Congratulations! You have just been handed your first little bundle of joy in the hospital and have embarked on the long journey of parenthood. It is a trip full of joyful experiences that make the corresponding aggravations worthwhile, and it comes with many benefits — some of which are tax-related. You can look forward to taking advantage of these child-related deductions and benefits.
- Standard Exemption – Every child that you can claim as a dependent decreases your taxable income. For the 2015 tax year, that amount is $4,000. In the 2016 tax year, the exemption will rise to $4,050. The exemptions begin to phase out at an adjusted gross income (AGI) of $259,400 for single filers and $311,300 for married filing jointly.
- Earned Income Credit (EIC) – Designed to help lower income taxpayers, the EIC is a tax credit that is scaled along with income and the number of dependents claimed. See IRS Publication 596, "Earned Income Credit (EIC)" for details on qualifications and the scaling criteria. The maximum EIC amount for tax year 2015 is $6,242 for joint filers with three or more qualifying children, and that number will rise to $6,269 in 2016 (next year’s return).
- Child Tax Credit and Additional Child Tax Credit – For tax year 2015, each qualifying child can allow you to take a tax credit of up to $1,000 if your modified adjusted gross income (MAGI) is less than $110,000 for married filing jointly status, $75,000 if single or head of household, and $55,000 if married filing separately. If your tax bill was not large enough to take the full tax credit, you may be able to take the Additional Child Tax Credit, which is a refundable credit (meaning that it is a credit you can claim and receive as a refund even if you do not owe any taxes). Check out IRS Publication 972 for more information.
- Child and Dependent Care Credit – If you incur child care costs in order for you or your spouse to be able to work (or to look for work), you may be able to claim up to 35% of your child care expenses. The limit on the expenses that can be claimed is $3,000 for one child/dependent or $6,000 for two or more. That results in $1,050 and $2,100 in actual credit respectively.
- Education Credits – As your children get older, you may be able to take advantage of either the American Opportunity Credit (AOC) or the Lifetime Learning Credit (LLC) that applies to the costs of higher education — but you must choose between the two. The AOC can yield up to $2,500 in tax credits that are refundable up to 40%, while the LLC can provide up to $2,000 in credit but is not refundable. Details on qualifications and phase-out limits are available in IRS Publication 970, "Tax Benefits for Education".
- Tuition and Fees/Student Loan Interest Deductions – If you do not meet the qualifications for the education credits, you may be able to take the tuition and fees deduction, and you may also be able to deduct up to $4,000 in tuition and fees. Publication 970 also covers these deductions.
Take special care to investigate the tax credits, because they are more valuable than deductions. Tax credits are subtracted directly from the taxes that you owe, while deductions only reduce your taxable income, and therefore reduce your tax bill by the percentage of your tax rate. For example, a $1,000 deduction lowers your taxes by $250 if you are in the 25% tax bracket, while a $1,000 tax credit lowers your taxes by the full $1,000.
Who knew that your new addition to the family could bring you all these tax benefits? Don't forget about them come tax time — but in the meantime, simply get used to your new lifestyle and take the time to enjoy your new bundle of joy. Before you know it, he or she will be asking for the car keys… and then your insurance will go up!