Tax Reform Act of 2014, Part 4, Tax Credits

House Ways and Means Committee Chairperson Dave Camp released draft legislation, the Tax Reform Act of 2014, proposing a wide variety of changes to America's tax system. In part 4 of a series, we look at proposals for changing personal tax credits.

Outline

  1. Credit for prior year minimum tax
  2. Family-related tax credits
      • Child tax credit
      • Child and dependent care tax credit
      • Earned income tax credit
      • Adoption tax credit
      1. Education-related tax credits
          • American Opportunity tax credit
          • Lifetime Learning tax credit
          1. Energy-related tax credits
              • Residential Energy Efficient Property tax credit
              • Credit for Plug-In Electric Drive Motor Vehicles
              1. Already expired tax credits
                  • Nonbusiness energy credit
                  • Credit for electric vehicles
                  • Credit for alternative motor vehicles
                  • Credit for alternative fuel vehicle refueling property
                  • Health coverage tax credit
                  • First-time homebuyer tax credit

                Credit for prior year minimum tax - Proposed Modifications

                The Tax Reform Act of 2014 proposes to repeal the alternative minimum tax (AMT) for tax years beginning 2015. Currently, taxpayers can claim a credit for AMT paid in the previous year under certain circumstances. The IRS explains, "The AMT is caused by two types of adjustments and preferences--deferral items and exclusion items. Deferral items (for example, depreciation) generally do not cause a permanent difference in taxable income over time.

                Exclusion items (for example, the standard deduction), on the other hand, do cause a permanent difference. The minimum tax credit is allowed only for the AMT caused by deferral items" (from the Instructions for Form 8801).

                Under the proposal, the alternative minimum tax would be repealed starting in 2015.

                "If a taxpayer has AMT credit carryforwards, the taxpayer would be able to claim a refund of 50 percent of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning in 2016, 2017, and 2018. Taxpayers would be able to claim a refund of all remaining credits in the tax year beginning in 2019," as explained by the Ways and Means Committee in their summary.

                According to the Joint Committee on Taxation, repealing the AMT would reduce personal income tax revenues by $1,331.8 billion over 2014-2023 (JCX-20-14, page 4).

                Family-related tax credits

                Child Tax Credit - Proposed Increase

                The Tax Reform Act of 2014 proposes to increase the child tax credit from $1,000 per child (currently) to $1,500 per child. The Ways and Means Committee summarizes the provision succinctly:

                "Under the provision, the child credit would be increased to $1,500 and would be allowed for qualifying children under the age of 18. A reduced credit of $500 would be allowed for non-child dependents. Both the $1,500 and $500 credit amounts would be indexed annually for changes in the chained CPI. The credit would be refundable to the extent of 25 percent of the taxpayer's earned income (earned income in excess of $3,000 before 2018).

                The credit would not begin to phase out until MAGI exceeds $413,750 for single filers and $627,500 for joint filers (indexed for inflation, using 2013 dollars). The refundable portion of the credit would be disallowed for taxpayers claiming the foreign earned income exclusion" (Ways and Means Summary, page 5).

                To be eligible, the child has to be age 17 or younger. The Tax Reform Act does not propose any revision to this age limit. The phrase "non-child dependents" means dependents who are not qualifying children. The Tax Reform Act also proposes that only children age 17 or younger can be qualifying children, or as it's phrased by the Joint Committee on Taxation: "The proposal modifies the age test for a qualifying child.

                Under the proposal, a child may only be a qualifying child if that child has not attained the age of 18 as of the close of the calendar year in which the taxable year of the taxpayer begins. Under the proposal, as under present law, there is no age test for an individual who is permanently and totally disabled" (JCT Technical Explanation, page 22).

