Determining Your Family Tax Benefits

Supporting children in college while also providing financial support for elderly relatives is commonplace today. If you are a source of support for others, be sure to review and understand all family deductions and credits that you may claim this year.

The dependent exemption, a flat deduction that is allowed for the taxpayer, spouse, and each dependent, was suspended; thus, no dependent exemptions will be allowed for tax years 2018–2025 (see Personal exemptions in this section) . Still, numerous other benefits are available, so it is important to understand who qualifies to be claimed as a dependent.

To qualify as your dependent, a person must be either your qualifying child or a qualifying relative. To be a qualifying child, the child:

  • must be your son, daughter, step-child, foster child, brother, sister, half-brother, half-sister, step-brother, step-sister, or a descendant of any of these;
  • must be under age 19 at year-end, or under age 24 at year-end and a full-time student (these age limits do not apply to disabled children);
  • must live with you for more than half the year and must not have provided more than half of his or her own support; and
  • must not file a joint tax return (unless this is done solely for the purpose of obtaining a refund).

To be a qualifying relative, the person:

  • must not be your (or anyone else’s) qualifying child;
  • must be related to you in one of the ways specified below, or must live with you as a member of your household;
  • must have gross income of less than $4,300 (for 2021); and
  • must receive more than half of his or her total support for the year from you.

The specified relationships for purposes of the qualifying relative test are: child (including adopted child), step-child, foster child, a descendant of any of these, siblings, half siblings and step-siblings, parents and ancestors (but not foster parents), step-parents, nieces and nephews (including the children of half siblings), uncles and aunts, son- and daughter-in-law, father- and mother-in-law, and brother- and sister-in-law.

Claiming Tax Credits for Dependent Family Members

Claiming Tax Credits for Dependent Family Members

As discussed in a previous section, . the new tax law nearly doubled the amount of the standard deduction, which for many taxpayers will mitigate the loss of the personal exemption. For others, a greatly expanded child tax credit should come as welcome relief.

You are allowed a credit for each dependent child who is under the age of 17 on the last day of the tax year. The amount of the credit is $2,000 per child, although that amount is phased out if your adjusted gross income (AGI) is over $200,000 ($400,000 in the case of a married couple filing jointly). If your credits exceed your tax liability, up to $1,400 of the credit may be refunded to you, increasing your tax refund. But there is an important caveat: the credit is allowed only if your child has a Social Security number (SSN). A child who has an ITIN (individual tax identification number) because he or she does not qualify for an SSN is not eligible for the $2,000 credit.

A special credit of $500 is allowed for each dependent who doesn’t qualify for the $2,000. This includes children age 17 or over, children with no SSN, and qualified dependents who aren’t children, such as parents or siblings.

Claiming the Child and Dependent-Care Credit

If you pay someone to provide day-care or household services for a member of your household while you work, you probably are entitled to a tax credit for child and dependent care. You can claim the credit for employment- related expenses incurred for the care of a member of your household who is your dependent under age 13 and any other dependent or your spouse incapable of caring for himself or herself.

Employment-related expenses include household services and expenses for care of the qualifying individual. Expenses of attending a daytime summer camp qualify if that is a reasonable means of providing care while you work. However, overnight camp expenses do not qualify for the credit. A preschool or day-care center generally qualifies, though an elementary school does not.

Credits are allowed for $3,000 of expenses for one dependent’s care, and $6,000 for two or more. The credit is 35% if AGI is $15,000 or less. For taxpayers with AGI over $15,000, the credit is reduced by one percentage point for each $2,000 of AGI (or fraction thereof) over $15,000.

The minimum percentage of 20% applies to taxpayers with AGI greater than $43,000. Eligible expenses are reduced for amounts excluded from income under an employer’s dependent-care assistance program. Special rules apply if your spouse is a student or is incapable of caring for himself or herself.

Most dependent-care payments to relatives qualify, unless the relative is a child of yours under age 19 or a person who qualifies as a dependent of you or your spouse. You must include the name, address, and taxpayer identification number of the care provider on the return. If the care provider is a tax-exempt organization, only its name and address must be furnished.

Paying tax on your children’s income

Paying Tax on Your Children’s Income

Special “kiddie tax” rules can apply to the net unearned income of children under the age of 19 and college students under the age of 24. These rules are meant to discourage the transfer of property to dependents in order to have the income from such property taxed at lower income tax rates. The new tax law significantly simplified how these rules apply.

