec. 36A). The credit is up to $400 for single taxpayers and $800 on a joint return; it is refundable.
The credit phases out for singles with modified adjusted gross income (MAGI) between $75,000 and $95,000, and for joint filers with MAGI between $150,000 and $190,000. Higher-income taxpayers do not qualify for the credit.
In 2009, some employees found that they owed federal income taxes because they were under withheld due to the making work pay credit (www.irs.gov/newsroom/article/0,,id=204447,00.html). Such workers should adjust withholding and estimated taxes for 2010 to avoid this problem for 2010.
Home Energy Credits
To encourage "green" homes, there are two types of tax credits for making certain energy improvements to a principal residence:
- Nonbusiness energy property credit for adding insulation, storm windows or doors, as well as energy-efficient central air conditioning, boilers, heaters and furnaces (Code Sec. 25C): The credit is 30% of the cost of the improvement, with a cap of $1,500 for aggregate expenditures made in 2009 and 2010. The credit does not apply after 2010 unless Congress extends it.
- Residential energy-efficient property credit for adding renewable energy property such as solar panels, thermal heat pumps, wind energy property, and fuel cells (Code Sec. 25D): The credit is 30% of the cost, without any dollar cap, and will continue through 2016.
Adoption Credit
To help adoptive parents defray the cost of adopting a child, there is a tax credit. The Patient Protection Act of 2010 increased the dollar limit on the credit for adoption expenses in 2010 to $13,170 (Code Sec. 23). Those who adopt a child with special needs can claim the credit without regard to their out-of-pocket adoption costs.
There continues to be an income cap on eligibility to claim the credit; the cap for 2010 is slightly higher than it was in 2009. The phase-out is MAGI between $182,520 and $222,520.
The credit had been scheduled to sunset at the end of 2010 but has been extended through 2011. The dollar limit may be indexed for inflation for 2011.
American Opportunity Credit
To help families pay for higher education, the American Recovery and Reinvestment Act of 2009 created a new and improved credit to replace temporarily the Hope credit for education. The American opportunity credit, which is set to run only through 2010 unless Congress extends it, can apply for the first four years of higher education (Code Sec. 25A(i)).
The credit is 100% of the first $2,000 of tuition, plus 25% of the next $2,000 of tuition, for a total credit of $2,500. Of this amount, 40% is refundable.
The credit is subject to an income limitation. The credit phases out for MAGI between $80,000 and $90,000 for singles and $160,000 to $180,000 for joint filers.
Retirement Savers Credit
The tax law wants to encourage retirement savings through IRAs and participation in qualified retirement plans. Toward this end, taxpayers with modest income can claim a tax credit for their contributions (Code Sec. 25B). In effect, they can "double dip" by benefiting from the contribution (e.g., a tax deduction for a contribution to a traditional IRA or a salary reduction for a contribution to a 401(k) plan) as well as claiming the tax credit.
Some of the income limits on eligibility for the tax credit in 2010 have been increased, allowing more taxpayers to qualify.
Home Buyer Credit
There had been a tax credit designed to encourage the purchase of a residence. The credit for a first-time homebuyer was up to $8,000, and the credit for a long-term resident was up to $6,500 (Code Sec. 36). The credit, created in the midst of the housing market crisis, expired at the end of April 2010. However, those who were in contract on April 30, 2010, have until June 30, 2010, to close in order to claim the credit.
The credit is refundable. A credit for a home purchased during the eligibility period in 2010 can be claimed on a 2009 tax return (those who are on extension for 2009 returns can claim the credit when they file; those who have already filed will need to submit an amended return).
Note: Taxpayers who purchased homes prior to 2009 under an older version of the first-time homebuyer credit must start to "recapture" the credit in 2010. Recapture of this credit is taken over 15 years, so that 1/15 of the credit for a 2008 purchase is reported as income on a 2010 return. If the maximum credit of $7,500 was claimed, then the recapture amount for 2010 is $500.
Credits for Business
- Small employer health credit: As part of the Patient Protection and Affordable Care Act (P.L. 111-148), small employers (those with fewer than 50 employees) may qualify for a tax credit starting in 2010 (Code Sec. 45R). The credit, which is intended to encourage small businesses to pay some or all of employee health care premiums, is highly complex, and depends on the number of employees, what their average income is, the portion of premiums paid by the employer, and the average premium rates for small group markets in the state in which the employer is located. The 2010 state average premium rates for small group markets for purposes of figuring the credit, as set by the Department of Health and Human Services, has been announced by the IRS (Rev. Rul. 2010-13, IRB 2010-21).
- Employee retention credit: As part of the Hiring Incentives to Restore Employment (HIRE) Act of 2010 (P.L. 111-147), employers who hire eligible workers after February 3, 2010, and before January 1, 2011, and keep them on the payroll for 52 consecutive weeks can qualify for a tax credit of up to $1,000 per employee; the credit is given through an increase in the general business credit (Code Sec. 38(b)). There is no limit to the number of employees for whom the credit can be claimed. The credit will be claimed on 2011 tax returns. Eligible employees for this credit are defined as those who have not worked more than 40 hours during the 60-day period prior to starting work with a new employer and for whom employers can qualify for a payroll tax holiday in 2010 (no Social Security taxes are owed by employers on the wages of eligible employees during 2010). When hired, employees must provide an affidavit that they have been unemployed; new Form W-11 is used for this purpose. The IRS has posted questions and answers about the payroll exemption, which impacts eligibility for the employee retention credit (www.irs.gov/newsroom/article/0,,id=221036,00.html).
- Work opportunity credit: To encourage employers to hire individuals who are part of targeted groups, such as welfare recipients and felons, there is a special tax credit (Code Secs. 51-53). In most cases, the credit is 40% of first-year wages up to $6,000, for a top credit of $2,400 per eligible employee. The American Recovery and Reinvestment Act of 2009 created two new targeted groups of workers for whom employers can claim this credit: unemployed veterans and youths between the ages of 16 and 25 who are not in school and lack a sufficient number of basic skills. These two new targeted groups apply only for 2009 and 2010 unless Congress extends this rule. Note: Employers who qualify for a payroll tax holiday with respect to new employees who are from targeted groups must decide between the payroll tax holiday and the work opportunity credit; they cannot claim both tax breaks with respect to the same employee. Opting for the work opportunity credit in lieu of the payroll tax holiday does not prevent an employer from claiming the employee retention credit for those who remain on the payroll.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.
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