Got Kids? Tax Tips for Taxpayers with Tots & Teens

Posted on 21. Jan, 2011 by in Taxes

I went to a baby shower a few months ago where there were 4 pregnant women in a small group of 11 people. This past year I have had numerous clients who were or are still expecting. Approximately 4.3 million babies (or should I say “tax deductions”) were born in the United States in 2010 with the top baby name for a girl being Sophia and for a boy Aiden. However, I am not here to speak about babies, but rather the tax implications about having babies. Also, if you have teens and young college students this blog will apply to you as well.

child tax credit

There are numerous tax benefits to having children:

1 – EXEMPTION For each dependent child, you will receive an exemption. An exemption reduces taxable income. For example, Jack and Jill are married and have a filing status of “married filing joint (MFJ)”. They have 2 children who are qualified dependents. Jack and Jill have four exemptions; 2 personal exemptions and 2 dependent exemptions. Their total exemption for 2010 would equal $14,600 ($3,650 X 4). The total exemption of $14,600 would reduce their taxable income. Here are the exemption amounts for 2010 & 2011:

2010 – $3,650
2011 – $3,750

Note: In most cases a child can be claimed as a dependent beginning in the year he/she is born. However, sometimes dependency status can be questionable. If you have questions about dependency statuses, please refer to the IRS Publication 501.

2 – CHILD TAX CREDIT For 2010-2012, the maximum you can receive for the child tax credit is $1,000. Not everyone qualifies for the credit.

First, you must have a “Qualifying Child” (see definition below).
Second, your modified adjusted gross income (AGI) cannot exceed:

Married Filing Joint – $110,000
Single/Head of Household/Qualifying Widower – $75,000
Married Filing Separate – $55,000

In addition to the above, the credit will be reduced if your tax is less than the credit. For example, your credit is $1,000 but your tax is $750. The credit will be reduced to $750. If your tax is zero, then you receive no credit. However, you may be eligible for the additional child tax credit.

3 – THE ADDITIONAL CHILD TAX CREDIT The difference between the Child Tax Credit and the Additional Tax Credit is that the Additional Child Tax Credit can result in a refund; this is known as a “refundable credit”. So if you weren’t able to take the full child tax credit, you may be eligible for the additional child tax credit. This credit has the same income guidelines as the child tax credit. The additional child tax credit is equal to the lesser of the unallowed child tax credit or 15% of your earned income that is greater than $3,000.

4 – CHILD AND DEPENDENT CARE CREDIT This credit is available if you paid for care for a dependent qualifying child under age 13 (see below for definition) so that you (if applicable – and your spouse) could work or look for work. If you are married, both spouses must have earned income with the exception if one spouse was a full time student or is incapable of self-care. The qualifying child must have the same principal abode as the taxpayer for more than half the year. The expenses for determining the credit are limited to $3,000 for one qualifying child and $6,000 for two or more qualifying children. The credit is equal to 35% of the maximum expenses. Therefore, the maximum credit is $1,050 ($3,000 X 35%) for one qualifying child or $2,100 ($6,000 X 35%) for two or more qualifying children. Earned income limitations do apply.

The typical expenses that qualify for the credit are payments to a day-care center, nanny or nursery school. Sleep-away camp doesn’t qualify. The cost of first grade or above doesn’t qualify because it’s primarily an education expense. Surprisingly, the rules on kindergartens aren’t clearly defined. Apparently, if the school offers a program similar to a nursery school (more play than education) it can qualify. If it offers more of an educational program, it may not (Thomas Reuters).

The total child and dependent care expenses claimed must be reduced by the Dependent Care Benefits you received from your employer. Employer-provided Dependent Care Benefits are reported in box 10 on the Form W-2.

Also, you and your spouse must file a joint return. Further, you must provide the caregiver’s name, address, tax ID number, and phone number.

5 – HIGHER EDUCATION TAX CREDIT The American Opportunity Credit and the Lifetime Learning Credit are two federal education tax credits that are available if you pay for higher education for yourself and/or your dependents. You are eligible for the credit if you pay postsecondary tuition and fees for yourself, your spouse and/or your dependent. One student – one credit – per year; you cannot claim the American Opportunity Credit and Lifetime Learning Credit for the same student in the same tax year. Either credit can be claimed by the parent or the student (but not by both); and if you claim the student as your dependent, the student cannot claim the credit on his/her tax return. Claim the credit which creates the best tax benefit.

Here are some key facts the IRS wants you to know about higher education tax credits:

The American Opportunity Credit

• The credit can be up to $2,500 per eligible student.
• It is available for the first four years of post-secondary education.
• Forty percent of the credit is refundable, which means that you may be able to receive up to $1,000, even if you owe no taxes.
• The student must be pursuing an undergraduate degree or other recognized educational credential.
• The student must be enrolled at least half time for at least one academic period.
• Qualified expenses include tuition and fees, course related books, supplies, and equipment.
• The full credit is generally available to eligible taxpayers who make less than $80,000 or $160,000 for married couples filing a joint return.

Lifetime Learning Credit

• The credit can be up to $2,000 per eligible student.
• It is available for all years of postsecondary education, and for courses to acquire or improve job skills.
• The maximum credited is limited to the amount of tax you must pay on your return.
• The student does not need to be pursuing a degree or other recognized education credential.
• Qualified expenses include tuition and fees, course related books, supplies, and equipment.
• The full credit is generally available to eligible taxpayers who make less than $60,000 or $120,000 for married couples filing a joint return.

529 Plans – Is your goal is to pay the entire or part of your child’s education? However, with tuition climbing it seems like a daunting task. A 529 Plan may help you reach your goal and also save some money on taxes. The plan allows you to invest in your child’s future and receive some special tax benefits; distributions are tax free to the recipient if the money is used to pay for higher education. Check out Saving for College for more information on 529 Plans.

Definitions:

A qualified child is your son, daughter, stepchild, foster child, brother, sister, or a descendant of any of them (grandchild, niece or nephew) who is under the age of 17 at the end of the tax year. This child could not have provided over half of his/her own support for the tax year and must have lived with you for more than half of the tax year (with exceptions) and is claimed as a dependent on your tax return. Oh yeah one more thing, he/she must be a U.S. citizen, U.S. national or a U.S. resident alien.

A qualified individual is (IRS website):
1. Your dependent who was under age 13 when the care was provided and who was your qualifying child (under the rules for qualifying child)
2. Your spouse who was physically or mentally incapable of self-care and who had the same principal place of abode as you for more than half of the year
3. Your dependent who was physically or mentally incapable of self-care and who had the same principal place of abode as you for more than half of the year
4. An individual who was physically or mentally incapable of self-care and had the same principal place of abode as you for more than half of the year, and who would have been your dependent except that the individual had gross income greater than or equal to the exemption amount, the individual filed a joint return, or the individual was the dependent of another taxpayer

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