Parenthood is an adventure. It is challenging, exciting, fulfilling and – sometimes – stressful. This is the second of two articles that address tax issues parents often encounter. Our first article covered parents’ filing status change, income exclusions, some deductions, household employee requirements, and tax return filing for children. This article covers tax credits parents may be entitled to receive on their tax returns.
Dollars for Dollars
Your child’s social security number is the key to unlocking credits and deductions on your tax return. This December 11, 1989 article from the Los Angeles Times discusses the mystery of the disappearing dependents. In 1987, the IRS began requiring taxpayers to list the social security numbers of children age five and older for whom they were claiming a dependency exemption. The mystery? Seven million less dependents were claimed on 1987 tax returns than in 1986.
The all-important Social Security number allows you to claim the child as a dependent, and as such to receive the child tax credit, credit for dependent care expenses, education credits, and the earned income credit if you meet the requirements for each. You may even get to change your filing status if you are not married and meet certain requirements. If you remember nothing else about taxes, remember that credits are dollar for dollar deductions of your tax bill, and deductions reduce your taxable income. The best credits are also refundable, meaning even if you have zero tax liability, you will then receive a refund.
Child Tax Credit and Family/Other Dependents Tax Credit
For 2018, the child tax credit was increased to $2,000 per “qualifying child.” A qualifying child has the same definition as the dependency exemption (which went away for 2018-2025, for now), with the additional requirement that the child must be under the age of 17. The refundable portion of this credit is limited to $1,400, and you must have earned income over $3,000. The rules surrounding who can claim a child for the purposes of the child tax credit can become complicated in the world of divorced or separated parents, grandchildren living with grandparents and the child’s parent(s), and unmarried parents. There is a helpful tool on the IRS website here; however, we recommend that you consult with a tax advisor to determine that the appropriate individual is claiming the credit.
The Tax Cuts and Jobs Act (TCJA) also added a new twist to the child tax credit arena. A family credit of $500 is allowed for each dependent that does not meet the threshold of being a qualifying child because they may be age 17 or older. This credit also applies to “qualifying relatives,” including parents, siblings, and others that meet the requirements and definition of a qualifying relative. This credit is not refundable.
The refundable portion of the child tax credit equals 15% of the taxpayer’s income above $2,500. This means that if your income exceeds $11,833, you may be entitled to the full refundable credit amount of $1,400. The credit will then offset your tax liability with any unused amounts up to $1,400 refunded. There are phaseout limits to the credit, so high earners may not receive some or all of the credit.
Taxpayers adopting an eligible or special needs child may be able to take an adoption expense tax credit and/or exclude employer-provided adoption benefits. We discussed some information about the adoption benefit exclusion in our previous parent article.
Both the credit and the exclusion can be claimed on the same tax return, but not for the same expenses. The credit can offset both regular and alternative minimum tax. The max credit limit is $13,570 and is not refundable. However, any unused credit can be carried forward for five years.
Qualified adoption expenses are reasonable and necessary adoption fees, court costs, attorney fees, and other expenses that are: (1) directly related to, and the principal purpose of which is for, the legal adoption of an eligible child by the taxpayer; (2) not incurred in violation of State or Federal law, or in carrying out any surrogate parenting arrangement; (3) not for the adoption of the child of the taxpayer’s spouse; and (4) not reimbursed (e.g., by an employer).
Special rules regarding when expenses are used for the exclusion benefit or credit, and certain substantiation requirements apply. We will be happy to consult with you to assist in determining whether you qualify to claim either an exclusion or credit or both.
Child and Dependent Care Credit
Taxpayers can claim a nonrefundable credit for a percentage of the dependent care expenses that enable them to work. The maximum credit is $600 for one child and $1,200 for two or more children. The credit is calculated at 20% of the maximum qualifying expenses of $3,000 for one child and $6,000 for two or more children. Tax-free benefits under a dependent care benefit plan reduce the maximum qualifying expenses for the credit. This is one situation where the income exclusion may be better than a credit.
