WFTRA's individual income tax provisions.

EXECUTIVE SUMMARY

* The WFTRA provides one definition of a "child" with variations, to be used for the dependency exemption, HOH filing status, the EIC, the child credit and the child and dependent care credit.

* The new law accelerates the EGTRRA and JGTRRA marriage penalty relief provisions, including the increased standard deduction and 10% and 15% brackets for joint fliers; they now apply through 2010.

* Other WFTRA provisions extend the AMT temporary exemptions to 2005, allow all nonrefundable personal credits in full for 2004 and 2005 and extend HSAs through 2005.

**********

Generally, the Working Families Tax Relief Act of 2004 (WFTRA) affects individuals by accelerating the effective dates of prior legislative changes, creating a uniform definition of a "child" and temporarily extending alternative minimum tax relief. This article analyzes the effect of these and others WFTRA provisions.

The Working Families Tax Relief Act of 2004 (WFTRA), (1) signed into law on Oct. 4, 2004, prevents estimated tax increases of $146 billion for some 94 million taxpayers ($132 billion for individuals; $14 billion for businesses). It also accelerates the effective dates of many of the tax reduction provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). However, a sunset remains in effect; thus, barring future Congressional action, all of the EGTRRA provisions expire for tax years beginning after 2010.

Even though the title refers only to working Families, the WFTRA also includes benefits and technical corrections affecting other individuals and businesses. This article details the significant changes for individuals; see Exhibit 1 on p. 100 for a summary of the provisions.

The WFTRA represents a number of election-year compromises between members of Congress wanting to make the EGTRRA tax cuts permanent and those who preferred fiscal constraint. The compromise and the margins by which the bill passed (339-65 in the House; 92-3 in the Senate) provide some insight as to the legislative climate and the potential for future changes, which have been altered somewhat after the Presidential election.

Uniform Definition of a "Child"

According to Treasury Secretary Snow, the new law's uniform definition of a child helps realize President Bush's overall goal of simplifying the Code, by creating one definition for purposes of the dependency exemption, head-of-household (HOH) filing status, the earned income credit (EIC), the child credit and the child and dependent care credit. For the most part, the WFTRA did not modify any other requirements of those respective provisions. The discussion below applies to tax years beginning after 2004, and, thus, does not affect 2004 tax liabilities.

Three Tests

Under the uniform definition of a child, a child is a "qualifying child" of the taxpayer if he or she satisfies three tests, as follows, under WFTRA Section 201:

1. The child has the stone principal place of abode as the taxpayer for more than half the tax year (See. 152(c)(1)(B)). As under pre-WFTRA law, temporary absences due to special circumstances, such as education, illness, business, vacation or military service, are not treated as absences.

2. The child has a specified relationship to the taxpayer (Set. 152(c)(2)). The child must be the taxpayer's child (natural child, stepchild, adopted child or eligible foster child); a descendant of the taxpayer's child; the taxpayer's sibling (including half-brother and half-sister) or step-sibling; or a descendant of the taxpayer's sibling or step-sibling. An eligible foster child includes one placed with the taxpayer by an authorized placement agency or by judgment, decree or other order of any court of competent jurisdiction. An adopted child is one lawfully placed with the taxpayer for legal adoption. Noteworthy is the elimination of the pre-WFTRA rule requiring a taxpayer to care for a sibling or step-sibling (or a descendant of such individual) "as if the child were the taxpayer's own child."

3. The child has not yet attained a specified axe (Sec. 152(c)(1)(C)). The age varies according to the benefit. For the dependency exemption, HOH status and the EIC, the child must be under age 19, or under age 24 if a full-time student for any part of five months during the tax year. For purposes of the child credit, the child must be under age 17, according to Sec. 24(a); for purposes of the child and dependent care credit, the child must be under age 13, according to Sec. 21 (b)(l)(A). Except in the case of the child credit, no age limit apples to individuals totally and permanently disabled (within the meaning of Sec. 22(e)(3)) at any time during the year. Further, except for EIC purposes, a child who provides more than one-half of his or her own support would not be a qualifying child, under Sec. 152(c)(1)(D).

