Determining Your Family Tax Benefits
Supporting children in college while also providing financial support for elderly relatives is commonplace today.
If you are a source of support for others, be sure to review and understand all family deductions and credits that you may claim this year.
The dependent exemption, a flat deduction that is allowed for the taxpayer, spouse, and each dependent, was suspended by the Tax Cuts and Jobs Act (TCJA); thus, no dependent exemptions will be allowed for tax years 2018 through 2025.
Still, numerous other benefits are available, so it is important to understand who qualifies to be claimed as a dependent. To qualify as your dependent, a person must be either your qualifying child or a qualifying relative.
Determining Your Family Tax Benefits
Supporting children in college while also providing financial support for elderly relatives is commonplace today.
If you are a source of support for others, be sure to review and understand all family deductions and credits that you may claim this year.
The dependent exemption, a flat deduction that is allowed for the taxpayer, spouse, and each dependent, was suspended by the Tax Cuts and Jobs Act (TCJA); thus, no dependent exemptions will be allowed for tax years 2018 through 2025.
Still, numerous other benefits are available, so it is important to understand who qualifies to be claimed as a dependent. To qualify as your dependent, a person must be either your qualifying child or a qualifying relative.
Claiming Tax Credits for Dependent Family Members
The TCJA nearly doubled the amount of the standard deduction, which for many taxpayers will mitigate the loss of the personal exemption. For others, a greatly expanded child tax credit should come as welcome relief.
You are allowed a credit for each dependent child who is under the age of 17 on the last day of the tax year. The amount of the credit is $2,000 per child, although that amount is phased out if your AGI is over $200,000 ($400,000 in the case of a married couple filing jointly). If your credits exceed your tax liability, up to $1,400 of the credit may be refunded to you, increasing your tax refund. But there is an important caveat: the credit is allowed only if your child has a Social Security number (SSN).
A special credit of $500 is allowed for each dependent who doesn’t qualify for the $2,000 child tax credit. This includes children age 17 or over, children with no SSN, and qualified dependents who aren’t children, such as parents or siblings. An individual must be a U.S. citizen, U.S. national, or U.S. resident alien to qualify for this credit for other dependents.
Claiming the Child and Dependent Care Credit
If you pay someone to provide household services or care for a qualifying member of your household while you work, you may be entitled to a tax credit for child and dependent care. You can claim the credit for employment related expenses incurred for the care of a member of your household who is your dependent under age 13 and any other dependent or your spouse incapable of caring for himself or herself.
Employment-related expenses include household services and expenses for care of the qualifying individual. The cost of a daytime summer camp should qualify if all other requirements are met. However, if the child or dependent stays overnight at the camp, the expenses would not qualify for the credit. Expenses for nursery school, preschool, or other similar programs may be employment related expenses. While the expense of an elementary school does not qualify, the expense for before- or after school care may qualify.
Credits are allowed for $3,000 of expenses for one dependent’s care, and $6,000 for two or more. The credit is 35 percent of the employment-related expenses if AGI is $15,000 or less. For taxpayers with AGI over $15,000, the 35 percent is reduced by one percentage point for each $2,000 of AGI (or fraction thereof) over $15,000 but not below 20 percent.
The minimum percentage of 20 percent applies to taxpayers with AGI greater than $43,000. Eligible expenses are reduced for amounts excluded from income under an employer’s dependent care assistance program.
Most dependent care expenses paid to relatives qualify, unless the relative is your spouse, the parent of the qualifying individual if the qualifying individual is your child and is under age 13, your child who is under age 19 or a person who qualifies as a dependent of you or your spouse. The name, address, and taxpayer identification number of the care provider must be reported on your return in order to claim the credit. If the care provider is a tax-exempt organization, only its name and address must be furnished.
In some cases, you may be able to pay a relative to care for your children. This approach allows you to provide income to a person who may be in a lower tax bracket while you use the credit.
— If your employer offers a dependent care assistance program, you should consider using this benefit. You may exclude from gross income up to $5,000 ($2,500 if you are married and filing separately) per year under an employer-provided program. While these amounts will reduce the expenses eligible for the childcare credit, the reimbursement plan usually provides better savings. The employer plan is free from Social Security and income taxes.
