Your Kids Could Lower Your Tax Bill Like Never Before
There’s a new tax break for many parents, but it ends when college expenses are approaching
ILLUSTRATION: RIKI BLANCO
Aug. 31, 2018 5:30 a.m. ET
Thanks to the new tax law, millions of American families will begin getting a $2,000-per-child break on their taxes—right up to when college expenses start looming.
Then they could get squeezed.
As part of the tax overhaul enacted late last year, Congress greatly expanded the child tax credit. This change has received less attention than other parts of the overhaul, but it will be highly important for many people.
Among other things, the change doubled the prior benefit of up to $1,000 per child under age 17 and also raised the income limit for the full credit from $110,000 to $400,000 for most married couples ($200,000 for most singles). Above these income levels, the credit phases out.
The upshot: “Many affluent families earning between about $140,000 and $400,000 who didn’t get a tax break for their children in the past will now qualify for one,” says Troy Lewis, a certified public accountant practicing in Draper, Utah.
A Bundle of Joy
Tax savings from the child credit for a married couple with three children under age 17
Note: Adjusted gross income, for most taxpayers
Source: Tax Policy Center
Mr. Lewis explains why. Under prior law, two principal tax benefits for most families were the child credit of $1,000 per dependent and the personal exemption for each family member, which was $4,050 in 2017.
Both tax breaks had important limits. The child credit disappeared as income rose above $110,000. And the personal exemption could lose value due to the alternative minimum tax, especially if a family had lots of children or high state taxes. A different provision phased this exemption out for higher earners.
The overhaul repealed the personal exemption and expanded the child credit. Overall, the expanded credit will be a better break for many filers—especially affluent ones—because they will be able to take its full value. In addition, the new $2,000 credit is a dollar-for-dollar offset of taxes. By contrast, the personal exemption was a deduction that reduced taxable income.
Here’s a simplified example from the Tax Policy Center illustrating the changes. Take a family with two parents and three children under 17. In 2017, the parents were in the 28% tax bracket and had taxable income of about $210,000, and they didn’t qualify for the prior child credit. They did qualify for $12,150 in personal exemptions for the children, and the deductions for these exemptions could have saved them about $3,400 in tax. But the tax savings could have been lower due to limits.
For 2018, the expanded child credit will reduce the parents’ tax bill by $6,000 even though there’s no longer a personal exemption. This provision expires after 2025 and is not indexed for inflation.
For lower earners, the expanded child credit also brings new benefits. Uncle Sam will now send a check of up to $1,400 per child under 17 to working people who don’t owe taxes, vs. $1,000 last year. The earned-income requirement has also dropped a bit. In order to qualify, each child must now have a Social Security number.
As under prior law, the new credit isn’t allowed beginning in the year when the child turns 17. At that point, the family can often receive a tax credit of $500 per dependent per year until the child is self-supporting.
This means that for many families, the credit drops sharply just as expenses for children are rising, as they become drivers and college approaches. For families who formerly could use the personal exemption for these children, the new $500 credit won’t offset its loss in many cases.
Many who also support indigent relatives, such as an elderly parent, will be at a disadvantage compared with prior law. These relatives also used to receive the personal exemption; now they can qualify for the new $500 tax credit, which often won’t offset the loss of the personal exemption.
For example, if a son in the 25% bracket got a full personal exemption for a parent he supported last year, that write off saved about $1,000 in tax, according to the Tax Policy Center. That’s more than double this year’s $500 credit.
This past week the Internal Revenue Service clarified an issue that further threatened to squeeze caretakers. Under prior law, the person being supported was allowed to have gross income up to the amount of the personal exemption and the caretaker could still claim the relative as a dependent. With the personal exemption repealed, it was unclear what this income limit would be.
In its clarification, the IRS said the indigent relative is allowed to have income equal to what the personal exemption would have been, after inflation. For 2018, the limit is $4,150.