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 child care expenses, parents have opportunities to lower their tax liability. That’s especially true for taxpayers who are likely to owe more due to changes in the federal tax code that reduced or eliminated certain deductions starting in 2018, including the new $10,000 limit on state and local property, income, and sales tax.
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 advisor 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 in tax year 2018 (which are filed in April of 2019) include:
- Child Tax Credit
- Credit for Other Dependents
- Child and Dependent Care Tax Credit
- Earned Income Credit
- State tax breaks
- Education credits
The following is a closer look at these areas.
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, you can claim a credit of $4,000, and so on.
To claim the credit, your child must be under age 17 at the end of the year and have a Social Security number.
For most families, the Child Tax Credit is 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).
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.
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).
As with the Child Tax Credit, the Credit for Other Dependents begins to phase out for single taxpayers with MAGI of $200,000 or more ($400,000 for married couples filing jointly).
The IRS offers an Interactive Tax Assistant tool to help you identify the tax credits and deductions for which you may be eligible.
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.
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 2018 is $3,461 with one qualifying child, $5,716 with two qualifying children, and $6,431 with three or more qualifying children.2
Some states offer their own version of the Child Tax Credit, CDCTC, or EITC often based on a percentage of the federal tax credit. Some are refundable, while others are not.
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.
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 taxpayers with MAGI of $114,000 to $134,000 (for joint filers).
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, “Understanding the Child and Dependent Care Tax Credit,” March 13, 2017.
2 Internal Revenue Service, “2018 EITC Income Limits, Maximum Credit Amounts and Tax Law Updates,” Jan. 24, 2019.