February 1, 2019
Congratulations! You have just been handed your first little bundle of joy in the hospital and have embarked on the long journey of parenthood. It is a trip full of joyful experiences that make the corresponding aggravations worthwhile, and it comes with many benefits — some of which are tax-related. You can look forward to taking advantage of these child-related deductions and benefits.
- Earned Income Tax Credit (EITC) – Designed to help lower income taxpayers, the EITC is a tax credit that is scaled along with income and the number of dependents claimed. See IRS Publication 596, “Earned Income Tax Credit (EITC)” for details on qualifications and the scaling criteria. The maximum EITC amount for tax year 2018 is $6,431 for joint filers with three or more qualifying children.
- Child Tax Credit and Additional Child Tax Credit – For tax year 2018, the Tax Cuts and Jobs Act (TCJA) of 2017 has doubled the maximum Child Tax Credit from $1,000 in 2017 to $2,000 for each qualifying kid. The TCJA also raised the qualifying modified adjusted gross income (MAGI) to $400,000 for married filing jointly status, $200,000 if single, head of household, or married filing separately. “The child tax credit has been increased from $1,000 to $2,000,” says Betterment Head of Tax Eric Bronnenkant. “And that’s credits for each child that you have that’s under the age 17. So, let’s say you have three children under age 17, and you’re below the income threshold, generally you’re going to get a tax credit of $6,000.”
If your tax bill was not large enough to take the full tax credit, you may be able to take the Additional Child Tax Credit, which is a refundable credit (meaning that it is a credit you can claim and receive as a refund even if you do not owe any taxes). Check out IRS Publication 972 for more information.
- Child and Dependent Care Credit – If you incur child care costs in order for you or your spouse to be able to work (or to look for work), you may be able to claim up to 35% of your child care expenses. The limit on the expenses that can be claimed is $3,000 for one child/dependent or $6,000 for two or more. That results in $1,050 and $2,100 in actual credit respectively.
- Education Credits – As your children get older, you may be able to take advantage of either the American Opportunity Credit (AOC) or the Lifetime Learning Credit (LLC) that applies to the costs of higher education — but you must choose between the two. The AOC can yield up to $2,500 in tax credits that are refundable up to 40%, while the LLC can provide up to $2,000 in credit but is not refundable. Details on qualifications and phase-out limits are available in IRS Publication 970, “Tax Benefits for Education“. The new tax law kept both these credits in place without change.
- Student Loan Interest Deduction – If you do not meet the qualifications for the education credits, you may be able to deduct up to $2,500 in student loan interest. To claim this deduction, your MAGI must be $165,000 or less if married filing jointly, or $80,000 or less for single filers. Publication 970 also covers this deduction.
- Tax-Free 529 Savings – The TCJA has expanded the use of funds in 529 savings plans. Before the new law, these funds could be drawn from your 529 plan tax-free only if used for qualified college expenses. Now you may use this fund to accumulate tax-free savings to pay for private elementary and high school fees up to $10,000, too.
- Standard Exemption – The TCJA has eliminated the standard exemption for tax years 2018-2025. When exemptions are in play, every child that you could claim as a dependent would decrease your taxable income by a set amount of money. Exemption amounts would usually begin to phase out above a certain adjusted gross income (AGI).
Take special care to investigate the tax credits, because they are more valuable than deductions. Tax credits are subtracted directly from the taxes that you owe, while deductions only reduce your taxable income, and therefore reduce your tax bill by the percentage of your tax rate. Confirms Bronnenkant, “Credits are, in general, more valuable than deductions, because they reduce your taxes dollar for dollar.” For example, a $1,000 deduction lowers your taxes by $100 if you are in the 10% tax bracket, while a $1,000 tax credit lowers your taxes by the full $1,000.
Who knew that your new addition to the family could bring you all these tax benefits? Don’t forget about them come tax time — but in the meantime, simply get used to your new lifestyle and take the time to enjoy your new bundle of joy. Before you know it, he or she will be asking for the car keys… and then your insurance will go up!