Tiebreaker Rules

When a person could be treated as a qualifying child on more than one return, WFTRA Section 201 provides tiebreaker rules in amended Sec. 152(c)(4). Ties are broken as follows:

* If only one of the taxpayers is the child's parent, the child is the qualifying child of that parent.

* If both taxpayers are the child's parents, the child is the qualifying child of the parent with whom he or she resides for the greatest period of time.

* If the child resides with both parents for same amount of time, the child is the qualifying child of the parent with the highest adjusted gross income (AGI).

* If neither taxpayer is the child's parent, the child is the qualifying child of the taxpayer with the highest AGI.

Dependency Exemption

For tax years beginning after 2004, Sec. 152(a) allows taxpayers to claim both querying children and relatives as dependents. A qualifying child must meet the uniform definition, as well as the current joint-return and citizenship tests. Neither the gross-income test nor the support test applies, except that the child must not have provided more than one-half of his or her own support during the calendar year in which the taxpayer's tax year begins.

Under Sec. 152(d), qualifying relatives must meet the five current (pre-WFTRA) tests--the gross-income test, support test, relationship test, joint-return test and citizenship test. A qualifying child of any taxpayer cannot be claimed as a qualifying relative by another taxpayer (i.e., the rules for a qualifying child apply). The requirements are a blend of prior and current law. Exhibit 2 on p. 101 summarizes the updated requirements.

The tiebreaking rules discussed above also apply. As a result, (1) an individual who is a qualifying child of any taxpayer cannot be a qualifying relative of another taxpayer; and (2) a qualifying child cannot be claimed on more than one return.

For children of parents who (1) are divorced, (2) are separated under a written separation agreement or (3) did not live together during the year, current law gives the dependency exemption to the custodial parent. WFTRA Section 201 retains a revised rule that allows the custodial parent to release that exemption through a custodial waiver. This waiver can take the form of a written decree of divorce or separate maintenance, or a written separation agreement. Alternatively, under Sec. 152(e)(2), it can take the same form as under prior law--a signed declaration that the custodial parent will not claim the dependency exemption.

The dependency exemption waiver also effectively waives the child credit. It does not, however, affect the EIC, the child and dependent care credit and HOH stares. (2)

Child Credit

Sec. 24(a), as amended by WFTRA Section 101, allows a $1,000 child tax credit per year for each of the taxpayer's qualifying children under age 17. The credit, which was scheduled to decrease to $700 in 2005 under the EGTRRA, now remains at $1,000 through 2010. Without future Congressional action, the credit will revert to $500 after that. Under Sec. 24(b), the credit is phased out $50 for each $1,000 (or fraction thereof) of modified AGI in excess of $75,000 for single taxpayers ($110,000 for married filing jointly (MEJ) and $55,000 for married filing separately (MFS)). These amounts are not indexed for inflation. Although both the Senate and House versions of the bill accelerated the phaseout ranges, they were unchanged in the final bill.

Under WFTRA Section 204 and Sec. 24(c), for tax years beginning after 2004, a qualifying child is an individual under age 17 (1) for whom a taxpayer can claim a dependency exemption; (2) who is a U.S. citizen or resident alien; and (3) who meets the uniform definition of a child.

Example 1: K is a divorced single mother. For 2004, she and her 12-year-old daughter, O, live with her mother, J. K works part-time and has $15,000 income. O has no income. J provides more than half of both K's and O's support.

J can claim the dependency exemption and child credit for O, but not K, who Fails the gross-income test. K may not claim O as her dependent, became she did not provide over half of O's support.

Example 2: The facts are the same as in Example 1, except that it is 2005.

Because O meets the definition of a qualifying child for purposes of the dependency exemption (i.e., is a child of the taxpayer, under age 19 or a full-time student under age 24 and lives in K's principal place of abode), K may claim O as her dependent. While O also qualifies as J's dependent, under the tiebreaking rules, K, the parent, is entitled to claim the dependency exemption and child credit.

