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WASHINGTON – Many dual-income parents who thought they’d get tax breaks this filing season were surprised to learn they’re too wealthy to qualify for them, tax preparers say.

More than 20 tax benefits, such as the child tax credit, phase out at higher income levels.

Complaints are on the rise as the number of households reporting two incomes continues to grow, pushing taxpayers who otherwise thought they were middle class into income ranges the government views as too high to deserve breaks.

Counted among the “rich,” for example, are a married couple working as a fire fighter and school teacher in New York. Two federal employees making relatively average GS-13 salaries here also would be considered “rich” by IRS standards.

Accountant Penelope Johnson says many of her Washington-area married clients were upset that their combined incomes excluded them from benefits such as the higher $600-per-child tax credit that went into effect last year as part of President Bush’s tax cut package. The credit had been $500.

“People were sitting there getting very agitated because they were expecting something more,” said Johnson, a manager in H&R Block’s district office in Arlington, Va.

Married couples whose adjusted gross income, or AGI, exceeds $110,000 a year are not eligible for the full child tax credit, which is popular because it’s a direct dollar-for-dollar subtraction from the tax owed, as listed in the IRS tables. And it will double to $1,000 per child by 2010.

The credit is phased out by $50 for each $1,000 of AGI above the beginning phase-out level of $110,000 for married couples filing jointly. For those filing as qualifying widows and widowers, singles or heads of household, the phase-out amount is $75,000. Spouses filing separately are subject to a $55,000 cap.

The AGI levels where the credit is completely phased out depends on the number of qualifying children.

If you’re married, filing jointly with one kid and report an AGI of $121,001 or more, you can kiss the entire credit goodbye. You also get no credit if you have two kids and report a minimum $132,001, or three kids and $143,001. With four children, the cut-off point is $154,001; five children, $165,001.

It’s hardly the only tax benefit limited by income tests.

Hoover Institution economist John Cogan, an early Bush tax-policy adviser, who favors broad-based tax cuts over credits, counts more than 20 phased-out deductions and credits in the federal tax code – which effectively boost marginal tax rates by roughly two percentage points, estimates Brian Wesbury, former chief economist of Congress’ Joint Economic Committee.

Here are a few examples of phase-outs for married couples filing jointly:

  • Those reporting $53,000 to $63,000 in AGI can’t deduct contributions to regular IRAs.

  • They also can’t deduct contributions to Coverdell
    education savings accounts if they report income between $150,000 and $160,000.

  • At $60,000 to $75,000, the deduction for student-loan interest phases out.

  • The phase-out range for the HOPE Scholarship and Lifetime Learning credit is $80,000 to $100,000.

  • The limitation on the Education Savings Bond interest exclusion runs from $83,650 to $114,650.

  • The personal exemption, which last year was $2,900 per dependent, phases out at $199,450 to $321,950.

  • Even itemized deductions are reduced starting at $132,950.

Changing face of rich

Cut-offs for tax breaks are becoming more of an issue, because the ranks of the working rich have been growing rapidly over the past 10 years, IRS and Census Bureau data show.

More than 6 million taxpayers had AGIs above $120,846 in 1999, putting them in the top 5 percent of all income earners, the latest IRS data show. They shouldered more than 55 percent of the entire federal tax load.

One main reason for recent income mobility is the growing number of families with multiple workers.

“Familes in the top fifth (of income-earners) often have three times as many workers per family as has the bottom fifth,” said Hoover Institution economist David R. Henderson. “The top fifth includes a disproportionately high number of two-earner married couples.”

Of families in the top quintile, a whopping 93 percent had two or more members working, according to recent Census figures. Eleven percent had four or more.

Among the richest 5 percent, more than half had two earners working full time, Census says.

More and more of the so-called “rich” who are cut off from tax benefits work in family-owned, “mom-and-pop” businesses.

Many in Washington don’t know that small business owners and entrepreneurs – independent contractors, sole proprietorships, limited partnerships and S-Corporations – typically file their tax returns as individual taxpayers.

According to recent IRS data, more than 22 million businesses file under the individual-income tax code – a stunning 5 million more than a decade ago.

Bracket creep

Few rich today inherited their wealth.

A recent Rand Corporation study found that among the richest 5 percent of households, inheritances made up less than a tenth of all assets.

And a recent survey of 1,100 American millionaires found that over 70 percent of them earn at least 80 percent of their household income. More than half inherited no money.

The notion of the idle, privileged rich is common among the Washington punditry, but it’s as dated as the high collar and the monocle. Today’s rich look a lot like ordinary folks.

The wealthiest 20 percent of Americans, in fact, include 1.7 million union workers, 2.4 million teachers, 4.2 million blue-collar workers and 8.1 million government workers, according to Census.

Yet as more working families move into higher tax brackets, they face not only higher rates, but phase-outs of deductions that could offset those higher rates.

In effect, families are losing tax breaks, such as the child tax credit, as they become more successful.

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