Raising a child is expensive, but under the Tax Cuts and Jobs Act (TCJA), there are tax breaks available to parents of minors that can reduce overall tax liability. While parents are no longer allowed a personal exemption for each child, there are several other credits and taxes under the TCJA that parents should be made aware of as the new filing season begins. Additionally, there are also some potential tax increases, such as the Kiddie Tax, to consider.
Child Tax Credit
The Child Tax Credit is one valuable option that was improved by the TCJA. On a tax return, a credit is even more impactful than a deduction in that it will reduce the taxes owed dollar-for-dollar, whereas a deduction only decreases the taxable income. This particular credit is available for all children under age 17 who are claimed as a dependent on the tax return. Tax reform doubled the amount of the credit from $1,000 per child to $2,000 per child, and added a $500 credit per non-child dependent.
More taxpayers will be able to take advantage of this credit in 2018, as the income limitation for the credit’s phase-out has increased. In 2017 the income limitations were $75,000 for single taxpayers and $110,000 for married-filing-jointly taxpayers. Now, in 2018, those limits are $200,000 for single taxpayers and $400,000 for married-filing-jointly taxpayers.
Another improvement to the credit is the change from non-refundable to refundable. With the TCJA, up to $1,400 of the Child Tax Credit is refundable. This means that even if the tax liability is $0, the filer can still receive a refund of up to $1,400. All changes will expire after December 31, 2025.
Child and Dependent Care Credit
A Child and Dependent Care Credit is available for parents paying high monthly daycare bills. The same credit that was available in 2017 remains for the 2018 tax year. To qualify, the child must be under 13 years of age or physically or mentally disabled. The credit amount will vary depending on the taxpayer’s earned income. Qualifying expenses can include fees paid for daycare, after-school programs, and day camps. Other dependents, such as elderly parents or relatives, can qualify for this credit too, and expenses paid for nurses or home care providers would also be considered qualifying expenses.
The credit will equal 20% to 35% of the total qualifying expenses paid, and the adjusted gross income (AGI) will be used to figure out the appropriate percentage. The total amount of expenses claimed cannot exceed $3,000 for a single child and $6,000 for two or more children. Unlike other credits, the credit itself will never fully phase out as AGI increases.
Many states offer their own version of the Child and Dependent Care Credit. For example, Georgia offers 30% of the federal credit up to $315 for a single child and $672 for two or more children. One should consult a tax advisor to determine if your state of residence affords a similar credit.
High net-worth individuals in a high income tax bracket sometimes consider shifting some of their income-producing assets to their children’s names. However, before doing so, they should be aware of the “Kiddie Tax”, which was established to keep parents and grandparents with higher tax rates from taking advantage of their children’s lower tax bracket by moving unearned income to their children. This rule applies to children 17-years or younger, or to children ages 18 to 23 who do not have earned income that exceeds half of the amount of their support. Unearned income includes items like dividends, interest, and capital gains.
Although the Kiddie Tax has been around for a while, the TCJA brings about a few changes. While the actual tax rules did not change, the rates at which a child’s unearned income is taxed did. In 2017, a child’s unearned income that exceeded $2,100 was taxed at the parents’ ordinary and capital gains tax rates. Now, in 2018, a child’s unearned income that exceeds $2,100 is taxed at the trust and estate tax rates. This change to the tax rate structure has made calculating the owed tax simpler, but could subject more income to higher tax rates.
The old bracket’s top tax rate was 39.6% and the new tax bracket’s top rate is 37%. However, the brackets are smaller for trusts, and more dollars will be taxed at the higher rates. Thus, children with large amounts of unearned income could see a significant tax hit. Now, without careful planning, a child could easily pay a higher tax rate on the dividends they receive than their parents would have paid.
If you have any questions about the various taxes and credits you could receive for your dependents or would like more information about strategic tax planning or estate planning, contact a PYA executive below at (800) 270-9629.
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