For 2004-2010, the child credit is refundable to the extent of 15% (increased from 10%) of the taxpayer's taxable earned income in excess of $10,750, indexed for inflation. (3) Families with three or more children are allowed a refundable credit for the amount by which the taxpayer's Social Security taxes exceed his or her EIC, if that amount exceeds the refundable credit computed under the 15% rule.

HOH Status

For tax years beginning after 2004, Sec. 2(b)(1)(A) is amended by WFTRA Section 202, to provide that a taxpayer is eligible for HOH status if he or she is unmarried and maintains a home that is the principal place of abode for more than half the year for either (1) a qualifying child, as defined in Sec. 152(c); or (2) an individual for whom the dependency exemption may be claimed. As under current rules, a married child must still be the taxpayer's dependent and a dependent parent need not live in the taxpayer's home, for the taxpayer to claim HOH status. Some taxpayers who qualified as HOH in 2004 may not under the new law.

Example 3: A is divorced and maintains a household for her 25-year-old unmarried son, T, who has $35,000 income.

T does not qualify as A's dependent, because he fails the gross-income test. However, for 2004, T will be considered a qualifying individual under the HOH provisions, because a taxpayer's unmarried child does not have to qualify as the taxpayer's dependent. Thus, A may file as HOH.

Example 4: The facts are the same as in Example 3, except that it is 2005.

A may not file as HOH, because T neither meets the uniform definition of a child nor qualifies as A's dependent.

Child and Dependent Care Credit

Under Sec. 21, taxpayers who pay qualifying expenses for the care of eligible individuals can claim a nonrefundable credit, so that they may work or seek work. Qualifying expenses include costs for both in-home care and daycare. Before the WFTRA, eligible individuals included: (1) a dependent or child under age 13; (2) a dependent (or someone who could be a dependent except for the gross-income test), physically or mentally incapable of self-care; and (3) a spouse of a taxpayer physically or mentally incapable of self-care. For divorced parents, the credit was available to the custodial parent.

WFTRA Section 203 adopts the uniform definition of a child with regard to a qualifying individual, but (1) Sec. 21(a)(1) eliminates the requirement that a taxpayer must provide more than one-half of the cost of maintaining the household; and (2) Sec. 21(b)(1)(B) adds the requirement that an individual who is physically or mentally incapable of self-care must live with the taxpayer for more than half the tax year.

EIC

For purposes of the EIC for parents, the uniform definition of a child is adopted for years beginning after 2004. Several special variations are made to the uniform definition to achieve the EIC's goals; these rules are summarized in Exhibit 3 above. Further, under Sec. 32(c)(1)(B), a qualifying child cannot claim an EIC on his or her own return.

Combat Pay for Armed Forces Members

The exclusion of sick pay for members of the armed forces, although intended to provide a tax benefit, can result in even larger reductions in other tax benefits. To avoid this for the child credit and EIC, the WFTRA includes two provisions, which provide nearly $200 million of assistance to families of military personnel in combat.

1. Child credit: WFTRA Section 104(a) amends Sec. 24(d)(1) by providing that combat pay otherwise excluded from gross income under Sec. 112 is treated as earned income only when calculating the refundable portion of the child credit. This change applies for tax years ending after 2003.

2. EIC: Armed forces members may treat excluded combat pay as earned income for EIC purposes under Sec. 32(c)(2)(B)(vi), as amended by WFTRA Section 104(b)(3). The taxpayer can elect this treatment if it increases the credit, or waive it if it reduces it. This election applies for any tax year ending after Oct. 4, 2004, and before 2006.

Marriage Penalty Relief/ Tax Rates

The EGTRRA, as amended by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), provided temporary relief from the marriage penalty--the additional tax due on the combined income of a married couple filing jointly (as compared to that which would be imposed if each filed single returns). WFTRA Section 101(b) increases the Sec. 63(c) basic standard deduction for MFJ to twice the basic standard deduction for single returns for tax years 2005-2008, effectively extending this relief for MFJ tax-payers through 2010.

