Posted by National Association of Tax Professionals

Taxes and Credits for Parents

Taxes and Credits for Parents

New parents often find themselves overwhelmed by the expenses that come with a baby as they had no idea as to how much they would cost them. This is a guide of the tax breaks (credits) and additional expenses (taxes) that may come with having children. 

There is a credit for child and dependent care expenses offered on your individual tax return. The credit can be up to 35 percent of your qualifying expenses, depending upon your adjusted gross income.

To be eligible, the person receiving the care must be a qualifying person—either your dependent child under the age of 13 or certain other individuals who are physically or mentally incapable of self-care. If you are divorced or separated, only the custodial parent can claim this credit. 

The care must have been provided while you (and your spouse) are either working or looking for work. If you are married, you must file a joint return in order to qualify for the credit. In order to claim the credit, you (and your spouse) must have earned income from wages, salaries, tips or net earnings from self-employment. One spouse can be exempt from having earned income if he or she was a full-time student or was physically or mentally unable to care for himself/herself. 

Additionally, expenses must be paid to a qualified caregiver. Spouses, dependents and children under the age of 19 are not qualified caregivers. At the end of the year, most caregivers will provide a statement with their federal employer ID number (EIN) or social security number (SSN), full name, address and amount paid. All of this information is necessary for your tax return. If you do not receive a statement at the end of the year with this information, you should request it prior to your tax appointment.

If your employer provides a dependent care benefit, the amount of dependent care expense claimed must be reduced by the benefit you receive. If you pay someone to come to your home and provide care, you may be considered a household employer. 

The Child Tax Credit is an important tax credit that may be worth as much as $1,000 per qualifying child depending upon your income. All or a portion of this credit may be refundable.

A qualifying child must satisfy six tests:

• Relationship. This is your child or step-child (whether by blood or adoption), foster child, sibling or step-sibling, or a descendant of one of these (for example: grandchild, niece or nephew).

• Residence. The child must have the same principal residence as you for more than half the tax year. In certain cases, exceptions apply for children of divorced or separated parents, kidnapped children, temporary absences and for children who were born or died during the year. 

• Age. The child is under the age of 17 at the end of the year. Support. The child must not have provided more than one-half of his/her own support for the year.

• Dependent. The child must be claimed as a dependent on your tax return.

• Citizen. The child is a U.S. citizen, resident or U.S. national. 

The credit is reduced by $50 for each $1,000 (or fraction thereof) by which the taxpayer’s modified adjusted gross income exceeds the threshold amount.

If you already adopted a child or have simply started the adoption process, you may be able to claim a credit on your 2014 tax return. The credit is limited to the qualified adoption expenses you paid, up to $13,190. In addition, the credit is reduced when your modified adjusted gross income is between $197,880 and $237,880. 

The adoption credit is not always claimed in the same year the expenses were paid. When to take the credit depends on whether the child is a U.S. child or foreign child, when the expense is paid, and when the adoption is final. 

• If the child is a U.S. citizen or resident and the adoption expenses (including expenses for an unsuccessful effort to adopt an eligible child) are paid during a tax year prior to the tax year in which the adoption is finalized, the credit is allowed in the tax year following the year the expenses were paid. 

• If the child is neither a U.S. citizen nor resident, the credit is allowed only in the year the adoption becomes final.

• If an expense is paid for a U.S. child or foreign child during or after the year the adoption becomes final, the credit is allowed in the tax year paid or incurred.

If the adoption credit for the year exceeds the limitation for that year, the excess credit is carried forward to the next tax year. No adoption credit can be carried forward to any tax year following the fifth tax year after the year in which the credit is derived. Note: After 2011, the adoption credit is not a refundable credit for any adoption.

Some parents choose to place investments in their children’s names. These investments can be a good tax-savings strategy depending on your income bracket. Investment income includes interest, dividends, capital gain distributions and gains from the sale of capital assets (stock). If you plan carefully, each child’s first $1,000 of investment income will result in no tax. The next $1,000 of investment income will be taxed at the lowest rate.

It’s important to know that if the investment income exceeds $2,000, and the child is under the age of 19 (age 24 if a full-time student), he or she could be subject to “kiddie tax” rules. If your child will be subject to this tax, contact your tax professional for further advice. Parents can elect to include their minor child’s gross income on their tax return if the child’s gross income is more than $1,000 but less than $10,000.

The American Opportunity Tax Credit (AOTC) is a partially-refundable tax credit to help make college more affordable. A refundable tax credit allows a taxpayer to receive a refund if the amount of the taxpayer’s tax credit exceeds the taxpayer’s income tax liability. The AOTC is based on 100% of the first $2,000 of qualified expenses, plus 25% of the next $2,000 of such expenses paid during the year, for a maximum credit of $2,500. Up to 40% of the credit is refundable unless the taxpayer claiming the credit is subject to the kiddie tax rules. 

If you claim your child as a dependent, you can claim an education credit for his or her qualified education expenses. You can even include expenses paid by your child or someone else. You can choose not to claim your child as a dependent so he or she can claim the education credit. However, if an individual is eligible to be claimed as a dependent, that individual’s personal exemption deduction is zero. Please note: If you don’t claim your child as a dependent so he or she can claim the AOTC, your child does not qualify for the refundable portion of the credit if all of the following apply.

Your child was:

Under age 18 at the end of the year; or 

Age 18 at the end of the year and his or her earned income (i.e., wages, salaries, tips, etc.) was less than one-half of his or her support; or

A full-time student over age 18 and under age 24 at the end of the year and his or her earned income was less than one-half of his or her support.

At least one of the child’s parents was alive at the end of the year. 

Your child is not filing a joint return for the year.

The AOTC can also be claimed in the same year a beneficiary takes a tax-free distribution from a 529 plan, as long as the same expenses are not used for both benefits.

National Association of Tax Professionals