                The rationale behind this proposal? The Ways and Means Committee offer the following considerations:

                • "The cost of raising children increases every year, but the current law child tax credit fails to recognize this because it is not indexed for inflation.
                • "Consolidating the personal exemption for children and dependents and the child tax credit into a single tax credit achieves simplification while better targeting relief to low- and middle-income families.
                • "Increasing the phase-out level dramatically would reward more families with children and would simplify the Code for middle-class families currently forced to perform a phase-out computation." (Summary, page 5)

                The proposal to expand the child tax credit would reduce personal income tax revenues " by $277.9 billion over 2014-2023, and increase outlays by $276.1 billion over 2014-2023," thereby decreasing federal tax revenues by a combined $554 billion over the ten-year period, according to estimates from the Joint Committee on Taxation (JCX-20-14, page 4).

                Child and Dependent Care Credit - Proposed Repeal

                The Tax Reform Act of 2014 proposes to repeal the child and dependent care tax credit. Currently, people can claim a credit based on expenses for daycare. Up to $3,000 of expenses can be used for taxpayers with one child, and up to $6,000 of expenses if a taxpayer is claiming two or more children. Children must be age 12 or younger. The amount of the tax credit varies, ranging from 35% of expenses for lower-income individuals to 20% for people with adjusted gross income over $43,000.

                The Ways and Means Committee offers the following reasons for why this tax credit should be repealed:

                • "The dependent care credit is complex and overlaps with other tax provisions that provide tax benefits for families.
                • "Consolidating redundant and complex family tax benefits, such as the dependent care credit, into an increased child credit and standard deduction would result in significant simplification" (Summary, page 13).

                Repealing the child and dependent care credit would increase tax revenues by $20 billion and reduce government spending by $6 billion, for a total revenue impact of $26 billion over 2014-2023, according to estimates provided by the Joint Committee on Taxation (JCX-20-14, page 2).

                Earned income credit - Modifications proposed

                The Tax Reform Act of 2014 proposes to modify the earned income tax credit.

                "Under the proposal, certain low-income taxpayers are entitled to a credit equal to the amount of the individual's employment-related taxes for the taxable year" (JCT Technical Explanation, page 18).

                The proposal is to refund payroll taxes as a tax credit taken on the personal income tax return for individuals with modest incomes. The earned income credit would be calculated by taking the amount of payroll taxes paid by the employee and his or her employer, subject to the maximum dollar amounts which vary by filing status, and then reducing that amount by a phaseout percentage once income exceeds a certain level. For the years 2015 through 2017, the earned income credit would be worth double the amount of payroll taxes paid. In 2018 and future years, the amount of the credit would be 100% of payroll taxes paid. Taxpayers without any qualifying children would be eligible for a refund only of the employee share of payroll taxes. Taxpayers with one, two or more qualifying children would be eligible for a refund of both the employee's and the employer's share of payroll taxes.

                The Tax Reform Act also proposes to change the definition of a qualifying child, namely that a qualifying child is someone age 17 or younger.

                A table showing these parameters:

                Earned Income Credit Parameters, proposed under the Tax Reform Act of 2014

                For Taxpayers with -->

                No Qualifying Children

                One Qualifying Child

                Two or More Qualifying Children

                The amount of EIC is equal to

                 

                 

                 

                 

                2015-2017

                200% of

                Employee's share only

                Employee's & Employer's Share

                Employee's & Employer's Share

                2018

                100% of

                 

                 

                of FICA, SECA, and RRTA taxes

                Limited to Maximum EIC Dollar Amount

                 

                 

                 

                 

                2015 - 2017

                Joint filers

                $200

                $3,000

                $4,000

                Other Filers

                $100

                $3,000

                $4,000

                2018

                Joint filers

                $200

                $2,400

                $4,000

                Other Filers

                $100

                $2,400

                $3,000

                EIC is further reduced by

                7.65%

                19%

                19%

                 

                 

                of the sum of the following two amounts

                 

                   

                 

                (1) The amount by which AGI exceeds

                Joint filers

                $8,000

                $27,000

                $27,000

                Other Filers

                $13,000

                $20,000

                $20,000

                plus (2) investment income in excess of

                 

                $3,300

                $3,300

                $3,300

                FICA = Social Security and Medicare taxes on wages. SECA = self-employment tax. RRTA = equivalent taxes on railroad compensation. AGI = adjusted gross income.