WFTRA Section 101(a) and (d) extends two of the tax reduction provisions under the EGTRRA, as amended by the JGTRRA. These extensions, coupled with the child credit extension, will save taxpayers from a $109 billion tax increase through 2010. First, for tax years 2005-2010, the size of the 15% rate bracket for joint returns (otherwise scheduled to decrease in tax year 2005), remains at twice the corresponding rate bracket for single returns for tax years 2005-2007. (4) This effectively eliminates the marriage penalty in the 15% bracket. However, the marriage penalty still exists above the 15% bracket (i.e., the "spread" in brackets for MFJ taxpayers is not twice that of single taxpayers).

Second, the expanded 10% bracket for single and MFJ taxpayers through 2010 is also extended. (5) In addition, although indexing was not scheduled to begin until after 2004, it is now allowed beginning after 2003. (6) Without further Congressional action, the EGTRRA's sunset provisions will apply.

Exhibit 4 below illustrates the effect of the changes in the child credit, marriage penalty relief and tax rate cuts by comparing the pre- and post-WFTRA tax liability of two families with two children each, filing joint returns--one with $30,000 income and one with $50,000 income. At the $30,000 income level, the WFTRA provides a $730 tax savings, which includes $130 ($1,300 x 0.10) from the increased standard deduction, and $600 ($300 x 2) from the increased child credit. The $925 tax savings for the family with $50,000 income consists of $130 from the increased standard deduction, $600 from the increased child credit, $130 (($14,600-$12,000) x (0.15-0.10)) from the expanded 10% bracket and $65 (($28,500-$27,200) x (0.15-0.10)) from the marriage penalty relief in the 15% bracket. This example does not consider the EIC.

AMT Relief

Without some relief, an IRS Taxpayer Advocate's Report (7) estimated that 12.4 million taxpayers would be subject to the AMT in 2005, up from 2.4 million in recent years. WFTRA Section 103(a) postpones this explosion until 2006, by temporarily increasing the AMT exemption for individuals. The temporary exemptions of $40,250 for singles and $58,000 for MFJ under Sec. 55(d)(1) applicable for tax years ending in 2003 and 2004 are extended to 2005. However, without further Congressional action, the exemption will drop in 2006 to the year 2000 amounts ($33,750 and $45,000, respectively), costing taxpayers an additional $23 billion over the next 10 years.

Example 5: J and E are married and file jointly for 2005. They support their three daughters and three sons, two under age 17. Their AGI is $65,000 and their itemized deductions are $12,800, including $5,550 in state and local taxes. Their regular taxable income is $26,600; their regular tax is $3,740. After adjustments for the state and local taxes, the couple has alternative minimum taxable income of $57,750 and, using the pre-WFTRA exemption of $45,000, a tentative minimum tax (TMT) of $3,315. Because their regular tax before credits is $3,260, they owe $55 minimum tax.

The 2005 AMT exemption under the WFTRA is $58,000 for MFJ. Using this exemption, the TMT is zero; J and E will pay the regular tax. They will also be able to claim the child credit, due to the extended personal tax credit relief.

Personal Tax Credit Relief

Sec. 26 generally limits nonrefundable credits to the excess of the regular tax over the TMT. With recent cuts to the regular tax rate and the granting of additional personal credits, this can limit benefits for many taxpayers--a possibility that has been postponed in recent years and again by the WFTKA. WFTKA Section 312(a) amends Sec. 26(a)(2), to permit all nonrefundable personal credits (e.g., the dependent care credit, the credit for the elderly and disabled, the adoption credit, part of the child credit, the credit for interest on certain home mortgages, the education credits, the savers' credit and the District of Columbia homebuyer's credit) to be used in full in calculating the regular tax and the AMT for tax years 2004 and 2005. Pre-WFTRA, only the adoption credit, child credit and IRA contributions credit were allowed in full against the regular tax and the AMT in 2004 and later years.

Example 6: F and E are married and file jointly for 2004. Their daughter attends college and they are eligible for a $1,500 education credit. Their regular tax liability before credits is $6,500; their TMT liability. before credits is $5,600.

Under prior law, the $1,500 education credit would have reduced their regular tax liability to $5,000, which would have triggered AMT of $600 ($5,600-$5,000). Their 2004 tax liability would have been $5,600. Under the new law; the education credit could offset both the regular tax liability and the AMT liability; reducing them to $5,000 and $4,100, respectively. Thus, their liability would be $3,000 for 2004.

