Children and Tax Benefits

With the upcoming birth of our son or daughter, I thought it would be appropriate to write about the tax benefits of raising children. The rules can get tricky, and your children must meet certain criteria to become your qualifying children for tax purposes. Here are a few highlights:

Dependency Exemption: For each qualifying dependent child, you can exempt from your income $4,000.

Child Tax Credit: For each qualifying child under 17 years of age you can receive a credit of up to $1,000 per child. The credit phases-out after your modified adjusted gross income is greater than $110,000 for filing jointly and $75,000 for filing as single or head of household.

Child Care Credit: If you pay for daycare, after-care or preschool so that you can work, you may be eligible for a credit of 20% to 35% of the cost, up to a maximum of $3,000 of qualified expenses for one child and $6,000 for two or more. Your children must be under age 13 to qualify.

Education Credits: There are several credits and deductions available for education expenses:

– The American Opportunity Credit provides a credit of up to $2,500 per eligible student for the first four years of college (100% of the first $2,000 of expenses and 25% of the next $2,000).

– The Lifetime Learning Credit provides a credit of up to $2,000 for an unlimited number of years (20% of the first $10,000 of expenses).

– The tuition and fees deduction provides a deduction of up to $4,000 as an adjustment to income (this means that you do not have to itemize).

– Student loan interest deduction allows for a deduction of up to $2,500 as an adjustment to income.

There are income limitations for each credit and deduction which vary widely based upon your modified adjusted gross income and filing status.

Income Shifting: If you are self-employed, you may be able to hire your minor children, pay them wages, and not have to pay income taxes or payroll taxes. Even if you do not own a business you may still be able to shift investment income to your children to minimize taxes. It takes a lot of planning, but strategizing can save a lot of taxes.

These are just some of the tax benefits to having children. Hopefully this will help to offset some of the cost of raising a family.

Common Questions & Answers

Tax season is just about upon us, and here are some common questions our clients have:

Q: Does an extension also extend the amount of time I have to pay my taxes?

A: An extension only extends the amount of time to file your return, but if you owe taxes, then you will incur penalties and interest for late payment of taxes. In NJ, if you do not pay 80% of your tax liability on April 15th, (100% for NY) then your extension will be disallowed.

Q: Is it better to file a separate tax return from my spouse?

A: Also known as “Married Filing Separately,” usually results in a higher amount of taxes being paid, but can be advantageous in certain situations. We always do an analysis to see if this is better for our married clients.

Q: Do I have to make estimated tax payments, and if so, why?

A: Usually self-employed taxpayers, retirees, and anyone who has income from sources that do not have taxes withheld are required to make quarterly estimated tax payments. If you need to make estimated payments and do not, you may be subject to underpayment penalties.

Q: Can I claim my elderly mother or father as a dependent?

A: Possibly. Certain rules have to be met, such as the amount of support provided and their gross income (the definition of gross income would take up half of this article). Interestingly, your parents do not have to live with you.