There is no doubt that having children can be joyous and exciting for any parent. However, along with this happiness comes responsibility and monetary expense. Raising and caring for children is not cheap. As such, the government provides two tax credits which may help you to offset some of this cost.
Tax credits work differently when compared to tax deductions. Once a tax credit is computed, it reduces your tax liability on a dollar for dollar basis. So if you have a tax credit of $500, for example, that is exactly how much you will save on your taxes.
With an equivalent $500 tax deduction on the other hand, you must multiply it by your marginal tax rate to determine your tax savings. So if you are in a 10% tax bracket, your tax savings will be $50 ($500 x 10%).
The two most common child related tax credits for individual taxpayers are discussed below.
Child and Dependent Care Credit
Do you pay to have someone watch your children while you and your spouse (if married) work or look for work? If so, you may be eligible for a tax break called the Child And Dependent Care Credit.
Unlike many other tax credits and benefits, this one is available regardless of your income level. However, the credit is nonrefundable. This means that it cannot be more than your income tax liability. Read on to determine if you qualify for this credit. The criteria are as follows:
Work and Earned Income Requirements
As mentioned above, this credit is intended to help defray the cost of caring for your child (or another qualifying individual) so that you (and your spouse if married) can work or look for work. So any expenses used for the credit must be incurred for this purpose.
You and your spouse (if married) must also both have earned income during the year in order to be eligible to claim the credit.
The amount of the dependent care expenses used to compute the credit cannot be more than your earned income for the year. If you are married at the end of the year, the maximum amount which can be used is the smaller of your or your spouse’s earned income.
Earned income generally includes wages from an employer, or self-employment income (earnings) from a business. A net self-employment business loss will act to reduce your earned income. Unemployment and workers’ compensation do not count as earned income.
If your spouse is a full-time student (for at least part of 5 calendar months), or disabled and unable to care for him/herself (and lived with you more than 1/2 the year), then there is no spousal earned income requirement.
Care Expenses Used To Compute The Credit Are Usually For A Child
The most common qualifying person for most who claim this credit is a dependent qualifying child who is younger than age thirteen when the care was provided.
In the case of divorced or separated parents, a child can be a qualifying person of the custodial parent even if the noncustodial parent claims the dependency exemption.
See Dependents – Who Can You Claim On Your Tax Return? for more detail on the various tests which determine who qualifies as a dependent qualifying child.
A Qualifying Person Can Be Someone Other Than A Child
However, dependent children are not the only ones who can be qualifying persons. Your spouse may also be a qualifying person if he or she is physically or mentally incapable of self-care and lived with you for more than half the year.
Further, an individual other than a spouse or child may also qualify. This individual must also be incapable of self-care either mentally or physically and must have lived with you for more than half the year. In addition, they must also be your dependent, or would have been your dependent but for the their failure to meet the gross income test or the joint return test. This (dependent) requirement is also met if they are not your dependent solely because you can be claimed as a dependent on another taxpayer’s tax return for the year.
Self care for this purpose is when the individual cannot care for their own hygiene or nutritional needs, or requires full time supervision to ensure their own safety or the safety of others.
Not All Care Qualifies
The care must be primarily for the well-being of the individual and may be provided in the home or at another location. Further, the care provider cannot be:
- Your spouse at any time during the year
- A parent of the qualifying person (if the qualifying person is your child and is under age 13)
- Your child who is under age 19 at year end
- A dependent for whom you or your spouse claim an exemption.
Note that if you pay someone to come to your home to provide the care, you may be a “household employer.” As such, you may be responsible for paying employment (payroll) taxes. See the instructions to Schedule H Household Employment Taxes for more information.
Examples of Nonqualifying Expenses
Expenses for care do not include the following:
- Food, lodging, clothing, education, and entertainment, unless they are incidental or can’t be separated from the cost of providing the care
- Child support payments
- Summer school and tutoring programs
- Overnight camp
- Transportation you pay for the care provider to come to your home to provide care
Examples of Qualifying Care Expenses
- Nursery school, pre-school, and similar programs for children below the level of kindergarten
- Expenses for before and after school child care for children in kindergarten or higher grades
- The cost of day camp or a daycare center
- Transportation provided by the care provider to and from the place where care is provided
- Fees paid to an agency in order to get the services of a care provider (as long as care is provided)
- Expenses for household services as long as they are at least partly for the well-being and protection of a qualifying person
- Payroll taxes you pay on the wages of a care provider
Expenses for child and dependent care may also qualify as medical expenses. Such expenses can either be used in computing the Child and Dependent Care Credit, or may be deducted as medical expenses. However, you can’t use the same expenses to claim both a credit and a deduction.
