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How Children Can Impact Your Tax Situation

How Children Impact Parents’ Tax Situations

Children have tremendous tax implications for parents. Typically, the implications are favorable for the parent, as conditions associated with having children qualify the parents for certain exemptions and tax credits. This is a good thing, considering how expensive raising a child can be for parents. From diapers to diploma, children cost their parents far more than Uncle Sam provides in credits and exemptions. Without those tax breaks, some parents might have to consider asking their children for a refund on all those years of allowances, not to mention student loan payments, first cars, and that envious Senior trip to Europe.

Credits and Exemptions Start at Birth

For tax purposes, a child is considered a dependent the year they are born. Even if little Johnny is born at 11:59 on New Year’s Eve night, he is still considered by the IRS to have lived with his parents for the entire tax year. After all, he was taking advantage of Mom’s internal condo accommodations for nine months prior to making his appearance.Adopted children, even if the adoption process is not final, are considered a child of the parent and thus, qualify for exemption, provided all other conditions of a qualifying child are met. In addition to qualifying as a dependent child, adopted children offer an additional tax credit in the form of the Adoption Credit. Parents can claim a credit based on qualifying adoption expenses, once the adoption is final. The IRS offers details about the Adoption Credit.

Ongoing Tax Breaks

Parents spend a small fortune raising their children and planning for the child’s future. Food, shelter, clothing, daycare expenses, college funds, investments, all of these are normal expenses and future financial planning tools most parents worry about. Luckily, Uncle Sam provides parents with the ability to better afford current expenses to encourage saving for a child’s future.

Credits such as the Child Tax Credit and the Additional Child Tax Credit provide a considerable credit, based on adjusted gross income and the parents’ tax liability. When the amount of tax credit available under the Child Tax Credit exceeds the parents’ tax liability, some parents can qualify for the Additional Child Tax Credit. The IRS offers detailed information on the Child Tax Credit and the Additional Child Tax Credit in Publication 972.

Similar to the two child tax credits is Earned Income Credit. Known as EIC, this credit focuses on low to medium income level households with qualifying children. Although people without qualifying children can qualify for the credit, it is considerably reduced compared to the credits for families. Single parents, low in come families, and other struggling taxpayers can qualify for a refundable credit, meaning any credit amount over the individual’s tax liability is refunded to the taxpayer. Even if parents have no tax liability, they may be eligible to receive a refund.

Planning for the Future

When little Jane or Johnny arrives, most parents immediately start planning for the future through savings accounts and college funds. While interest income on savings accounts is taxable, parents have some options. Coverdell Education Savings Accounts, for example, allow parents to save money for their child’s college tuition with tremendous tax benefits. In some cases, under certain circumstances, the money saved is tax-free. Learn more about these savings vehicles at the IRS’s website.

Preschool Through Elementary School

Most states require children under 13 to have continuous adult supervision. For parents who need to work, that means daycare for children who have not yet reached school age. It can also mean daycare for school age children for the hours before and after school, or during school vacations. Uncle Sam knows how expensive daycare can be, so parents can claim a childcare tax credit, based on actual expenses. Certain rules and qualifications apply, and parents must provide the name, address, and taxpayer identification number of the person providing paid daycare.

High School, Part-time Jobs, and Claiming Income

Remember that savings account opened the month little Johnny was born? If parents continue to sock away a little bit here and a little bit there, the interest income can add up by the time Johnny starts high school. Likewise, those stock shares Great Aunt Mildred bought for Johnny’s second birthday are now paying dividends. Throw in the part-time job bagging groceries after school and Johnny could have a nice little bit of income coming in each year. That can affect Mom and Dad’s taxes.

Parents have two options in regards to their child’s earned and unearned income. Depending on the specific annual dollar amount, the parents can absorb the child’s income into the parents’ tax return and pay the applicable income taxes. Alternatively, if the child’s earned, unearned, or combined earned and unearned income are above IRS thresholds, the parents must file an individual return on behalf of the child. No matter which option is used, parents are liable for a minor child’s tax liability. For more information on children with investment, interest or earned income, consult Publication 929.

The Road to Higher Education and Independence

While parents can claim certain tax credits and exemptions throughout a child’s life, other credits and exemptions do not come into play until certain situations arise. For example, a child graduating high school and going off to college presents new tax implications for parents. The IRS allows certain higher education credits and deductions for interest paid on student loans. The American Opportunity Credit allows parents to claim a credit for each year their child attends a four-year post-secondary school. Once student loans accrue, parents can also deduct the interest paid on student loans in the form of allowable expense deductions. The IRS offers more information about higher education credits and allowable deductions on its website.