                The Tax Reform Act does not propose any changes in our payroll taxes are withheld from compensation by employers, however. Also, the draft legislation instructs the IRS make recommendations to Congress for how to make advance payments of the earned income to eligible taxpayers.

                Why change the earned income credit? The Ways and Means Committee offers the following reasons why:

                • "Exempting a portion of wages from payroll tax would represent a tax cut, whereas the current EITC constitutes government spending.
                • "The Treasury Inspector General for Tax Administration (TIGTA) recently estimated that up to 25 percent of EITC payments are improper (including fraudulent claims), costing the Federal government up to $132 billion over the last 10 years.
                • "The EITC calculation is highly complex, and TIGTA has estimated that as many as 22 percent of eligible taxpayers fail to claim it.
                • "Simply allowing low-income taxpayers a rebate of their payroll taxes is both much simpler and more transparent than current law, with the potential for fraud reduced by the direct link to payroll taxes withheld on a taxpayer's Form W-2.
                • "Allowing a larger maximum credit for joint filers than for other filers helps to reduce the marriage penalty embedded in the current EITC" (Ways & Means Summary, page 7).

                These changes to the earned income credit would reduce the amount of tax collected by $160.8 and would also reduce government spending by $378 billion over 2014-2023, resulting in net cost savings to the government of $217.2 billion, according to estimates provided by the Joint Committee on Taxation (JCX-20-14, pages 1 and 17).

                Adoption Credit - Proposed Repeal

                The Tax Reform Act of 2014 proposes to repeal the adoption tax credit, starting from the year 2015. The adoption credit provides a tax credit of up to $13,190 (for 2014) based on expenses incurred to complete an adoption successfully. People who adopt a special needs child, however, can claim the full credit even if their expenses are less that the credit amount. While the Tax Reform Act proposes to repeal the adoption tax credit, individuals would still be able to seek tax-free reimbursement of adoption expenses (up to an annual limit) from their employer. The Tax Reform Act would modify the adoption assistance benefit program in two ways: (1) to require that employees who take avail themselves of this benefit report the taxpayer identification number of their adopted child, and (2) if the employee is married, then the employee would need to file a joint return to qualify for the tax-free benefit.

                The Joint Committee on Taxation estimates that repealing the adoption credit would increase tax revenues by $4.7 billion over 2014-2023 (JCX-20-14, pdf, pages 2).

                The Ways and Means Committee offers the following reasons why they think the adoption credit should be repealed:

                • "The adoption credit can be complex and overlaps with other tax provisions that provide tax benefits for families.
                • "Consolidating redundant and complex family tax benefits, such as the adoption credit, into an increased child credit and standard deduction would result in significant simplification" (Ways & Means Summary, page 14).

                Education-related tax credits

                American Opportunity Credit - Proposed Modifications

                The American Opportunity tax credit provides up to $2,500 in tax credits on the first $4,000 of qualifying educational expenses. Qualifying educational expenses are tuition and related course materials for the first four years of postsecondary education. Up to 40% of the credit is refundable, which can potentially generate a tax refund greater than the amount of tax paid. This credit is scheduled to expire at the end of 2017. The Tax Reform Act would make the American Opportunity Credit permanent (that is, without an expiration date). The bill also proposes changes in how the refundable portion is calculated and in the income ranges over which the credit is phased out. The following table summarizes these proposed changes:

                American Opportunity Credit

                Currently

                Proposed

                Calculation of tax credit

                100% of the first $2,000 of education expenses

                No change

                25% of the next $2,000 of education expenses

                No change

                Calculation of refundable portion

                up to 40% of the credit amount ($1,000 maximum)

                First $1,500 of the credit amount

                Credit phase out range, based on Modified AGI

                $160,000 to $180,00 for joint filers

                $86,000 and $126,000 for joint filers

                $80,000 to $90,000 for other filers

                $43,000 and $63,000 for other filers

                In addition, the Tax Reform Act would alter how qualifying educational expenses are measured. "Qualified tuition and related expenses that may be used for calculating the AOTC would be reduced by Pell Grants only to the extent the Pell Grants exceed the non-AOTC covered costs of college attendance," (Ways & Means Summary, page 9).

