The disappearing supplemental child credit.

The Taxpayer Relief Act of 1997 established a supplemental child credit (as distinguished from the additional credit for families with three or more children) as a component of the earned income credit (EIC). Sec. 32(n), as modified by the Internal Revenue Service Restructuring and Reform Act of 1998, provides how to compute the supplemental child credit. The credit is the lesser of (1) the excess of the total allowable nonrefundable personal credits (including the child tax credit) over the total allowable nonrefundable personal credits (excluding the child tax credit) or (2) the excess of all credits against tax (except taxes withheld on wages, taxes withheld at source on nonresident aliens and credits for certain uses of gasoline and special fuels) over the sum of the regular tax and Social Security taxes (employee portion). Sec 32(n)(2) provides that the supplemental child credit reduces the allowable nonrefundable personal credits.

Example: J is a single father with two dependent children under age 17. Thus, he is entitled to a maximum child tax credit of $800 for 1998. In addition, he has an $850 regular tax liability, an $800 Social Security tax, a $250 child and dependent care credit and a $1,000 EIC.

J's total amount of allowable nonrefundable personal credits (including the child tax credit) is $850. J's total allowable nonrefundable personal credits (excluding the child tax credit) is $250. Thus, the first part of the calculation is $600 ($850 - $250). J's total credits against tax are $1,850 ($850 (nonrefundable) + $1,000 EIC). The sum of J's regular tax and Social Security tax is $1,650. Thus, the second calculation is $200.

J's supplemental child credit is $200. In addition, his nonrefundable personal credits are reduced by $200. He has total refundable credits of $1,200 ($1,000 + an additional $200) and total nonrefundable credits of $650 ($850 (amount allowed given his regular tax liability) - $200 (amount converted to a supplemental child credit)).

The effect of this calculation is a wash. With or without the supplemental child credit, J receives a $1,000 refund (assuming he has not paid any income tax withholdings or estimated taxes).

The Joint Committee on Taxation verifies this result, explaining "the treatment of a portion of the child credit as a supplemental child credit under the EIC (Sec. 32) and the offsetting reduction of the child credit (Sec. 24) does not affect the total tax credits allowed to the taxpayer or any other tax credit otherwise available to the taxpayer." Rather, it simply reduces the otherwise allowable nonrefundable child credit dollar-for-dollar by the amount treated as a supplemental child credit.

Interestingly, the 1998 tax forms do not address this issue. Schedule EIC does not provide a way to increase the EIC as described above. Likewise, the instructions for the child tax credit do not discuss reducing it for amounts treated as a supplemental child credit. Presumably (as the example demonstrates), the IRS recognizes that the supplemental child credit makes no difference to the taxpayer's bottom-line tax liability or refund. Therefore, it seems reasonable that the Service is ignoring the supplemental child credit, thus avoiding further complexity in the tax preparation process.

FROM CRAIG WHITE, PH.D., CPA, ASSISTANT PROFESSOR OF ACCOUNTING, UNIVERSITY OF NEW MEXICO, ALBUQUERQUE, NM