For millions of parents across America, tax season is characterized by stress, anxiety, frustration, and confusion. Aside from the fact that the IRS tax code is confusing, there’s the burden of trying to determine how to save more on taxes and keep cash in your pockets.
Thankfully, recent tax form legislation has lifted some of this burden by providing parents with a generous child tax credit. But before you file your 2019 return, it’s important that you know what this credit is, who qualifies, and how you claim it.
The Difference Between a Deduction and a Credit
Before we dig into the intricacies of the child tax credit and what it means for you and your family, let’s take a momentary sidestep and address a common point of confusion. We’re talking about the difference between a deduction and a credit, of course.
Though taxpayers often use these two terms interchangeably, the fact of the matter is that deductions and credits are two very distinct concepts.
- A tax deduction reduces the amount of income you pay taxes on. This means you could
- pay less in taxes – though the amount depends on which tax bracket you fall under. Your total amount of deductions is subtracted from your income and this gives your taxable income. Let’s say, for example, that you gross income is $50,000 and you have $5,000 in deductions. This leaves you with a taxable income of $45,000. If you’re in a 15 percent tax bracket, this means your $5,000 in deductions saved you roughly $750 (15 percent X $5,000).
- A tax credit is a dollar-for-dollar reduction in the amount of taxes you pay. In other words, it’s factored in after all of your income and deductions are calculated. If you owe $7,000 in taxes and you get a tax credit for $1,000, you only have to pay $6,000.
Both deductions and credits are helpful in lowering the amount of taxes you pay, but a credit is far more enticing than a deduction. At a 15 percent tax rate, a $1,000 deduction is worth $150, whereas a $1,000 credit is worth exactly $1,000. Keep this in mind as we discuss the child tax credit in this blog. Don’t tune this out – it can save you significant money every single year.
What is the Child Tax Credit?
The child tax credit, which was first enacted in 1997 and has been modified several times since, is a tax credit for parents and other qualified caretakers of qualified children. The Tax Cuts and Jobs ACT (TCJA) passed in 2017, and increased the amount from $1,000 to $2,000 per child. This means a family with four children can take up to $8,000 in credits.
It’s worth noting that the child tax credit is partially refundable. In other words, if the credit reduces a taxpayers tax rate below zero, they can still receive a portion of the credit as payment from the IRS. The refund is equal to 15 percent of qualifying earnings above $2,500 and is capped at a maximum of $1,400.
It’s also important to mention the fact that the child tax credit is not the same thing as the dependent exemption. In the past, the dependent exemption has allowed taxpayers to pull out a deduction for each qualifying dependent (which includes most children). The deduction was worth approximately $4,050 per dependent. The new tax reform law suspends the dependent exemption and replaces it with the child tax credit. (This ends up being far more advantageous for almost all taxpayers.)
Basic Requirements for the Child Tax Credit
As with every credit the IRS offers, there are certain requirements you must use to determine whether or not you qualify. In particular, we recommend you run through the following tests:
- Age Test
Age is probably the easiest factor to analyze. To qualify for the child tax credit, a child must have been under the age of 17 at the end of the tax year for which you’re claiming the credit. This means a child who turns 17 on December 23, 2019 does not qualify for the tax credit in that year. If that child’s 17th birthday weren’t until January 14, 2020, the child would qualify for a tax credit in 2019 but not in 2020.
2. Relationship Test
The IRS considers a “child” to be your own biological child, an adopted child, a stepchild, or a foster child placed in your care by a court or authorized agency. It’s also possible to claim a younger brother, sister, or a descendent of a qualifying individual (like nieces, nephews, or grandchildren) – so long as they satisfy all other tests and requirements.
3. Dependent Test
You can only claim a child tax credit for a child who is also claimed as a dependent on your tax return. As a reminder, a child must meet the following requirements to be considered a qualifying dependent:
- Be your child (biological, adopted, or foster), niece, nephew, sibling, or grandchild;
- Be under the age of 19 (or under the age of 24 if a full-time student);
- Have lived with you for at least 6 months of the year; and
- Have provided less than half of his or her own support for the tax year.
For most families, this is pretty straightforward. Difficulties with determining dependents typically arise when there are disputes over custody and other complex family matters.
4. Residence Test
The residence test says that a child must have lived in your home for more than half of the tax year in order to claim the child tax credit. There are, however, a few exceptions to the rule:
- A child who was born (or died) at any point during the year is considered to have been present in the home for the entire tax year.
- A temporary absence by the child (school, vacation, summer camp, etc.) or yourself (business, medical care, military service, etc.) counts as time the child lives with you in your home.
If you’re confused about how all of this works, a qualified tax professional can help you sort through the details.
5. Family Income Test
Finally, there are income requirements to qualify for the child tax credit. The phase-out threshold is $200,000 for individuals filing separately and $400,000 for married couples filing jointly. This means most taxpayers qualify for this credit. Only extremely high earners are disqualified.
Claiming the Child Tax Credit
Claiming a child tax credit is very easy and simply requires you to file a federal tax return. You’ll need to be prepared to supply valid Social Security numbers for each dependent and you won’t be able to claim a child who is already being claimed by another taxpayer. This means parents filing individually will have to discuss who claims the children (or how they’re divided up). It’s also important for parents with shared custody to coordinate who takes the credit.
If you’re just now learning of the child tax credit and believe you forgot to take it in previous years, you’ll need to amend your original tax return. It’s also worth noting that all qualifying children must have had a valid Social Security number during those years. Likewise, you’ll be restricted by the tax laws of that year. This means claiming a child tax credit prior to 2018 will only result in a $1,000 credit per qualifying child.
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