                The following reason is offered for adopting these changes to the American Opportunity Credit:

                "The provision would help to simplify the tax benefits relating to education by consolidating four similar, but not identical, tax benefits - [the American Opportunity Tax Credit, the Hope Credit, the Lifetime Learning Credit,] and the deduction for qualified tuition and related expenses - into a single, easy-to-understand tax credit," (Ways & Means Summary, page 9).

                Modifying the American Opportunity credit, along with a separate proposal to eliminate taxes on Pell Grants used for expenses other than tuition, "would increase revenues by $29.4 billion over 2014-2023 and would increase outlays by $38.1 billion over 2014-2023," resulting in an overall net decrease in federal tax revenues of $8.7 billion, according to estimates provided by the Joint Committee on Taxation (Ways & Means Summary, page 9; JCX-20-14, page 1).

                Lifetime Learning Credit - Proposed Repeal

                The Lifetime Learning tax credit would be repealed in favor of a permanent and modified American Opportunity tax credit.

                Energy-related tax credits

                Residential Energy Efficient Property Credit - Proposed Repeal

                The tax credit for the energy-efficient property is for homeowners who install solar panels, solar-powered water heaters, geothermal heat pumps, small wind energy systems, and fuel cells in their home. This credit is worth 30% of the cost of the equipment, including any labor expenses to install the equipment. This tax credit is currently scheduled to expire at the end of 2016. The Tax Reform Act proposes to repeal the Residential Energy Efficient Property Credit beginning with the year 2015. This would increase tax revenues by $2.3 billion over 2014-2023, according to estimates provided by the Joint Committee on Taxation (JCX-20-14, page 2).

                The Ways and Means Committee did not offer any reasons for why this tax credit should be repealed.

                Credit for Plug-In Electric Drive Motor Vehicles - Proposed Repeal

                Purchasing a battery-operated four-wheel vehicle can generate a tax credit of up to $7,500. Eliminating this tax credit would generate an additional $5 billion in tax revenue (Ways & Means Summary, pages 15-16; JCX-20-14, page 2). No explanations were offered for why this tax credit should be repealed.

                Repealing Expired Tax Credits

                The Tax Reform Act proposes to repeal the following tax credits that have already expired by the end of 2014. Accordingly, repealing these tax credits would neither increase nor decrease tax revenues for the federal government. These tax credits are as follows:

                • Nonbusiness Energy Credit
                • Credit for electric vehicles
                • Credit for alternative motor vehicles (such as fuel cell vehicles, hybrid vehicles, advanced lean burn technology vehicles, and other alternative fuel vehicles)
                • Credit for Alternative Fuel Vehicle Refueling Property
                • Health coverage tax credit
                • First-time homebuyer tax credit

                The Ways and Means Committee did not offer any reasons for why these tax credits should be repealed. (Ways and Means Summary, pages 14-17; JCX-20-14, page 2).

                Reference Material

                For this article, the following documents were the primary source of information:

                • Press Release: Camp Releases Tax Reform Plan to Strengthen the Economy and Make the Tax Code Simpler, Fairer and Flatter 500
                • Tax Reform Act of 2014 Draft Legislation 503 (PDF)
                • Ways and Means Committee's Detailed Section-by-Section Analysis of the Tax Reform Act of 2014 500 (PDF)
                • Joint Committee on Taxation's Technical Explanation of individual tax provisions 500 (JCX-12-14) (PDF)
                • Joint Committee on Taxation's Revenue Estimates (JCX-20-14) (PDF)
                • Next week (part 5), we'll discuss changes proposed for employee benefits. In previous installments, we discussed changes in tax rates and the tax base (part 1), changes in income (part 2), and changes in personal tax deductions (part 3).