The Expanded Child Tax Credit Is an Imperfect Replacement for Personal Exemptions

By Sam Brunson

The conference tax bill follows both the House and the Senate bills in drastically increasing the standard deduction (from current law’s $13,000 in 2018 to $24,000). At the same time, it gets rid of personal exemptions. As Stephanie Hoffer pointed out eight months ago, eliminating personal exemptions would essentially increase taxes on families of four or more people; the more children a family had, the bigger its tax increase.

To fix that problem, the bill doubles the child tax credit from $1,000 to $2,000 per child. In addition, to get Marco Rubio’s vote, the bill provides that up to $1,400 of each child tax credit is refundable.

So do the child tax credits alleviate the problem of eliminating personal exemptions? Sometimes.

The Smiths

To see what’s happening, let’s look at a hypothetical family. The Smiths are married, file a joint return, and have three children, the oldest of whom is 12. In 2018, they have $62,912 in gross income.[fn1] They don’t itemize.

Under current law, they’ll reduce their gross income by the $13,000 standard deduction and five $4,150 personal exemptions, leaving them with taxable income of $29,162. They’re in the 15-percent tax bracket, and have a tentative tax liability of $3,421.80.

Current law provides for a child tax credit of $1,000 per qualifying child, though. So the Smiths will be able to reduce their tax liability by $3,000, leaving them with an income tax liability of $421.80. (They’ll owe more in payroll taxes.)

Under the tax bill, instead of the $13,000 standard deduction, they’ll have a standard deduction of $24,000, but they’ll have no personal exemptions. Their taxable income will be $38,912. That puts them in the 12-percent tax bracket, and they have a tentative tax liability of $4,288.44.

But under the tax bill, the child tax credit has been doubled to $2,000 per child. Not only that, up to $1,400 per child is refundable. As a result, under the tax bill, not only do the Smiths wipe out their income tax liability, but they get a refund of $1,711.56. Under the tax bill, then, the Smiths’ tax liability has gone down by more than $2,000.

The Joneses

But here’s the thing: the child tax credit maps onto the personal exemption imperfectly. For purposes of the personal exemption, a qualifying child must be 18 or younger, unless she’s a student, in which case she must be 23 or younger.

But for purposes of the child tax credit, a qualifying child must be 16 or younger.

So the Joneses: they’re economically identical to the Smiths, only their kids are a little bit older. Their oldest is 22 and a college senior, their second child is 19 and a freshman in college, and their third child is 17 and a high school junior.

Under current law, the Joneses have three qualifying children for personal exemption purposes, so they have the same tentative tax liability: $3,421.80. Because none of their children is a qualifying child for child tax credit purposes, though, their tentative tax liability is also their final tax liability.

And what happens under the tax bill? Again, they have the same tentative tax liability. And, just like under current law, their tentative tax liability is their final tax liability. The Joneses owe $4,288.44 in taxes. Not only is that about $800 more than they would owe under current law, the fact that their children are older—albeit still dependents (meaning, among other things, that they live with their parents for more than half of the year and they don’t supply more than half of their own support)—has increased the Joneses’ tax liability by $6,000 over the Smiths, who have younger children.

Even if the Joneses’ children are too old to be qualifying children, the bill provides a reduced $1,500 credit for dependents other than qualifying children; to meet the non-qualifying child requirement, however, the children would have to earn less than $4,150 in 2018.[fn2] In addition, the tax credit for dependents who are not qualifying children is not refundable.

So it’s not a foregone conclusion that the two-to-seven-year difference between a qualifying child for purposes of the personal exemption and a qualifying child for purposes of the child tax credit will be costly to families with older children, but it is possible for that gap to significantly increase the taxes of older families.

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[fn1] Yes, I know, $62,912 is a very specific amount of gross income; it was the median household income in Utah in 2015. I used it for some calculations in another blog post and, instead of doing all new math here, I figured I’d reuse the math I’d already done.

[fn2] Among other things, to be a “qualifying relative” under section 152 of the Code, an individual cannot earn more than section 151(d)’s exemption amount, which is $2,000, adjusted for inflation.