Beginning in 2018, if your child is subject to these rules, his or her unearned income will be taxed as if it were retained in a trust. Trusts are subject to similar income tax rates as individuals, but the brackets are much lower. For example, the top marginal tax rate of 37% applies to a married couple filing jointly with taxable income in excess of $600,000. The same tax rate of 37% applies to a trust—and a child subject to kiddie tax—with taxable income in excess of $12,500.

However, in some cases you may be eligible to elect to include your child’s income in your tax return as if it belonged to you. This could result in a lower tax burden, if your effective tax rate is lower than the trust tax rate that would apply to your child’s income. The administrative ease of filing only one tax return, and the cost saving of not having an additional tax return prepared, should also be taken into account when deciding whether to make this election.

Alimony Makes a Difference for Both Parties

Alimony Makes a Difference for Both Parties

Alimony is essentially an amount paid by a person to a spouse or former spouse under a divorce or separation agreement. Usually, these payments provide support to a spouse or former spouse with whom you no longer live. Alimony does not include child support payments or property settlement amounts. If you pay alimony, you may deduct it from your gross income in the year you pay it—even if you do not itemize—as long as you meet certain requirements. Your spouse or former spouse must include alimony in his or her gross income in the year it is received.

In certain situations, it may be possible for the parties to a divorce to elect out of treating payments as alimony for tax purposes. If this is done, the former spouse making the payments cannot claim a deduction, and the former spouse receiving the payments does not treat them as income.

The new law changes the treatment of alimony paid beginning with divorce settlements or decrees of separate maintenance concluded in 2019 and after. If you pay alimony under a post-2018 agreement, you will not be allowed a deduction and your former spouse will not include the payment in taxable income. (Alimony payments made in 2019 and after with respect to earlier divorces or separations will not be subject to this new rule.)

In general, alimony is paid from the spouse with more income to the spouse who has less income, i.e., from the spouse in a higher tax bracket to the spouse in a lower tax bracket. The new rule could increase the overall tax burden on the total income of the two spouses, and will mean that the manner in which an equitable amount of alimony to be paid is calculated may need to be reconsidered because the paying spouse will effectively have less income with which to pay the alimony. Conversely, the receiving spouse will not have to take tax into consideration when determining the spending power of the amount received. Because not all states have adopted this provision, so alimony related to post-2018 settlements may be treated as deductible to the payor and taxable to the recipient at the state level.

Education: A Top Investment Priority

With higher-education costs climbing steadily upward (significantly above the general rate of inflation), many families are particularly concerned about accumulating sufficient funds to put their children through college.

Cost projections clarify the challenge. For example, based on projections from The College Board and recent average annual cost increases, a child who entered kindergarten in 2021 will face four-year costs in excess of $275,000 if he or she chooses an out-of-state public university in 2029 (assumptions include a 5% inflation rate on tuition costs). For a private college, costs would be significantly higher.

Various saving/investment alternatives exist. The major savings vehicles for college expenses are qualified tuition programs, also known as 529 plans, and Coverdell education savings accounts (Coverdell ESAs). 529 plans allow individuals to either prepay tuition credit or make cash contributions on behalf of a beneficiary for payment of qualified higher-education expenses. Contributions to a 529 plan are not subject to limits or phase-outs based on the donor’s AGI, but cannot exceed the necessary amount of qualified higher-education expenses of the beneficiary. Contributions are treated as gifts for gift tax purposes; annual donations of $15,000 (2021 amount) can therefore be made without incurring gift tax liability. Amounts in the plan grow tax free, and distributions from the plan are not treated as income to the beneficiary to the extent they are used to pay for qualified higher-education expenses.

Coverdell ESAs permit up to $2,000 to be contributed per year towards qualified education expenses of a beneficiary. As with 529 plans, contributions are treated as gifts by the donor to the beneficiary of the plan. However, in contrast to 529 plans, the ability to make contributions to a Coverdell ESA is subject to phase-out for single filers with AGI between $95,000 and $110,000 and for joint filers with AGI between $190,000 and $220,000. The contribution deadline is April 15 of the following year. Amounts within the account can grow tax free and are not treated as income to the beneficiary if used for qualified education expenses.

If your child receives a scholarship

Monitor estimated tax payments for children who receive taxable scholarships, as the institutions granting the scholarships are not required to withhold tax.

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