Mommy and Daddy’s Little Deduction
There’s nothing quite like looking into the eyes of your newborn child and seeing all the tax breaks coming your way. Okay, so maybe it isn’t the first thing you see, but if you haven’t thought about recouping some of the expense of having a kid, you will soon! Thankfully there are several ways to cash in on those kiddos at tax time.
Before we go too much farther, here’s a quick aside about deductions and credits: both deductions and credits can reduce the amount of tax you may owe, but they do it in different ways. Deductions are subtracted from your gross income to reduce the amount you pay tax on, while credits reduce your actual tax dollar for dollar (which is way better!). Non-refundable credits will bring your tax down to zero, but any leftover amount is lost. Refundable credits, on the other hand, can reduce your tax to zero and any leftover amount is, well, refunded to you (which is way better!). Child-related tax benefits come in all three of these forms, so it’s good to know a little about how they work.
Credit Where Credit’s Due
You probably heard a lot of talk about the Child Tax Credit in recent months. It was a hot topic on just about every news show when the tax reform laws passed, and for good reason: under the new laws the credit is double what it had been and the income limits have been substantially increased which makes this valuable credit available to families who haven’t qualified in the past. It makes sense that this was such big news, especially considering that the credit is worth $2,000 per qualifying child AND that up to $1,400 of that is available as a refundable credit.
Another credit you may have heard about is the Earned Income Tax Credit (EITC). This is a refundable credit that can put quite a few dollars in the pockets of taxpayers within the income limits who have qualifying dependents. Because of the value of this credit (the maximum for taxpayers with three qualifying dependents is almost $6,500) there have been some pretty serious efforts to make sure that the credit is only claimed by taxpayers who qualify to claim it, so be ready to answer quite a few questions before they hand that money over!
Costs for childcare can be considerable, and with more and more families depending on two incomes, many parents may want to take advantage of the Child and Dependent Care Credit. This nonrefundable credit is based on a percentage of childcare expenses paid so that parents can work (or look for work). To qualify for the credit, both spouses must have earned income (although there is an exception for a spouse who is a full-time student or who is disabled) and the percentage of credit allowed is reduced down as income increases, going from 35% down to 20%. Despite the dollar limit for expenses being capped at $3,000 for one dependent ($6,000 for two or more) even though most families pay a fair amount more than that for childcare, this credit still provides some welcome relief for working parents.
Here’s your W-2, Ms. Poppins
Childcare isn’t always a matter of dropping the kids at a daycare facility; nannies and babysitters provide services within the home and can come with their own set of income tax requirements. If you pay a household employee cash wages of $2,100 or more in any year, or if you paid all household employees $1,000 or more in any calendar quarter, you will need to file Schedule H. You may also need to file form W-2 for any household employee who hit that $2,100 mark. Even a teenage babysitter might need to be sent a Form 1099 as an independent contractor if you pay them over $600 in a year. I don’t remember that being covered in my Babysitter’s Club books!
With the costs of education on the rise, it’s never too early to start saving for college! Relief from the tuition expenses can come in many forms, but your newborn bundle of joy is probably most interested in Qualified Tuition Plans (QTP, also called §529 plans) and Education Savings Accounts (ESA).
Though neither offers a deductible benefit for contributions, both of these accounts allow for tax-free earnings provided withdrawn amounts are put to use on qualifying education expenses. The definition of qualifying expenses is somewhat broader for distributions from these plans than it is for education credits, which allows (with some planning) for maximized use of tax benefits when you start paying those expenses!
There is quite a bit of similarity between these two types of accounts, with the main differences coming from age limits, contribution limits, and income limits. ESAs also allow for additional qualified expenses, including costs for K-12 education.
Whether you’re wondering if you qualify for EITC, trying to figure out how to file a W-2 for your nanny, or weighing the differences between a QTP and an ESA, our knowledgeable tax pros are here to help you make the most of your little deduction!
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