Teacher Deduction

The Sec. 62(a)(2) (D) above-the-line deduction for eligible educators' expense, scheduled to expire after tax year 2003, is extended by WFTKA Section 307 to tax years 2004 and 2005. Eligible educators (kindergarten-grade 12 teachers, instructors, counselors, principals or aides for at least 900 hours during the school year) may deduct up to 8250 of unreimbursed classroom expenses incurred in connection with books, supplies (excluding those for health or physical education), computer equipment (including software, services and other equipment) and supplemental materials. As before, the maximum deduction is allowed only to the extent that the expenses exceed excludible U.S. educational savings bond interest, distributions from Sec. 529 qualified tuition plans and Coverdell education savings accounts.

Archer MSAs

Sec. 220, added by the Health Insurance Portability and Accountability Act of 1996, allows employees of small employers and self-employed individuals to establish Archer MSAs to help pay for medical expenses in conjunction with a high-deductible health plan. Originally established as a pilot project that allowed new Archer MSAs to be established through 2003, WFTRA Section 322 extends that through 2005.

Business Provisions

The WFTRA extends, without change, generally through tax year 2005, several business incentives originally scheduled to expire in tax years ending after 2003, including:

* The research tax credit (originally scheduled to expire on June 30, 2004)(WFTRA Section 301).

* The work opportunity tax credit (WFTRA Section 303).

* The welfare-to-work tax credit (WFTRA Section 303).

* The credit for electricity from renewable resources (WFTRA Section 301).

* The repeal of the credit phaseout for electric vehicles (WFTRA Section 318).

* The repeal of the deduction phaseout for clean-fuel vehicles (WFTRA Section 319).

* Charitable contributions of computer technology and equipment used for educational purposes and of scientific property used for research (WFTRA Section 306).

* The expensing of environmental remediation costs (WFTB, A Section 308).

* Tax incentives for investment in the District of Columbia (WFTRA Section 310).

* New York Liberty Zone Bond incentives (WFTRA Section 309).

Conclusion

The President has included tax simplification, the preservation of current tax cuts/incentives and small business tax relief as major components of his second-term agenda, while Senate Finance Chair Charles Grassley (R-IA) has pledged his committee's support, indicating that taxpayers should see no lapse in tax relief. Tax advisers and taxpayers should continue to monitor expected tax-related activity in the 109th Congress.

Exhibit 1: WFTRA's individual provisions

Code      Provision      WFTRA Section  Details
Sec.

1(f)(8)   Tax rate       101(c)         Increases size of married
                                        filing jointly (MFJ) 15% rate
                                        bracket to twice that of single
                                        returns for 2005-2007, thus
                                        extending expansion through
                                        2010.

1(i)(1)   Tax rate       101(d)         Extends expansion of 10% tax
                                        bracket through 2010.

2(b)(1)   HOH filing     202            Changes requirements for HOH
          status                        status. Removes reference to
                                        taxpayer's child, step-child,
                                        etc., and replaces it with
                                        "qualifying child," as defined.
                                        However, a married child must
                                        still be a dependent. Effective
                                        for tax years beginning after
                                        2003.

21        Child and      203, 207       Adopts uniform definition of a
          dependent                     child. Eliminates the
          care credit                   requirement that a taxpayer
                                        must provide more than one-half
                                        of the cost of maintaining the
                                        household.

24        Child credit   101(a)         Maintains credit at $1,000
                                        through 2010.

                         204(a)         Adopts qualifying child, as
                                        defined, effective for tax
                                        years after 2004.

                         102(a)         Accelerates to 2004 the
                                        increase in refundability to
                                        15% of a taxpayer's earned
                                        income in excess of $10,750, as
                                        indexed.

                         104(a)         Otherwise excludible combat pay
                                        is earned income for purposes
                                        of the refundable portion of
                                        the child credit and EIC.

