Awesome Tax Credits
Tax Credits Available Without the Personal Exemption
The Tax Cuts and Jobs Act that took effect on 2018 tax returns, allowed certain tax credits to continue, but only for those who had qualified dependents. Prior to the new tax law, taxpayers had been claiming dependents as personal exemptions and got a $4,050 deduction on their 2017 return for each one.
So, a married couple with two children could deduct a total of $16,200 from their gross income – a pretty good deal. There were limitations, however, high income taxpayers had their dependents phased out, depending on the gross income they reported.
At first blush, the loss of the personal exemption appeared to be a drastic move. However, other changes that took effect made up for it. So, is there any benefit to claiming dependents on your tax return now? You bet it is. Several tax credits that were not affected by the new tax law, require the taxpayer to have dependents to qualify.
Filing as head of household
To claim this beneficial filing status, you have to be considered not married. You could be a single individual with a dependent, or you didn’t live with your married spouse for even one day during the last 6 months of the tax year.
When you file using that filing status, it gives you a higher standard deduction than if you filed as a single individual. What that means is that your standard deduction is $18,650 instead of $12,400 for the 2020 tax year. Plus, the income level is increased before going into a higher tax bracket.
In order to use that dependent for claiming the head of household filing status, you must have paid more than 50% of the dependent’s annual support. In addition, the dependent must be your qualified child or a qualified relative. Other guidelines must be met for each type.
Child tax credit
Normally, getting tax credits works better for you than getting a tax deduction. With the tax credit, you’re able to reduce your tax liability dollar for dollar – not so with a tax deduction. The child tax credit is one of the best that was not affected by the TCJA in 2018.
You need to have at least one child dependent to qualify for this credit. The new tax law in 2018 increased the amount of this credit from $1,000 to $2,000 per child. Under the old tax law, the credit used to phase out (lowered) when taxpayer’s income reached a certain level. The TCJA more than doubled the income levels so that more people could qualify for this benefit.
Some tax credits are refundable and some are not. This one is partially refundable depending on a few circumstances. How that works is, the credit is used to lower what you owe the IRS, and if the total tax liability is wiped out, the leftover credit, up to $1,400, can be sent to you as a refund.
There are a few requirements that must be met to qualify for this tax credit. The child that qualifies for this credit cannot have attained age 17 by December 31 of the tax year. Plus, you must have earned income of at least $2,500. If it exceeds $200,000, it is phased out. The child must have a valid social security number as well.
Credit for other dependents
This is similar to the child tax credit but not as generous. Beginning with 2018 tax returns, you can claim a tax credit for other dependents that you may be qualified to claim. The new tax law gives you a credit for $500, not much, but it’s something.
Most of the rules that qualify you for child tax credits are the same for this smaller credit. This credit, however, is not refundable like the child tax credit. But at least, it will reduce your tax bill by $500.
Child and dependent care credit
This credit was allowed to survive by the TCJA too, and has to do with expenses you pay to others for caring for your child while you go to work. This credit has some restrictions and in general equals up to a maximum of 35% depending on your income.
It provides the credit based on up to $3,000 in costs for care for one child and up to $6,000 of care costs for 2 or more children. The dependents claimed must be under the age of 13, or disabled and not able to care for himself.
You must have earned income to qualify, and if you’re married, the other spouse must also. The person caring for your child can’t be the other spouse, if married, the child’s parent, or another dependent on your tax return. This credit is non-refundable.
Earned income tax credit
This credit can be claimed whether you have a child dependent or not. However, the benefits are higher if you have one or more children as dependents. The purpose of the credit is to give low income families more money in their pockets.
To qualify for this credit, you must have earned income, but within certain limits. If too high, no credit is available. Plus, if your unearned income (interest, dividends, etc.) exceeds $3,650 for 2020, you can’t claim the credit. This credit is refundable.
The limits for the earned income tax credit are indexed each year for inflation. With the new limits established, it’s definitely worth your while to claim this credit even though you have no children.
Education tax credits
Two other tax credits that were passed over by TCJA are the American Opportunity Credit and the Lifetime Learning Credit. Both are education credits, but you can qualify for only one each tax year. They can be used by yourself, your spouse, or any of your qualifying dependents.
What this means is that you can claim one particular credit for one student and another credit for someone else, provided each has their own expenses that were paid. You cannot use one student’s expenses to claim both credits.
To qualify for the American Opportunity credit, the student must be attending college in any of the first four years. Those restrictions are not in the Lifetime Learning credit. For the AOC, the maximum credit allowed is $2,500 per student. Plus, up to 40% of that credit is refundable.
The Lifetime Learning credit has a cap of $2,000 per student. The calculation for it is 20% of the eligible expenses up to $10,000. Normally, it’s only tuition and fees.
Interest deduction for student loans
Your qualified dependents can also allow you to meet the requirements for taking certain tax deductions. Interest that you paid for student loans during the year for yourself, your spouse or your dependents can be deducted up to $2,500.
This deduction is an above the line and doesn’t get reported on your Schedule A. It’s taken as an adjustment to income, which is generally more beneficial. When the TCJA was being drafted, this deduction was eliminated, but was back in for the final version.
If you have sufficient expenses to be able to itemize your deductions in 2020, it may be to your benefit to complete Schedule A rather than using the new standard deduction. If, for instance, you or your qualified dependents have large medical bills, this may boost the overall Schedule A expenses.
In 2020, you can deduct as a medical expense, approved items that exceed 10% of your AGI (adjusted gross income). The IRS has a lengthy list of expenses that you can deduct. The 10% threshold is an increase over the 2019 one of 7.5%.
Other tax breaks for having dependents
The items in this article aren’t the only ones that give you a tax benefit for claiming dependents. The Adoption Credit is still available as well as a few more tax deductions.