Having a baby and adopting a child are joyous occasions in life. Most events such as welcoming a child have tax consequences that occur during the year that can affect your tax situation.
Many parents can claim tax credits to offset the amount of tax they owe after having a child, and each credit comes with specific qualification requirements. A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself.
Most tax credits are nonrefundable: If the credit amount exceeds the tax owed, no refund is given. Refundable credits are different: If the credit amount exceeds the tax owed, a refund may be due to the taxpayer.
Here are the tax credits:
Child Tax Credit. A 2020 tax credit of up to $2,000 for qualifying children under the age of 17. The credit is reduced by $50 for each $1000 of Modified Adjusted Gross Income (MAGI) above the phaseout limit.
Additional Child Tax Credit. A credit up to $1,400 of the Child Tax Credit is refundable. You may be able to claim the additional credit if a portion of the regular Child Tax Credit was disallowed because tax was reduced to zero before the entire credit was used. The portion of the Child Tax Credit phased out because of AGI, cannot be used to claim the additional credit.
Child and Dependent Care Credit. Amounts you pay someone to care for your child so you can work or look for work may be deductible, depending on your level of income. The percentage of your child care expenses you are able to claim is from 20% to 35% of your expenses up to $3,000 for one child and up to $6,000 for two or more children depending on your income. If you have lower income you may be able to claim 35% of your expenses ($1,050 for one child and $2,100 for two or more kids) instead of the lower percentage based on higher income.
Adoption Credit. You can claim a credit of up to $14,300 (2020) and also exclude up to $14,300 of employer-provided benefits from income for expenses of adopting an eligible child. The same qualifying expenses cannot be used for both. Limits apply to the total spent over all years for each effort to adopt an eligible child. An attempt that leads to adoption and any unsuccessful attempt to adopt a different child is treated as one effort. Unmarried persons who adopt a child can divide each limit in any way they agree.
Earned Income Tax Credit. The Earned Income Credit (EIC) is a refundable credit for low-income earners. The amount of the credit increases the more children you have. A taxpayer with three or more qualifying children is eligible for a maximum credit of $6,660 in 2020. You do not qualify for the credit if you have investment income of more than $3,650.
Adjusting your withholding to compensate for this life change can free up money to use throughout the year. Not doing so could result in more funds being withheld from your pay check than necessary, all other things being equal®.
Tax planning doesn’t begin and end on April 15th. Contact us with your questions about the tax effects of a transaction or event.