26(a)(2)  Limits on tax  312(a)(2)      For tax years beginning in 2004
          liability                     and 2005, all nonrefundable
                                        personal credits may be offset
                                        against both regular tax and
                                        AMT. The regular tax must be
                                        reduced by any applicable
                                        foreign tax credit.

32(c)     EIC            104(b)(3)      In 2004 and 2005, military
                         205            families can include combat pay
                                        when calculating the EIC.
                                        Adopts uniform definition of a
                                        child.

55(d)     Alternative    103(a)         Extends increased AMT exemption
          minimum tax                   of $40,250 for single and
          (AMT) relief                  $58,000 for MFJ taxpayers for
                                        2003 and 2004 to tax year 2005.

63(c)     Standard       101(b)         Increases basic standard
          deduction                     deduction for MFJ returns to
                                        twice the basic standard
                                        deduction for single returns,
                                        effectively extending the
                                        provision through 2010.

152(c)    Definition     201            Creates uniform definition of a
          of child                      child.

220(i)    Medical        322(a)         Extends deadline for
          savings                       establishing Archer MSAs from
          accounts                      Dec. 31, 2003 to Dec. 31, 2005.
          (MSAs)

Exhibit 2: Dependency rules under WFTRA Section 201

Test          Qualifying child              Qualifying relative

Gross-income  No longer applies.            Same as under current law
test                                        (i.e., individual must have
                                            gross income less than the
                                            personal exemption).

Support test  No support test, although     Same as under current law
              qualifying child must not     (i.e., taxpayer provides
              have provided more than one-  over one-half of
              half of his or her own        individual's support).
              support during the calendar
              year in which the taxpayer's  Multiple support agreement
              tax year begins.              may apply.

              If the child is the           In the case of remarriage
              taxpayer's child and is a     of a parent, child support
              full-time student,            received from the parent's
              scholarships are not deemed   spouse is treated as
              support.                      received from the parent.

Citizenship   Unchanged (i.e., a dependent  Unchanged (i.e., a
test          must be a U.S. citizen or     dependent must be a U.S.
              national, or a resident of    citizen or national, or a
              the U.S., Canada or Mexico    resident of the U.S.,
              for some part of the year).   Canada or Mexico for some
                                            part of the year).

              Under Sec. 152(b)(3), this    Under Sec. 152(b)(3), this
              test does not apply to the    test does not apply to the
              taxpayer's legally adopted    taxpayer's legally adopted
              child if, for the taxpayer's  child if, for the
              tax year, the child's         taxpayer's tax year, the
              principal place of abode is   child's principal place of
              the taxpayer's home, the      abode is the taxpayer's
              child is a member of the      home, the child is a member
              taxpayer's household and the  of the taxpayer's household
              taxpayer is a U.S. citizen    and the taxpayer is a U.S.
              or national.                  citizen or national.

Joint-return  Unchanged (i.e., a dependent  Unchanged (i.e., a
test          cannot file a taxable joint   dependent cannot file a
              return with another           taxable joint return with
              taxpayer).                    another taxpayer).

Relationship  Must be the taxpayer's child  Unchanged from pre-WFTRA
test          * or a descendant of the      rules.
              taxpayer's child, or the
              taxpayer's sibling            Relative or member of
              (including half-brother and   household (as defined in
              half-sister) or step-         Sec. 152(d)(2)).
              sibling, or a descendant of
              the taxpayer's sibling or     Cannot be a qualifying
              step-sibling.                 child of the taxpayer or
                                            any other taxpayer.
              * The taxpayer's child
              includes the taxpayer's
              natural child, step-child,
              adopted child and eligible
              foster child.

Age test      Must be under age 19 or a     N/A
              full-time student under age
              24.

              Does not apply to a child
              permanently and totally
              disabled at any time during
              the calendar year.

Abode test    Must have the same principal  N/A
              place of abode as the
              taxpayer for more than half
              of the taxpayer's tax year.
              (Special rules apply to
              missing children.)

              Note: A child cannot be
              claimed as a dependent on
              more than one return for any
              calendar year, even though
              the child satisfies the
              qualifying child tests for
              two or more taxpayers.
              Tiebreaker rules * determine
              who may claim the dependency
              exemption.

