Our Little Bundle of (Tax Saving) Joy
Despite the joy they bring to our lives, kids are expensive. According to this story, you can expect to spend between $12,350 and nearly $14,000 a year, on average, to raise a child through age 17. (1)
The consolation is that for most Americans, your children can lower your tax bill. Using certain deductions, exemptions, and credits, eligible taxpayers can either reduce their taxable liability and some may even receive more money back than they paid in taxes a for the year.
Some of these tax savings are available while the child is still a dependent and others are useful once the child reaches school age. Make sure you check with your tax advisor to get the maximum amount in savings.
Here are eight basic ways your kids can lower your tax bill:
1. Dependency exemption - $4,050 per child per year (2)
- For 2016, you can lower your income by $4,050 per dependent child. An exemption works the same as a deduction because it decreases your income upon which your tax liability is calculated.
- Fine print: your adjusted gross income (line 37) must be below $259,400 for single-filers and $311,300 for married-filers.
2. Child Tax Credit (CTC) - $1,000 per child per year (3)
- If your dependent child was under the age of 17 at the end of the tax year, you can receive a nonrefundable credit towards your taxes of $1,000 per child. That almost covers tuba lessons.
- Fine print: the dependent child must pass all 6 qualifications and your modified adjusted gross income must be below $75,000 for single-filers and $110,000 for married-filers.
3. Child & Dependent Care Credit (CDCC) - Up to $6,000 per year (4)
- The Child Care Credit is intended to enable you to work or seek work and to claim a credit for the costs of providing care to any child while you’re away from your family. The calculation for the amount of the credit is more complex than I want to get into, but you can receive a nonrefundable credit towards your taxes for daycare, home-care, and a nanny*.
- Fine print: Too long to explain here. Call your tax-preparer or explore the IRS guidelines at your leisure.
4. American Opportunity Tax Credit (AOTC) - Up to $2,500 per student per year (5)
- The AOTC will reimburse qualified expenses for educating your child for the first four years of post-secondary school in the form of a partially refundable tax credit. Spend more than $4,000 on qualified expenses (tuition, fees, materials, etc.) and you can knock $2,500 off your tax bill per year, per student for the first four years of college.
- Fine print: income limitations start at $80,000 for single-filers and $160,000 for married-filers. If your tax liability is low, you can be refunded up to 40% of the credit ($1,000).
5. Lifetime Learning Credit (LLC) - Up to $2,000 per year (6)
- Unlike the AOTC, which can only be claimed for a maximum of four years per student, the Lifetime Learning Credit can be claimed for an unlimited number of years, thought the credit is typically smaller and is per return, not per student. When you run out of AOTC credits for Jr., you can still claim the LLC. Also, you can’t file both the AOTC and LLC in a single year, so claim the one that saves you the most money.
- Fine print: your income (MAGI) must be below $130,000 for married-filers and $65,000 for single-filers. Your qualified expenses must exceed $10,000 to claim the full credit and it’s nonrefundable.
6. Deduction for Tuition and Fees - Up to $4,000 per year (7)
- Though you may not claim this deduction if you claimed the AOTC or the LLC for the same student in the same year, you may be able to deduct up to $4,000 per year in qualified tuition and education expenses.
- Fine print: The deduction has limits at certain income levels.
7. Student Loan Interest Deduction - Up to $2,500 per year (8)
- For some silver lining to that five and six-figure student debt balance, you can deduct up to $2,500 of the interest you paid on your child’s student loans.
- Fine print: the deduction can be phased out for MAGI levels beginning at $65,000 for single-filers and $130,000 for married-filers.
8. Earned Income Credit (EIC) - Up to $6,269 per year (9)
- Typically for moderate and low-income earners, having dependent children increases the amount of the refundable credit.
As you can see, most of these credits and deductions are subject to income limits, which provides an opportunity for planning if you’re close to hitting certain thresholds.
Remember, filing mistakes can be frustrating, costly, and time-consuming. Trident Financial Planning is not an accounting or tax-preparation firm, so seek out a professional to make sure you’re obeying all the IRS Guidelines.
Happy Tax Season!
*Be careful about a nanny, you may be considered a household employer and be required to withhold taxes from the nanny’s pay.