Your kids may be your single greatest source of joy, but you have to admit that they’re expensive.
To help soften the financial blow of paying for diapers, day care, and, in some cases, a college degree, Uncle Sam offers parents a number of tax breaks that can potentially save them thousands of dollars per year.
From credits that favor families, to write-offs for childcare expenses, parents have opportunities to lower their tax liability.
It is “extremely important for taxpayers to either become knowledgeable about utilization of tax credits available,” use tax-planning software that alerts them to credits and deductions, or seek out a tax preparer who can guide them, said Michael D. Porter, a MassMutual financial professional and certified public accountant in Houston, Texas. “Significant dollars could be lost if they don’t.”
Six of the most notable tax opportunities for parents include:
1. Child Tax Credit
The Tax Cuts and Jobs Act (TCJA), which took effect in 2018, doubled the Child Tax Credit to $2,000 from $1,000 per qualifying child. If you have two kids in 2021, you can claim a credit of $4,000, and so on.
Apart from increasing the amount of the Child Tax Credit, the TCJA also increased the beginning of the modified adjusted gross income (MAGI) phaseout limit for joint filers to $400,000 from $110,000, allowing higher earning families to qualify.
It’s worth noting, too, that a portion of the credit is refundable, depending on the parent's income. Up to $1,400 of the $2,000 tax credit per qualifying child can be returned to the taxpayer in the form of a refund check if their tax liability is less than zero. The refundable portion of the Child Tax Credit is capped at 15 percent of the parent's or guardian’s income that exceeds $2,500.
Nonrefundable tax credits, in comparison, can only be used to reduce your tax bill to zero, but do not produce a refund for any additional amount a taxpayer might be owed.
The new $1.9 billion American Rescue Plan Act, aimed at helping families that have suffered a financial loss due to Covid-19, also temporarily expanded the Child Tax Credit for tax year 2021 (income tax forms that are due in 2022). The stimulus bill:
- Increased the amount of money eligible parents may receive to $3,000 per child under age 17, and $3,600 per child under age 6 as of December 31, 2021.
- Waived the $2,500 earnings requirement, allowing parents who are unemployed to claim the credit.
- Phases out the temporary increase at a rate of $50 for each $1,000 that the taxpayer’s income exceeds the following applicable threshold: $75,000 for single filers, $112,500 for heads of household, and $150,000 for married couples filing jointly, based on either their 2019 or 2020 income tax returns (depending on when they filed in 2020).
- Permits eligible families to receive up to half of their credit for 2021 in advance as early as July 2021.
- Allows 17-year-old dependents to qualify.
Families who are not eligible for the expanded tax credit in 2021 may still be permitted to claim the standard $2,000 Child Tax Credit, subject to a different phase-out amount of $50 for each $1,000 that the taxpayer’s income exceeds $200,000 (single filers) or $400,000 (joint filers).
To claim the credit, your child must have a Social Security number.
For most families, the Child Tax Credit is the most lucrative of the parent-specific tax breaks available.
Remember, tax credits are worth more than tax deductions because they provide a dollar-for-dollar reduction in your income tax liability. By contrast, a tax deduction reduces the amount of your income that is subject to taxation. They are equal to the percentage of your marginal tax bracket.
This means, for example, that a $1,000 tax credit saves you $1,000 in taxes. If you are in the 32 percent federal tax bracket, a $1,000 deduction saves you $320 in taxes (0.32 X $1,000 = $300).
2. Credit for Other Dependents
Parents or guardians with a dependent who does not qualify for the Child Tax Credit may still be able to claim the Credit for Other Dependents worth up to $500 per qualifying person.
That includes children who are age 17 or older, qualifying relatives, and dependent parents. It also includes dependent children who are younger than age 17 and either a U.S. citizen or U.S. resident, but who do not have a Social Security number, according to the Internal Revenue Service (IRS).
The IRS offers an Interactive Tax Assistant tool to help you identify the tax credits and deductions for which you may be eligible.
3. Child and Dependent Care Tax Credit
Working taxpayers who paid babysitters, day care centers, day camps, or other care providers for a qualifying child under age 13 or an incapacitated spouse or parent may be eligible for the Child and Dependent Care Tax Credit (CDCTC).1
The credit, which varies depending on the taxpayer’s earned income, is worth between 20 percent and 35 percent of allowable expenses. According to the IRS, allowable expenses are limited to $3,000 for paid care of one qualifying person. The limit is $6,000 if the taxpayer paid for the care of two or more dependents.
Overnight summer camps do not qualify for the credit.
4. Earned Income Credit
For low- and moderate-income working families, the Earned Income Tax Credit (EITC) is another potentially powerful tool to lower their tax bill. It’s not specifically reserved for parents, but has higher income phaseouts for taxpayers with kids.
Under the EITC, workers receive a credit based on a percentage of their earnings up to a maximum credit, which is based on family size. As such, families with more children generally qualify for a much larger credit than childless workers. The maximum amount of credit for tax year 2020 is $3,584 with one qualifying child, $5,920 with two qualifying children, and $6,660 with three or more qualifying children. Those numbers climb to, $3,618, $5,980, and $6,728 respectively for tax year 2021.
The credit was enhanced for 2021 to make it easier for taxpayers without children and separated spouses to claim the credit. For 2021 only, the minimum age for taxpayers without children to qualify for the credit is lowered from 25 to 19; 18 for former homeless youth or those in foster care after age 14. A new credit of $543 was added if you have no qualifying children.
5. State tax breaks
The nonprofit group Tax Credits for Workers and Their Families offers a map with information on each state and whether it offers an EITC, CTC, or CDCTC.
6. Education tax credits
Parents who are helping to pay for their child’s education may also benefit from one of two education tax credits.
The American Opportunity Tax Credit (AOTC) is worth up to $2,500 per year for the cost of tuition, certain required fees, and course materials needed for attendance for the first four years of higher education. If the credit reduces your tax bill down to zero, you can have 40 percent of the remaining amount of the credit (up to $1,000) refunded to you. The credit phases out for taxpayers with MAGI of $160,000 to $180,000 (for joint filers).
Separately, the Lifetime Learning Credit (LLC), worth up to $2,000 per tax return, is available for qualified tuition and related expenses paid for students enrolled in an eligible education institution. It can be used for undergraduate, graduate, and professional degree courses, including courses to help improve job skills. There is no limit to the number of years you can claim the LLC. This credit phases out for tax year 2021 for taxpayers with MAGI of $160,000 to $180,000 (for joint filers). Note that the Consolidated Appropriations Act, 2021, unified the phaseout range for the American Opportunity Tax Credit and the Lifetime Learning Credit.
You cannot claim both the AOTC and the LLC for the same student in the same year.
You wouldn’t trade your offspring for all the money in the world, but you can help trim the cost of raising them by taking advantage of tax breaks tailored to families.
As you gather your W-2s and 1099s for the current tax-filing season, take the time to determine which credits and deductions you may be eligible to claim.
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1 Internal Revenue Service, “Publication 972, Child Tax Credit and Credit for Other Dependents,” Jan. 15, 2021.
2 Internal Revenue Service, “2018 EITC Income Limits, Maximum Credit Amounts and Tax Law Updates,” Feb. 3, 2021.