Paying Tax on Your Children’s Income
Special “kiddie tax” rules can apply to the net unearned income of children under the age of 18 and full-time college students under the age of 24. These rules are meant to discourage the transfer of property to dependents in order to have the income from such property taxed at lower income tax rates.
The kiddie tax rules apply when the child is required to file a tax return (but not a joint return) and at least one parent of the child is living. If a child is subject to the kiddie tax and their unearned income exceeds $2,200, it will be taxed at the parent’s marginal tax rate. In addition, the 3.8 percent net investment income tax may apply.
Alimony Makes a Difference for Both Parties
Alimony is essentially an amount paid by a person to a spouse or former spouse under a divorce or separation agreement. Usually, these payments provide support to a spouse or former spouse with whom you no longer live. Alimony does not include child support payments or property settlement amounts. For tax years through 2018, if you paid alimony, you generally could deduct it from your gross income in the year you paid it—even if you did not itemize—as long as you met certain requirements. Your spouse or former spouse included the alimony in his or her gross income in the year it was received.
In certain situations, it may be possible for the parties to a divorce to elect out of treating payments as alimony for tax purposes. If this is done, the former spouse making the payments cannot claim a deduction, and the former spouse receiving the payments does not treat them as income.
The 2017 law changed the treatment of alimony paid beginning with divorce settlements or decrees of separate maintenance concluded in 2019 and after. If you pay alimony under a post-2018 agreement, you will not be allowed a deduction, and your former spouse will not include the payment in taxable income. Alimony payments made in 2019 and after for divorce settlements or separation agreements entered into prior to January 1, 2019 are not subject to this new rule.
In general, alimony is paid from the spouse with more income to the spouse who has less income, i.e., from the spouse in a higher tax bracket to the spouse in a lower tax bracket. The current rule could increase the overall tax burden on the total income of the two spouses and will mean that the manner in which an equitable amount of alimony to be paid is calculated may need to be reconsidered because the paying spouse will effectively have less income with which to pay the alimony. Conversely, the receiving spouse will not have to take tax into consideration when determining the spending power of the amount received. Not all states have adopted this provision, so alimony related to post-2018 settlements could be treated as deductible to the payor and taxable to the recipient at the state level.
If you are paying alimony, carefully review your situation to ensure that you achieve the most desirable tax consequences. You may need to modify agreements to re-characterize payments or make certain elections. Consult your attorney and tax adviser.
Payment of alimony became more expensive for divorces and separations settled beginning in 2019 because the payment is now made from after-tax rather than pretax dollars.
Education: A Top Investment Priority
With higher education costs climbing steadily above the general rate of inflation, many families are particularly concerned about accumulating sufficient funds to put their children through college.
Cost projections from The College Board and recent average annual cost increases, show for a child who enters kindergarten in 2021, four-year costs in excess of $276,000 for an out-of-state public university in 2034 For a private college, costs would be significantly higher.
Various saving/investment alternatives exist. The major savings vehicles for college expenses are qualified tuition programs, also known as 529 plans, and Coverdell education savings accounts (Coverdell ESAs). 529 plans allow individuals to either prepay tuition credit or make cash contributions on behalf of a beneficiary for payment of qualified higher education expenses. In addition, 529 plans may also be used to pay up to $10,000 of expenses per student per year with respect to elementary and secondary schools.
Tax-free distributions from 529 plans can also be used to pay for registered apprenticeship programs and to pay down student loans. There is a lifetime limit for student loan repayments of $10,000 for a beneficiary and each of the beneficiary’s siblings. Additionally, no student loan interest deduction is permitted for payments made from the 529 plan.
If Your Child Receives a Scholarship
Students who receive scholarships may exclude from income the amount required for tuition, fees, books, and supplies. However, they must report as income any scholarship funds used for other expenses, such as room and board.
Monitor estimated tax payments for children who receive taxable scholarships,as the institutions granting the scholarships are not required to withhold tax.