The credit is available for taxpayers that have qualifying dependents that are under 13 years of age or are physically or mentally incapable of caring for themselves and who have the same principal residence as the taxpayer for over half the year. Taxpayers must identify those that are caring for these dependents by name, address, and tax identification number.
The expenses are limited to the earned income of the taxpayer or spouse, whichever is less. There are a few other required provisions, so be sure to double check the requirements when filing your tax returns.
Education Tax Credits
Your little one may not be ready for college quite yet, but if you have older children there are a few benefits to that big tuition bill (aside from the degree or licensing your child may be earning). What may be considered qualified expenses under the American Opportunity Tax Credit or the Lifetime Learning Credit varies with each credit. Please double check the requirements for each category.
American Opportunity Tax Credit
The American Opportunity Tax Credit provides individuals with a tax credit of up to $2,500 per eligible student per year for qualified tuition and related expenses (including course materials) paid for each of the first four years of the student’s post-secondary education in a degree or certificate program. The credit rate is 100 percent on the first $2,000 of qualified tuition and related expenses, and 25 percent on the next $2,000 of qualified tuition and related expenses. The student must be claimed on the taxpayer’s tax return in order to claim the credit.
The American Opportunity Tax Credit is phased out ratably for taxpayers with modified adjusted gross income (MAGI) between $80,000 and $90,000 ($160,000 and $180,000 for married taxpayers filing a joint return). The credit may be claimed against a taxpayer’s AMT (alternative minimum tax) liability.
Forty percent of a taxpayer’s otherwise allowable modified credit is refundable. A refundable credit is a credit which, if the amount of the credit exceeds the taxpayer’s Federal income tax liability, the excess is payable to the taxpayer as a direct transfer payment.
Lifetime Learning Credit
The Lifetime Learning Credit is not just for your children – individual taxpayers may be eligible to claim this nonrefundable credit against Federal income taxes equal to 20 percent of qualified tuition and related expenses incurred during the taxable year on behalf of the taxpayer, the taxpayer’s spouse, or any dependents. Up to $10,000 of qualified tuition and related expenses per taxpayer return are eligible for the Lifetime Learning Credit (the maximum credit per taxpayer return is $2,000).
In contrast to the American Opportunity Tax Credit, a taxpayer may claim the Lifetime Learning Credit for an unlimited number of taxable years. Also, in contrast to the American Opportunity Tax Credit, the maximum amount of the Lifetime Learning Credit that may be claimed on a taxpayer’s return does not vary based on the number of students in the taxpayer’s family – that is, the American Opportunity Tax Credit is computed on a per-student basis, while the Lifetime Learning Credit is computed on a family-wide basis. The Lifetime Learning Credit amount that a taxpayer may otherwise claim is phased out ratably for taxpayers with MAGI between certain levels.
There are many things to worry about with having a child, taxes shouldn’t have to be one of them. Hopefully with the information presented above, you have a better idea of the credits available to parents and have some resources to learn more. Please contact us to speak with one of our tax specialists if you have any questions.
Written by Eric Goble & Erin Kidd, EA
Eric is a Tax Senior at Thompson Greenspon specializing in non-profit, trust and estate, and individual taxation.
Eric holds a J.D. from the Syracuse University College of Law, and a BA in Economics and Political Science from Hartwick College.
Erin Kidd is the Tax Individual Practice Supervisor at Thompson Greenspon and has nearly a decade of tax experience specializing in individual taxation. Throughout her career, she has focused on simplifying complex tax issues and educating clients to maximize their tax benefits and plan for future events. Erin is responsible for the review of individual Federal and multi-state tax returns, managing the firm’s Military Spouse Remote Preparer Program, preparation of individual tax returns with international taxation and reporting requirements, and assisting with the resolution of client issues with Federal and State Taxing Authorities.
Erin holds a Bachelor’s and Master’s Degree in Business Administration from Morehead State University, is an Enrolled Agent, a federally licensed tax preparer who has unlimited rights to practice before the IRS, and an Accredited Financial Counselor ®. She has been recognized by the Garrison Commands of West Point, NY and Fort Leavenworth, KS for her contributions to the military community for her work with the installations’ Volunteer Income Tax Assistance Centers.