10 Tax Breaks Every Parent Needs to Know
Starting a family isn't cheap. According to a report issued by the Department of Agriculture in early January, a middle-income married couple with two children is estimated to spend $233,610 to raise a child born in 2015. Keep in mind that this cumulative expense only covers the cost to raise a child through age 17, meaning it doesn't include college expenses.
However, if you're already a parent and raising one or more children, you probably didn't need a report to tell you they can be expensive.
But here's the good news: your kids can also be an excellent source of tax credits or deductions come April. Sure, you may just wind up spending any money saved come tax time on your kids, but select parenting expenses can help lower your taxable income. Here are 10 tax breaks that every parent needs to be aware of.
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1. Dependent exemption
Unless you make a lot of money and face an exemption ($155,650 for a married individual filing separate, $259,400 for a single individual, or $311,300 for married filing jointly), qualifying dependents can reduce your taxable income by $4,050 per dependent for your 2016 calendar year taxes. As long as the child is under the age of 19 (24 if they're a student), or they happen to be permanently disabled, and they lived with you more than half the year, they can qualify as a dependent. The more legal dependents you have, the bigger your dependent deduction.
2. Child Tax Credit
Unlike deductions, tax credits lower your tax bill on a dollar-for-dollar basis, and are thus the cream of the crop when it comes to reducing your tax liability.
The Child Tax Credit (CTC) allows parents to reduce their federal income tax by up to $1,000 per child, assuming six criteria are met: age, relationship, support, dependent, citizenship, and residence. While you can read about the CTC qualifications in more detail, the main gist is that the child needs to be under age 17, your dependent, reliant on you for at least half of their expenses, a U.S. citizen, and have lived with you for at least half the year.
3. Child and Dependent Care Credit
Another potentially juicy credit is the Child and Dependent Care Credit (CDCC), which is given to couples or single parents who've paid someone else to take care of their child aged 12 and under in order for the parent(s) to work or find a job. The CDCC can be up to 35% of your qualifying expenses, but as usual your adjusted gross income can have some bearing on how much of a credit you'll receive. This credit caps at $3,000 for one qualifying individual, or $6,000 for two or more qualifying individuals, in 2016.
What's more, as the IRS points out, if your employer makes any contributions toward your qualifying child care expenses, you must subtract them from your own qualifying expense calculation.
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4. Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is an exceptionally valuable credit issued by the federal government to hard-working low-and middle-income individuals and families. Based on your adjusted gross income and filing status, as well as how many children you have, your maximum credit amount can vary wildly. For example, someone with three or more qualifying children may wind up receiving the maximum credit of $6,269 for the 2016 tax year. To get a better idea if you'll qualify, the IRS has a handy chart you can use.
Also, it's worth pointing out that the EITC is also a major source of fraud for the IRS. Millions of people are unaware that they qualify because they assume that once their taxable income has fallen to $0, it's not worth filing a tax return. The EITC can still reward individuals and families with a refund, even if they have no taxable income. However, because of the high propensity for fraud, the recently passed PATH Act is likely to delay any tax refunds with an attached EITC by a few weeks this year (and perhaps going forward).
5. Adoption Credit
If you've recently adopted a child or multiple children under the age of 18, you may be able to claim some hefty deductions via Form 8839 when preparing your taxes.
According to the IRS, reasonable and necessary adoption fees, court costs and attorney fees, travel expenses, and other expenses (including meals) that are directly related to the legal adoption of a child would all be qualified adoption expenses. The maximum amount of this credit for 2016 is $13,460 per child, but, as is often the case, there are income limits. The adoption credit begins to phase out when modified adjusted gross income crosses $201,920, and phases out completely above $241,920.
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6. Higher education credits
Sending your kids to college can be expensive, and yet still rewarding. There are two tax credits that parents may be able to claim when sending their child to college: the American Opportunity Tax Credit (AOTC), which can be taken for the first four years, and the Lifetime Learning Credit (LLC), which is designed for specific degrees (i.e., graduate school), and thus has no time-based limit.
The AOTC can be worth as much as $2,500 of the cost of tuition. Best yet, if the amount of the AOTC is more than the tax you owe, then up to 40% of the credit can be refunded to you, for a max of $1,000. The LLC has a maximum benefit of $2,000 of the cost of tuition.
As should be no surprise, there is an income limit for the AOTC. Phase-outs begin at $80,000 in modified adjusted gross income ($160,000 in MAGI for married filers), with a complete phase-out at $90,000 in MAGI ($180,000 for married filers). It's also critically important to realize that room and board expenses don't qualify. Only tuition, enrollment fees, and school materials do.
7. 529 plan state-level deductions
Another consideration to be made is funding a qualified tuition plan, known more commonly as a 529 plan. These are tax-advantaged plans that allow money contributed on a child's behalf to grow on a tax-deferred basis. Eventually that money has to be used to cover the increasingly high costs of a postsecondary education.
529 plans provide no upfront federal tax benefits. However, the tax-deferred nature of the funds within a 529, along with the fact that a number of states do offer tax deductions, could make them worthwhile for parents. Today, nearly two-thirds of all states offer a tax deduction for contributing to a 529. Find out if your state is one.
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8. Student loan interest deduction
Continuing with the college theme, parents may also be able to reduce their income subject to tax by up to $2,500 with the student loan interest deduction. In order to qualify, the loan must have been taken out solely for qualified education expenses (and can't be from a relative), it has to be for you, your spouse, or your qualified dependent child, and you'll have to be below certain modified adjusted gross income limits of $80,000 for a single filer and $160,000 for joint filers. Phase-outs begin at $65,000 for single filers and $130,000 for joint filers.
9. Self-employed health insurance deduction
If you are self-employed, there's a pretty good chance that you're paying for health insurance to cover you and your family, including your kids. If that's the case, you may be able to deduct the entire cost of the premiums you paid to cover your children under the age of 27, regardless of whether or not they were considered your dependents at the end of the year. It should be pointed out that this includes not only standard health insurance, but dental and long-term care premiums paid on behalf of a child by a parent too.
10. Hiring your child
Finally, if you run a small business, it could be worthwhile to hire your child in order to take advantage of some delectable tax benefits. Hiring your kid can allow you to write off their salaries as a tax deduction, which lowers your taxable income. Best of all, federal withholding requirements for Social Security and Medicare taxes wouldn't apply for children under the age of 18, and your child won't owe any federal income tax until they cross the standard deduction threshold of $6,300 in 2016.
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