Children and Tax Benefits

Summer, 2008

Updated Spring, 2009

With children come rewards, and yes, some of those rewards are monetary, by way of tax benefits.  However, few know the details about some of these tax savings.  The following is an overview of various tax benefits children provide.

The benefit most known is the tax deduction for a dependant child that is under the age of nineteen at the end of the tax year, twenty-four if a full-time student.  Yet, many do not realize that this deduction is phased out if income limits exceed a certain threshold, which begins at $166,800 for a single person in 2009.   Even fewer know that the child does not have to be your child to be a dependant.

In addition to the dependency exemption deduction, there are several tax credits available.  One of those tax credits is the Child Tax Credit.  This is a tax credit of up to $1,000 per child under the age of 17 at the end of the year.  This credit is also subject to phase out based upon filing status and modified adjusted gross income.  For 2009, phase out begins at $75,000 for a single person.

Next is the Dependent Care Credit.  If you pay someone to care for a dependent child that is under the age of 13 while you work or attend school full time, you can get a tax credit for those childcare expenses.  The maximum expense allowed for one child is $3,000, and is $6,000 for two or more children.  This credit ranges from 35% down to 20% of the childcare expenses, depending on your income level.

Then, there are the education credits, the Hope Credit and the Lifetime Learning Credit.  The Hope Credit is a tax credit of up to $1,800 on the first $2,400 of college tuition and fees for a first-year or second-year college student, enrolled at least half-time at an eligible education institution.  The Lifetime Learning Credit tax credit of up to $2,000 on the first $10,000 of college tuition and fees.  However, to claim either credit, you must be the one responsible for paying the college expenses.

College tuition paid for a dependent can also generate a deduction, the Tuition and Fees Deduction.  This is a deduction from taxable income up to $4,000 per year for qualified tuition and related expenses.   However, you may claim only the deduction or the credit for these expenses, depending on which is the most beneficial.  Again, there are income limitations.

Another way to get a deduction for your child’s education is to employ them.  A dependent can earn up to $5,700 in wages a year without owing any federal income tax and not have to file a federal income tax return, so if you own a business and your dependent child works for you, when you pay them for the services performed, you get a tax deduction for the wages paid.  The wages earned could then be contributed to a Roth IRA annually up to $5,000 and taxes would never be paid on the earnings.  The child could use the earnings for college, so in effect, your getting a deduction for financing the college education because your business deducted the wages.

Remember, the child must perform a service for the business in order for the business to get the deduction.  Use your imagination; there are many services children can perform for your business.  For example, a preschooler or infant could be used as a model for a business brochure or actor for a commercial.

If you have any questions regarding these or other tax issues, please contact our office for additional information.