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Child Tax Credit and Deductible Expenses

Tax Planning

The Tax Cuts and Jobs Act (TCJA) brought with it the removal of personal exemptions, which had been part of modern income tax since 1913, and changes to tax credits related to children and dependents.  If you have children/dependents, you know that they can create significant tax benefit.

Loss of personal exemption

In previous years, taxpayers benefited from personal and dependent exemptions on their annual tax return.  This meant that for each taxpayer, (1 for single filers and 2 for married filing jointly) plus each claimed dependent, the taxpayer received a deduction of up to $4,050.  This amount could easily add up to a sizable sum, especially for those families with many dependents.  For example, married filing jointly taxpayers with 4 dependents received personal exemptions totaling $24,300 ($4,050 x 6) on their 2017 return.  Personal exemptions were in addition to an itemized or standard deduction.  Under TCJA, personal exemptions are no longer available (no exceptions) and the standard deductions were significantly increased for both single and joint filers.

Changes to credit

Under TCJA, the Child Tax Credit (CTC) increased to $2,000 per qualifying child. The refundable portion of the credit is limited to $1,400 (up from $1,000 in 2017).  A new $500, non-refundable credit for other dependents (such as a parent or sibling that a taxpayer cares for) was also introduced.  Additionally, the earned income threshold for the refundable credit dropped to $2,500 from $3,000 (meaning you must have earned income of at least $2,500 for the tax year).  The income limit before credit phaseout increased to $200,000 or $400,000 for joint filers (meaning you cannot make more than $200,000 or $400,000 to be eligible for the credit).

What is meant by refundable and non-refundable in terms of the credit? When a credit is referred to as non-refundable it means that the amount can reduce your tax liability, but it cannot give you a refund.  In other words, if a taxpayer had a tax bill of $400 and claimed a parent as a dependent and received the $500 credit, their tax bill would be reduced to $0, but they would not get the $100 difference as a refund. For the CTC, the refundable portion is limited to $1,400 of the $2,000 credit so a tax payer with a $2,000 tax bill would have it reduced to $0 by the credit.  A taxpayer with a $1,000 tax bill would see that bill reduced to $0 but would also receive a refund of $1,000.  However, the refund resulting from the credit could never be more than $1,400.

Are there any age limitations to the CTC?

In order to claim the credit for a child, he or she must be under the age of 17 at the end of the tax year.  Additionally, you (the taxpayer) must claim him or her as a dependent on your tax return.

What if my child’s other parent and I are now divorced? 

Who can claim the credit? The first step in determining who should be claiming the credit is to refer to your divorce agreement.  If there is not specific instruction, then IRS guidance indicates that the parent with primary custody can claim the credit.  For 50/50 custody, there is a precedent for the IRS to side in favor of whomever makes the most money.  Consult your divorce attorney or CPA for more information.

I have a legal right to claim my children, but my ex-spouse filed before me and claimed the kids.  What can I do?

If you are filing electronically, your return will be rejected since your child/children’s social security numbers are attached to an already filed return.  We recommend filing your state and federal returns on paper.  The IRS and your state will review the return and see that the SSNs are associated with another return.  At this point you will receive official written notice from the taxing authorities about this issue.  Respond with a detailed description of the issue and explain your claim.  Provide copies of any supporting documentation such as the custody agreement in your divorce decree.

What are the rules for the $500 credit for other dependents?

For the most part the same rules apply to the $500 dependent credit and the CTC.  The significant difference is the age limit.  The $500 dependent credit can be claimed by the taxpayer for anyone over the age of 17 (the limit for the CTC) who lives with the taxpayer for at least 6 months out of the year that the taxpayer claims as a dependent on his/her tax return.  In other words, a taxpayer could claim their 20-year-old son who is a full-time college student. They could also claim their elderly mother whom they care for full time.

Other deductions related to children/dependents

In addition to the CTC, parents/guardians who pay for childcare can also benefit from a deduction of these expenses.  Deductible expenses include:

  • Day care
  • After school program (at child’s school)
  • Summer camps

You can also claim care expenses for a spouse or another individual you claim as a dependent (such as a parent or sibling) if he or she has lived with you for at least half the year and that person is unable to take care of him or herself.

What expenses do not count?

  • For children/dependents, extracurricular activities such as sports or music lessons are not considered deductible expenses.
  • You cannot claim childcare/nanny expenses paid to your spouse, the parent of the child (for example an ex-spouse), anyone listed as a dependent on your tax return, or your own child aged 18 or younger even if he/she is not claimed as a dependent.
  • If you are a single filer, you must have earned income to benefit from the deduction.  
  • If you are married, both you AND your spouse must have earned income.  You must have paid for the childcare to work or to find work.  Childcare costs paid so that the parent/guardian can be a full-time student or because he/she is unable to care for the child (such as from the result of a medical complication) doesn’t count as “working” for the purposes of the credit.

Important Note

Credit vs. deduction – what’s the difference?  To fully understand the tax implications of the CTC and deductible expenses you need to understand the fundamental differences between a tax credit and a tax deduction.  A tax credit is a straight reduction of tax due.  In other words, if your total tax bill for a year is $5,000 and you receive a tax credit, such as the CTC for one child in the amount of $2,000, your tax bill would be reduced to $3,000 ($5,000 - $2,000).Deductions, on the other hand, reduce your taxable income.  For example, if you are a single filer with $55,000 in income, your tax bracket is 22%.  Deductions move the needle.  If you took the standard deduction of $12,000 your adjusted gross income would be $43,000.  You would still be in the same 22% bracket, but your tax due would be based on $43,000 instead of $55,000.  If you itemized deductions totaling $19,000, your taxable income would be reduced to $36,000.  Not only would you be paying tax on significantly less income, but your new tax bracket would be 12%.

Other questions about changes to the personal exemptions, the CTC, or deductible expenses?  Get in touch with us!  We’re happy to help.