How Much Is The Child and Dependent Care Credit?
The credit is based on up to $3,000 of child care expenses for one qualifying person and up to $6,000 total for two or more qualifying persons.
The amount of the credit is computed by multiplying the expenses (up to the indicated limits above), by a percentage. This percentage varies depending on your income for the year. It can be as high as 35%, and falls to a minimum of 20% if your adjusted gross income exceeds $43,000.
So the maximum child and dependent care credit for taxpayers with one qualifying person is $1,050 ($3,000 x 35%), and the minimum would be $600 ($3,000 x 20%).
If you have two or more qualifying persons, the maximum credit is $2,100 ($6,000 x 35%), and the minimum would be $1,200 ($6,000 x 20%).
Employer Provided Child Care Benefits
You may be eligible to contribute pre-tax dollars to a flexible spending account (FSA) for dependent care through your employer. This amount would be reflected in box 10 of your Form W-2. Any child care benefits paid for by your employer are included here as well.
Employer paid benefits and pre-tax flexible spending account contributions essentially give you a deduction for the amount paid or contributed since they reduce your taxable wages. The maximum contribution is $5,000 ($2,500 if married but filing separately). Employer dependent care benefits in excess of $5,000 are taxable to the taxpayer.
Also, to the extent you do not use funds contributed to a flexible spending plan for child care, the difference will be picked up as wages on your income tax return. Use Form 2441 to report child care expenses paid from your flexible spending account.
It is also important to understand that you must reduce the maximum amount of allowable dependent care expenses in figuring your credit by the amount in box 10 of your Form W-2.
So, for example, if you have two qualifying persons and you contributed $5,000 to a flexible spending account via your employer, you can only use $1,000 ($6,000 – $5,000) as the dollar limit of care expenses in computing your Child and Dependent Care credit.
Qualifying individuals must also have a tax identification number, which is typically their social security number. You must fill out IRS Form 2441 in order to claim the credit. On this form you must report the name, address, and tax identification number of the care provider.
You also cannot claim the credit if your filing status is Married Filing Separately (MFS).
Child Tax Credit
Another child related tax credit available to many taxpayers is the Child Tax Credit (CTC). This credit, however, is generally not available to higher income individuals for tax year 2017.
How Much Is The Credit?
The credit can be as much as $1,000 per qualifying child. However, it can be limited if your income is above certain thresholds.
For tax year 2017, if you file as Married Filing Jointly (MFJ), the credit starts to get phased out when you reach $110,000 in adjusted gross income. If you file MFS, the phaseout begins at $55,000.
For single and head of household filing status, limitations kick in once your income reaches $75,000.
The credit also may be reduced if your tax liability before other credits is less than the CTC.
Who Is A Qualifying Child?
A qualifying child must be younger than age 17 at the end of the year. The child must also meet the joint return, relationship, support, citizenship, and residence tests. Further, the child must be claimed as a dependent on your federal tax return.
See Dependents – Who Can You Claim On Your Tax Return? for more detail on the specific tests which must be met to claim a qualifying child.
Additional Child Tax Credit
The Additional Child Tax Credit (ACTC) is essentially an extension of the Child Tax Credit. The Child Tax Credit is not refundable. This means that the amount of the credit is limited to the extent of your tax liability.
However, if your Child Tax Credit is limited because it’s greater than your tax liability, you may be able to claim the rest of it as the Additional Child Tax Credit. This credit is refundable, so you will receive a tax refund if you claim it.
The ACTC is 15% of your taxable earned income which is in excess of $3,000. The maximum amount of the credit is $1,000 per qualifying child.
Note: New legislation expected to take effect for tax year 2018 will double the maximum CTC to $2,000 per child. Up to $1,400 of this amount may be refundable (currently the ACTC). The thresholds under which the credit begins to be phased out will also increase to $200,000 for single filers, and $400,000 for those filing jointly.
When preparing your tax return, it is important to make sure you claim all deductions and credits to which you are legally entitled. As such, a little knowledge can go a long way to making sure nothing falls through the cracks.
If you pay a professional to prepare your income tax return, make sure you provide any pertinent information relating to child and dependent care expenses. With regard to the Child Tax Credit and Additional Child Tax Credit, no additional information which isn’t already otherwise needed to prepare the tax return is necessary. If you have a new addition to the family, make sure you provide the pertinent information to your accountant.
Finally, whether you prepare your tax return manually, using tax software, or use a tax preparer, look it over before filing to make sure there are no glaring errors or that nothing obvious has been missed. At the very least ask your accountant or someone else if you are not sure.