              * Tiebreaker rules: Parent
              with whom child resided for
              longest period of time
              during the tax year or, if
              child resided with both
              parents for same amount of
              time, the parent with the
              highest AGI.

Exhibit 3: EIC--definition of qualifying child (WFTRA Section 205;
Sec. 32)

Tax year         Rules

2004             Taxpayer's son or daughter (or descendant of either),
                 step-son or step-daughter (or descendant of either);
                 sibling or step-sibling (or descendant of either), who
                 the taxpayer cares for as his or her own child;
                 eligible foster child.
                 Qualifying child is under age 19 or is a full-time
                 student under age 24. No age limit for an individual
                 permanently and totally disabled.
                 Must share an abode with the individual for more than
                 half the year.
                 Taxpayer cannot be the qualifying child of another
                 taxpayer.
                 Chill must be a U.S. citizen or resident alien.

2005 and beyond  A qualifying child (as defined), except that:
                 1. The individual (only if unmarried) may provide more
                 than half of his or her own support; or
                 2. The individual may be claimed as a dependent by the
                 other parent under a decree of divorce or separate
                 maintenance, a written separation agreement or a
                 declaration that the custodial parent will not claim
                 the dependency exemption.
                 Qualifying child is under age 19 or is a full-time
                 student under age 24. No age limit for an individual
                 permanently and totally disabled.
                 Must share an abode with the individual for more than
                 half the year.
                 Taxpayer cannot be the qualifying child of another
                 taxpayer.
                 Child must be a U.S. citizen or resident alien.

Exhibit 4: Effect of the WFTRA's tax rate cuts on marriage penalty
relief and the child credit in 2005

                            MFJ with two children,
                                $30,000 income

                         2005 pre-WFTRA   2005 WFTRA

Income                      $30,000        $30,000
Standard deduction          (8,700)        (10,000)
Exemptions               (12,800) (1)    (12,800) (1)
Taxable income               $8,500         $7,200

Regular tax                 $850 (2)       $720 (3)
Child credit              (1,400) (6)    (2,000) (7)

Potentially refundable    ($2,850) (8)   ($2,850) (8)
child credit

Tax after credits            ($550)        ($1,280)

Tax savings under WFTRA                      $730

                            MFJ with two children,
                                $50,000 income

                         2005 pre-WFTRA   2005 WFTRA

Income                      $50,000        $50,000
Standard deduction          (8,700)        (10,000)
Exemptions                (12,800) (1)   (12,800) (1)
Taxable income              $28,500        $27,200

Regular tax                $3,675 (4)     $3,350 (5)
Child credit              (1,400) (6)    (2,000) (7)

Potentially refundable
child credit

Tax after credits            $2,275         $1,350

Tax savings under WFTRA                     $925

(1) $3,200 x 4

(2) $8,500 x 0.10

(3) $7,200 x 0.10

(4) 0.10 x $12,000 + 0.15 ($28,500 - $12,000)

(5) 0.10 x $14,600 + 0.15 ($21,200 - $14,600)

(6) $700 x 2

(7) $1,000 x 2

(8) 0.15 x ($30,000 - $11,000)

Source: Senate Finance Committee, "Signing of the Working
Families Tax Relief Act of 2004" (10/5/04)

Editor's note: Profs. Cook and Oestreich are members of the AICPA Tax Division's Individual Taxation Technical Resource Panel.

(1) P.L. 108-311.

(2) See Secs. 2(b)(1)(A)(i), 32(c)(3)(A) and 21(c)(5).

(3) See Sec. (24(d)(1)(B)(i).

(4) See Sec. 1(f)(8).

(5) See Sec. 1(i)(1)(B).

(6) See Sec. 1(i)(1)(C)

(7) See the National Taxpayer Advocate's Report, IRS Pub. 2103 (12/31/03).

Ellen D. Cook, MS, CPA

Professor of Accounting

University of Louisiana-Lafayette

Lafayette, LA

Nathan Oestreich, Ph.D.

Professor of Accountancy

School of Accountancy

College of Business

San Diego State University

San Diego, CA