Got Kids? You Need to Know About These Income Tax Credits

Child tax credit

Having children brings a whole host of concerns, especially for first-timers--like me. Is my child receiving enough emotional support? How do I know she’s eating enough? Is it okay for her to cry herself to sleep? What type of diapers should I use?

In addition, financial concerns quickly become a reality as well. The cost of another mouth to feed, future college expenses. Fortunately, our tax system is set up in such a way that incentivizes socially beneficial activities--like having kids.

To the taxpayer, this means something extra special--TAX CREDITS--which are very different and typically more financially advantageous than tax deductions.

Here is a brief discussion of how tax credits differ from tax deductions, some of the main tax credits available to families with kids or wanting to grow their family, and how to make sure you qualify for these credits.

Tax Credits are Very Different Than Tax Deductions

In my recent article about tax deductions, I discussed the difference between above-the-line and below-the-line deductions. Both types of deductions ultimately reduce your taxable income, potentially resulting in tax savings to you.

Tax credits, on the other hand, constitute an actual dollar-for-dollar reduction in the amount of taxes you owe, not simply a reduction of your taxable income. So if your final taxes owed are $2,000 and you qualify for a $1,000 tax credit, you now owe $1,000. If you qualify for a refund of $500 and also qualify for the same tax credit, you now qualify for a refund of $1,500.

Clearly tax credits are the creme de la creme of tax savings, but they don’t tend to be earned for just any ol’ thing either. Tax credits, as you’ll see, tend to incentivize socially beneficial or economically necessary activities. For parents, these activities mostly come down to two broad categories (at least, the way I look at it): Having kids and taking care of kids.

Uncle Sam Wants Us to Have Kids

The first, most well-known tax credit is the annual Child Tax Credit. The amount of this credit is up to $1,000 for each eligible child. How does a child qualify? Each child must be under the age of 17, unmarried, a U.S. citizen, and a dependent of the taxpayer.

But notice I said the credit is “up to $1,000.” There is a phaseout for qualifying for the Child Tax Credit--if your AGI is too high, it could be reduced or go away completely. This is why it can be so advantageous to try to lower your AGI as much as possible through above-the-line deductions. Doing so can affect the amount of your Child Tax Credit!

A lesser known tax credit is the Adoption Tax Credit. The amount of this credit is up to $13,460 per eligible child. The credit is received as qualified expenses are incurred over the course of adoption a child, even if that time frame spans several years. The tax credit may seem significant--and it is--but adoption can be extremely expensive as well. The credit is even more favorable when it comes to adopting children with special needs.

As I mentioned, this credit can be claimed as long as there are qualified, adoption-related expenses. These include legal fees, costs of hiring an attorney, and other related costs. Like all other tax credits, the Adoption Tax Credit also phases out depending on your AGI.

Uncle Sam Wants Us to Take Care of Our Kids

Parents with dependents who attend college can qualify for tax credits as well. The government wants your kids in college, and they’re willing reward you for it.

There is an extra benefit for claiming children as dependents who attend college. In most cases, children no longer qualify as dependents if they’re over the age of 19, however, if a child meets the IRS definition of a “student” then the parents can claim the child as a dependent until the age of 24.

Assuming you have a dependent college student for whom you’re paying eligible college expenses--like tuition--then you can claim the American Opportunity Tax Credit or the Lifetime Learning Credit (but not both).

The American Opportunity Tax Credit is up to $2,500 per student (total, not per year) depending on the level of qualified post-secondary education expenses. These expenses must be incurred over a maximum period of 4 years. Students must also be at least “half time” students to qualify. Phaseouts for this credit also apply.

The Lifetime Learning Credit is quite different. This credit can be claimed for all post-secondary schooling and professional schooling expenses. It can also be claimed--and this is very cool--for expenses incurred by taking courses or training to improve your job skills over your life. This has allowed folks like me to develop myself professionally long after completing college. The same tax credit is available to you assuming you’re paying these expenses for a dependent.

I hope this brief discussion of tax credits has been helpful. The government provides some great incentives as you raise and care for your children--and yourself. It’s worth understanding tax credits, their applicable phaseout rules, and their place in your financial plan.