Tax Credit for Low (and Middle?) Income Earners
Finally, the IRS officially tells us what it means by low income. If you are married, file a joint return and your adjusted gross income is $49,999 or less you are officially a low-income taxpayer. If you are single and your adjusted gross income is $24,999 or less you also are officially a low-income taxpayer.
On the other hand, if you are married and your adjusted gross income is $50,000 or more, you are a high-income taxpayer. If you are single and your adjusted gross income is $25,000 or more, you too are a high-income taxpayer.
Why is this of interest? Well, there is a benefit available to you if you qualify.
Beginning in 2002, low-income taxpayers can reduce income taxes by as much as $1,000 by contributing to a 401(k) savings plan, or an IRA, including a Roth IRA.
Naturally, there are IRS rules to follow, but, overall, if you are married and your income is below $50,000, or if you are single and earn less than $25,000, taking the credit on your tax return in 2002 should not be too difficult.
The basic rules:
1. You must be 18 or over.
2. You cannot be a full-time student.
3. You cannot be claimed as a dependent on someone else's return.
4. This credit only applies to your tax returns for 2002 through 2006. It is not available after 2006.
5. It is a nonrefundable credit and is used after your other credits for child and dependent care and the child tax credit. What does the IRS mean by nonrefundable?
Nonrefundable means that if the savings credit reduces your taxes below zero, you will not get a refund of the excess over zero. For example, if your tax liability is $700 before the credit and the credit you are entitled to is $1,000, you will reduce your tax liability to zero by using $700 of the $1,000 credit. The remaining $300 of credit is lost and you do not get a refund of this amount since your tax liability has been reduced to zero by using $700 of the credit.
Distributions from an IRA (for example, for first time home buying) or other qualified plan during the current or two preceding years reduce the amount of your contribution eligible for the credit.
To claim the credit, all you must do is contribute to your 401(k) plan and, when you prepare your 2002 tax return, the forms will help you calculate the amount of credit that will reduce your income tax.
The following table will help put the new savings credit in perspective for both married couples and single taxpayers. All income numbers reference adjusted gross income (AGI). You can find your AGI by looking at the last line of page 1 of your tax return (Form 1040).
| Joint Return |
Single |
|
| Adjusted Gross Income Over |
Adjusted Gross Income Under |
Adjusted Gross Income Over |
Adjusted Gross Income Under |
Applicable Percentage |
Maximum Credit Possible |
| $0 |
$30,000 |
$0 |
$15,000 |
50% |
$1,000 |
| $30,000 |
$32,500 |
$15,000 |
$16,250 |
20% |
$400 |
| $32,500 |
$50,000 |
$16,250 |
$25,000 |
10% |
$100 |
| $50,000 |
- |
$25,000 |
- |
0% |
$0 |
Action Plan:
Instead of using the dependent care credit on your tax return, enroll in your company's Dependent Care Flexible Spending Account (FSA). If you use your FSA, your savings credit will not be reduced by the dependent care credit and; therefore, you will use the maximum savings credit possible.
If you meet the income qualifications for this tax credit and are not already contributing to a qualified savings plan, start now. You may believe that you are not able to afford to save, but by contributing to a savings plan, you will redirect money that you are currently paying in income taxes to your savings. And, because your taxes are lower, you may be able to readjust your withholding so that the effect on your net income each month is very little. It's never too early to start saving for financial independence, even if you are on a tight budget.
This article originally appeared in the February 2002 edition of Financial Advantage, published by Decker & Associates, Inc.
