Tax Insight: For Tax Year 2014 and Beyond, 3rd ed. Edition (2015)
Part VI. Personal Expenses, Deductions, and Credits
Chapter 28. Your Children
Kids Aren’t as Taxing as People Claim—In Fact, They’ll Lower Your Taxes Quite a Bit
People seem a little shocked when they learn that I have eight children. Sometimes I joke that I have a lot of kids because they are such a great tax write-off. Although there is no truth in the joke in regard to why I have eight children, it is true that kids provide some great tax benefits.
The first tax benefit that comes from having dependent children in the home is that you receive an additional exemption for each child, which automatically reduces your taxable income by $3,950 per child (see Chapter 4 for details). Then the Child Tax Credit and any other applicable credits kick in to bring you even greater tax savings. With all of these tax-saving opportunities it is conceivable that the cost of supporting a child’s basic needs could be offset by the tax savings of these laws. Here is a list of the child-related tax credits that are covered in this chapter:
· The Additional Child Tax Credit (Non-Refundable)
· The Child Tax Credit (Refundable)
· The Child Care Credit
· The Adoption Credit
In addition to the strategies discussed in this chapter, be sure to also read about how to reduce your taxes by employing children in your business, discussed in Chapter 21.
The Child Tax Credit (Non-Refundable)
The child tax credit is one of the best tax benefits available. It is a dollar-for-dollar credit against your tax for as much as $1,000 per child. This credit is available to you if you have a “qualifying” child. To qualify, your child must:
· Be your son, daughter, stepson or stepdaughter, or a descendant of those children, or a brother, sister, stepbrother or stepsister, or a descendant of those persons. These children include foster and adopted children.
· Be 16 years old or younger at the year’s end.
· Live in the same principal residence as you do, for more than half of the year (including children born at the end of the year, as long as their residence was the same as yours).
· Not provide more than half of his or her own support during the year.
If the child meets all four criteria, he or she qualifies to be claimed for the credit. The only other thing that could stand in the way of claiming the credit is your Adjusted Gross Income (AGI). The $1,000 credit begins to be reduced at an AGI of $110,000 if you are married, or $75,000 if you are single. The credit is completely phased out by the time your AGI reaches $130,000 or $95,000, respectively. If your income is close to the phase-out range for this credit it is worth careful planning to reduce your AGI below the phase-out as much as possible.
The child tax credit is nonrefundable, meaning that it can be used to reduce your tax liability only to $0. Once the credit brings your tax liability to $0, the remainder of the credit is forfeited and is not carried forward into future years.
Example Ted and Vickie own a daycare service and have two children who qualify for the child tax credit. Because they have two qualifying children and an AGI of $90,000, they have a total potential credit of $2,000. However, their total tax liability is only $1,200, so the credit will eliminate the entire $1,200 of income taxes they would have owed, but $800 of the credit will go unused.
If you share responsibility for caring for a child with another taxpayer (besides your spouse), specific rules determine which person can claim the credit. Consult an advisor in this situation, or study the pertinent IRS documents.
The Additional Child Tax Credit (Refundable)
In contrast to the child tax credit, the additional child tax credit is refundable. This means that even if your tax liability has been reduced to $0, you can receive a “refund” for the amount of credit that wasn’t used in that year. The refundable additional child tax credit is equal to the lesser of:
· The unused portion of the child tax credit
· Your total earned income, minus $3,000, multiplied by 15%
Example Ted and Vickie’s earned income was $90,000. This means they could claim a refundable credit of $800. This is because the unused portion of their child tax credit of $800 is less than the alternate calculation of $13,050 ($90,000 − $3,000 = $87,000; $87,000 × 15% = $13,050).
A significant benefit that comes from the Additional Child Tax Credit is that it reduces the self-employment tax, as well as any tax penalties that you might owe, whereas the non-refundable tax credit reduces only income tax and Alternative Minimum Tax (AMT). This can really help those who run their own business and have little to no income tax, but have a hefty self-employment tax. This credit is set to expire at the end of 2017.
Tip If you are expecting a child to be born very close to the end of the year and the delivery will be induced, the potentially large tax ramifications of this credit and the dependency exemption may be one factor (of many) worth considering when you determine the birth date. It isn’t the most important factor, obviously, but all else being equal it would be worth considering.
The Child Care Credit
A non-refundable credit is available for child care expenses that are incurred to enable a taxpayer to earn an income. For the expenses to qualify, the person receiving care must be a dependent of the taxpayer and no older than 12 years old. (The child can be older than 12 if he or she is mentally or physically unable to care for him/herself.)
