New and Improved Child Tax Credit:
For 2000 tax returns, the tax law allowed a credit of $2,000 per child under 17. Under the American Rescue Plan Act passed in March 2021, that child tax credit has been increased to $3,000 per child between the ages of 6 and 17, and $3,600 per child under age 6. Not only that, but the tax credit is fully refundable in 2021, unlike the old tax credit. This is not a tax deduction, but a dollar-for-dollar reduction in tax. The credit is reduced for taxpayers (filing jointly) with income of $112,500 or more, and completely goes away for taxpayers with joint income over $400,000.
Please note – in order to get this credit, you need a social security number for your child. So, if your child joins your family late in the year, you should not delay in applying for a social security number so that you will have it in time to file your tax return.
Increased Child and Dependent Care Credit:
If both parents are working, including self-employment, there is relief available for the cost of childcare in the form of the child and dependent care credit. Parents can claim a credit for amounts paid for daycare, home child-care employees, preschool or after-school programs, and some day camps during the summer.
The credit is based on expenses up to $8,000 for one child or $16,000 for more than one. A percentage of those costs (based on your income level) is credited toward your tax bill – and there is no income limit phase-out. In addition, this same credit is available for older children who are disabled or parents who qualify as dependents.
Adoption Tax Credit:
If you, like me, have adopted children, there is a fairly generous tax credit available to offset your adoption expenses. If you incur expenses to adopt a child under 18, or a special-needs person over 18, you can claim a credit for qualified adoption expenses incurred up to $14,440 (in 2020). For special needs children, the full $14,440 credit is available even if the adoptive parents spent less than that amount.
The child will need a social security number to claim this credit, and the rules are very specific regarding when you can take the credit relative to the progress of your adoption. This credit is phased out for taxpayers in higher brackets (amounts over $216,600). If your employer reimburses you for adoption expenses, that amount is excludable from income (subject to the rules above).
Hiring Your Child:
If you have your own business, there are several benefits (besides providing your child work experience) to hiring on your child as an employee for a legitimate business purpose. If you have a sole proprietorship or single-member LLC, your under-age-18 child’s wages will be exempt from both employee and employer taxes for social security and Medicare, a tax savings of nearly 18%. (You will want to consider 2020 COVID-19 tax relief as well, which could affect this.)
This exemption is not applicable if your business is incorporated, but there is an additional tax strategy that applies no matter how your business is organized. Since your employee-child now has earned wages, that child can make contributions to a Roth IRA up to the amount of their wages, and that Roth account can accumulate tax-free earnings throughout your child’s life.
Head of Household Status:
If you’re unmarried and providing more than half of the support for dependents living with you, you can claim “Head of Household” filing status rather than “Single” and benefit from both lower tax brackets and a higher standard deduction.
More Good News:
Parents may also benefit from tax-free education savings plans, tax credits and deductions, and the deduction of medical expenses for dependents (and some non-dependents in certain circumstances).
Pitfalls to be Aware of:
Children of dependent age may be taxed on investment income according to their parent’s tax bracket under the “Kiddie Tax.” In addition, the IRS is aware that child-based tax credit programs can be used by the unscrupulous to claim tax benefits so it’s important to maintain documentation of any credit claimed.
We would be pleased to help you through the details of these tax considerations.