Tax Tips

Take Credit for Your Kids

Each qualifying child could slash your tax bill by up to $1,000.

By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance

March 9, 2010

You love your children dearly, but you know only too well that they’re not cheap to keep -- except at tax time. Depending on your children’s ages and your income, each one may qualify for a child tax credit of up to $1,000, reducing your tax bill dollar for dollar. (A tax credit is more valuable than a tax deduction, which merely reduces the amount of income that is taxed.)

And in these tough economic times, when many families have seen their incomes slashed, some taxpayers may qualify for the newly expanded Additional Child Tax Credit, which could trigger a refund even if no tax is due.

Related Links

• New Ways to Save Big on Taxes
• TAXOPEDIA: Children and Other Dependents
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Basic child credit

In addition to the $3,650 personal exemption that you can claim for you and each member of your household, you can claim a tax credit of up to $1,000 for each of your children under age 17 as long as you meet the income eligibility requirements. The credit phases out in $50 increments for each $1,000 (or fraction thereof) by which your adjusted gross income exceeds $75,000 for individuals or $110,000 for married couples filing jointly ($55,000 for married filing separately).

The income level at which the credit completely disappears depends on the number of qualifying children. For example, a married couple filing jointly with one child would lose the credit completely when their income topped $129,001. But with two children, they could claim at least part of the child credit until their income exceeded $149,001, and with three children, the credit would disappear once their AGI topped $169,001. Use Form 8812 to claim the child tax credit.

Refundable credit

Some low-income families qualify for a refundable child tax credit, which was increased significantly as a result of the economic-stimulus package passed last year. The earned-income base for the refundable credit dropped from $8,500 to $3,000 for both 2009 and 2010. It is the second time in two years that Congress has lowered the income threshold, which, in turn, boosts the size of the refund available to qualifying taxpayers. It’s designed to put cash in the hands of Americans who may have lost their jobs or whose hours were cut back during this recession.

For example, a single mother of two children with $10,000 of earned income would owe no tax after claiming a standard deduction and personal exemptions for each member of her household. So the $2,000 in child tax credits normally would go to waste because she owes no tax. But under the revised law, she is able to claim a refundable tax credit worth the lesser of the unused child tax credit -- in this case, $2,000 -- or 15% of her earned income that exceeds the $3,000 threshold. In this example, her $7,000 of income over the threshold would translate into a refund of $1,050. So even those people who don’t have to file a tax return because they own no tax should file so they can collect a refund.

Child-care credit

If you pay someone to watch your child while you and your spouse work -- or while you are looking for work -- you may be able to write off some of your expenses for children up to age 13 or older children who are physically or mentally disabled. You can claim a tax credit for a portion of your expenses or use a flexible spending account at work, which allows you to pay your child-care related costs with pretax dollars.

The child-care tax credit runs from 20% to 35% of what you spend, depending on your income. Taxpayers with AGIs of $15,000 or less get the 35% credit, and the rate gradually declines to 20% for taxpayers with incomes above $43,000. The maximum credit is $3,000 for one child and $6,000 for two or more children.

The flex plan is often a better deal for higher-income workers because the money set aside for child-care costs not only escapes income tax, it also avoids the 7.65% Social Security and Medicare tax. So if you’re in the 25% federal tax bracket, running the maximum $5,000 of child-care expenses through your flex plan avoids a 32.65% tax hit, lowering your tax bill by $1,633. You'll save even more if your FSA contribution escapes state income taxes, too.

If the flex plan is better for you, note this twist: Although you can’t shelter more than $5,000 in a flex plan, the maximum child-care credit for two or more children is $6,000. So even if you max out your flex plan, you may be able to claim up to $1,000 of additional expenses through the child-care credit. That could lower your tax bill by $200 or more.

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