Expenses that qualify for this credit include household services (such as cleaning and cooking), in-home child care and services outside the home as long as the child is normally in the home at least eight hours per day. The payments can be made to a family member of the taxpayer, as long as the caregiver is not a dependent of the taxpayer and is not a child of the taxpayer younger than the age of 19.
Caution I am often given receipts for overnight summer camps as expenses that my clients want to claim for this credit. However, none of the cost of an overnight camp qualifies for the child care credit. On the other hand, day camps (where the child returns home each night) do qualify for this credit.
To claim the credit the child care must be for the purpose of allowing the taxpayer to go to work, or to seek employment. If married, both spouses must work in order to claim this credit. If one spouse does not work then no credit can be claimed. An exception to this is if one spouse is a full-time student or is mentally or physically incapable of self-care.
The maximum amount of child care expenses that can be claimed is $3,000 per year for one child, or $6,000 for two or more children. The credit is 35% of allowable expenses for taxpayers with an AGI of $15,000 or less. The credit is reduced by 1% for every $2,000 of AGI (or fraction thereof) over the $15,000 threshold, until it reaches the minimum credit of 20% of allowable expenses for anyone with an AGI greater than $43,000 per year.
Example Lynne is a single mother of two children, ages 8 and 10. She spends $6,500 per year on child care, evenly split between the kids, so that she can be at work during some of the time that her children are not in school. Lynne’s AGI is $40,000 per year. Lynne would be able to claim a Child Care Credit of $1,320 [($40,000 AGI – $15,000 threshold = $25,000 over the threshold) → ($25,000 over brings a 13% reduction from the maximum credit of 35% by reducing it 1% for every $2,000 over the threshold, 35% – 13% = 22% credit) → ($6,000 maximum expenses allowed × 22% = $1,320)].
The maximum credit that a person could claim would be $2,100 for two children with $6,000 of expenses and less than $15,000 of income, making it pretty unlikely that the full amount of the credit will be claimed. Making matters worse, an individual with less than $15,000 of AGI and two children would owe no tax (because the exemptions and standard deduction would eliminate his/her taxable income), and since the credit is non-refundable, it would do the person no good. I have a hard time understanding how they came up with the phase-outs for this law; they really don’t make sense. Regardless, individuals with a higher tax liability may be able to benefit from this credit by as much as $600 fewer taxes if they have one eligible child, or $1,200 for two (or more) children.
The allowable child care expenses cannot exceed the individual’s earned income for the year. In the case of a married couple, the expenses cannot exceed the earned income of the spouse with the lower income. In the case of a spouse who is a full-time student or unable to care for him- or herself, the law assumes an earned income amount for each month of school attendance or disability in the amount of $250 per month for one child or $500 per month for two.
Note There is a very significant nuance in this credit that nearly everyone misses, including many professional tax preparers. Part of the determination of the credit is based on eligible children. The determination of eligibility of a child is based on age, not on whether the child had child-care expenses. I have had several clients who had two eligible children, but only one has child care expenses. In this case the credit can still be claimed for both children! This little known fact can double the value of the credit.
You will be required to put the Social Security number (or employer tax ID) and other identifying information of the child care provider on your tax return, as well as the Social Security number of the child who is being claimed. Depending on the person you have arranged with for care, this could pose an obstacle to claiming the credit.
The Adoption Credit
Adopting a child can be extremely expensive. I have been surprised recently by clients who have had to pay as much as $35,000 for an adoption (and I’m sure there are more expensive stories out there). Of course, you can’t put a price on the joy and blessings that come to the family from the adoption.
Congress views adoption as a good thing to encourage in our society. For this reason they have instilled a significant credit for adoption expenses in the tax code. Unlike other credits that are usually based on a percentage of the money you spent, the adoption credit brings a dollar-for-dollar benefit for all of your costs, up to a maximum amount of $12,970. Every dollar that you spend up to that amount will come back to you in tax benefits—assuming you have enough of a tax liability to be offset by the credit (since it is non-refundable). Unused credits can be carried forward to the following year.
Of course, the credit is phased out for high-income taxpayers. In 2013 the phase-out begins at $194,580 AGI and the credit is completely eliminated once AGI reaches $234,580.
Note In 2010 and 2011, the Adoption Credit was refundable and allowed for a higher amount of qualified expenses. If you are filing a return for one of those years please be sure to speak with a tax preparer or to understand the significant implications of the refundable credit. There is no indication at this point in time that the refundable nature of this credit will be reinstated for future years.