Personal Finance

What Does It Mean To Maximize Deductions And Credit

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

Do you spend hours or days sifting through old receipts, canceled checks, W-2 forms, 1099s, and statements from your banks, credit card companies, and mortgage companies during tax season in order to prove every deduction and minimize your federal income tax liability?

Keeping up with tax filing requirements and attempting to maximize deductions in an ever-evolving tax system is a significant time commitment. Electronic filing of tax forms, withholding calculators, and anticipated tax payment status checks are all available free of charge from the IRS any time, day or night.

Many parents feel they are missing out on tax refunds, despite the fact that the IRS, tax preparation services like H&R Block, and other resources are available to them. Here’s a rundown of possible tax breaks and rebates for those who fit that description.

The Long-Term Financial Impact of Having a Child

The cost of raising a family consistently ranks among the highest of all major expenditures. Expenses like rent, utilities, and transportation are more difficult to ignore than others. Other costs, such as the potential loss of income when a parent remains at home to care for a kid, and the need for greater space, higher utility bills, and larger cars, are harder to put a price on.

Even if you aren’t tracking the price of child rearing, rest certain that someone else is. The 2015 Expenditures on Children by Families study was published by the United States Department of Agriculture in 2016, predicting the amount of money a middle-class American couple would spend on raising a kid born in 2015.

The organization calculated that the average family spends $233,610 between the ages of 0 and 17, which is between $12,350 and $13,900 per kid. This does not include any potential expenditures associated with furthering your education.

All parents, regardless of their economic level, are probably interested in recouping as much of their cash as possible from the government. So, let’s take a look at the tax breaks and credits that can apply to your household.

Deductions and credits for children

You or your tax adviser may then begin filling out the necessary tax forms once you have gathered, organized, and tallied all of your income and expenses. Depending on the details provided, you may either owe taxes, receive a refund of taxes already paid, or be even after filing your taxes for the year.

The following deductions and credits may help you pay less in taxes.

  1. Deductions, Standard or Itemized

At tax time, you may reduce your tax liability by either accepting the standard deduction or by itemizing your deductions. Regardless of your tax filing status, there is a standard deduction that you may use. In 2020, the standard deduction will be as follows:

Filing StatusStandard Deduction Amount
Single$12,400
Married Filing Jointly & Surviving Spouse$24,800
Married Filing Separately$12,400
Head of Household$18,650

People who are married and 65 or older, or who are blind, are eligible for an extra standard deduction of $1,300 from the Internal Revenue Service. An extra $1,650 can be deducted as a standard deduction by single taxpayers who are 65 or older or legally blind.

Mortgage interest, property taxes, and charity donations are all examples of itemized deductions.

Medical expenses that exceed 7.5% of your adjusted gross income (AGI) in 2020 can also be deducted as an itemized deduction. This can be a challenging level to fulfill, even for healthy taxpayers who have access to affordable health care via their employers.

Parents of children with specific needs including autism, cerebral palsy, and attention deficit hyperactivity disorder (ADHD) may, nevertheless, incur higher costs of this nature. As one of these parents, you might want to think about how much you spend on things like:

  • Special education, training, or treatment, including fitness programs advised by medical professionals
  • Aides necessary for the kid to get standard or special education
  • Evaluations of diagnostic significance
  • Some home enhancements
  • Diets for special medical conditions

Depending on how much of a burden your medical expenditures already are, including insurance premiums, copayments, and prescription drug prices, you may find that itemizing your deductions is worthwhile since they surpass 7.5% of your adjusted gross income.

Keep tabs on how much you spent on each of these things during the year, and deduct the total amount on Schedule A of Form 1040 if you’re eligible to itemize deductions. If your itemized deductions add up to more than your filing status allows for, you should itemize.

  1. Student Loan Interest Deduction

If you don’t want to bother with itemizing deductions but still want to deduct your student loan interest, you may. Interest paid on some student loans that you or your spouse are legally required to repay can be deducted up to $2,500.

High-income filers won’t be able to take advantage of the full deduction. If your MAGI for 2020 is between $70,000 and $85,000 (or $140,000 and $170,000 for a married couple filing jointly), the deduction will begin to be reduced. This deduction is not available to taxpayers whose MAGI is higher than the maximum allowed by their tax classification.

  1. Education Tax Credits

Parents who contribute to their dependent child’s college expenses can take advantage of a variety of tax benefits provided by the tax code. Income tax credits are preferable to deductions since they reduce your tax liability by the same amount for which you are eligible. 

If you are eligible for a tax credit and it exceeds your tax liability for the year, you may be eligible for a refund.

Tax Credit for Americans with Disabilities

Each eligible student can get up to $2,500 in annual AOTC benefits. A maximum of $1,000 can be reimbursed to you if this credit completely eliminates any tax liability you may have.
Students must be enrolled at least half-time and within their first four years of postsecondary study to be considered. There is no annual cap on the number of eligible children.

Limits on household income are also in place for those seeking the AOTC. If your MAGI is less than $80,000 ($160,000 if married filing jointly), you are eligible for the entire credit. 

Taxpayers with modified adjusted gross incomes (MAGIs) between $80,000 and $90,000 ($160,000 and $180,000 for couples filing jointly) would have their credit reduced, while those with MAGIs over these thresholds will receive no benefit at all.

Credit for Lifetime Learning

You can claim the Lifetime Learning Credit for an infinite number of years if you paid tuition, fees, and needed books and supplies at an eligible educational institution, up to $2,000 each return.

There is no need that the student be enrolled in school at a minimum of half-time or be working toward a degree.

If your modified adjusted gross income is between $59,000 and $68,000 ($118,000 and $136,000 for married couples filing jointly), the credit will begin to decrease. When the credit line reaches or exceeds the maximum amount, further borrowing is not permitted. Married couples who want to file separately are not eligible for the Lifetime Learning Credit.

  1. Additional Child Tax Credits

There are other tax benefits that help parents during their child’s dependent years.

Child Tax Credit

Any kid under the age of 17 who is your dependent and who resides with you for more than half the year is eligible for the Child Tax Credit. As much as $2,000 can be claimed each year per child. You can get your money back for as much as $1,400 of the credit you were given.

If your modified adjusted gross income (MAGI) is over $200,000 ($400,000 if married filing jointly), the credit will begin to be reduced. If you’re interested in learning more about the Child Tax Credit, check out IRS Publication 972.

Adoption Tax Credit

If you adopt a qualifying child, you can receive a credit of up to $14,300 of your qualifying adoption expenditures. Adoption costs that do not exceed the threshold include:

  • Adoption costs that are fair and essential
  • Court expenses and legal fees
  • Traveling expenditures (including amounts spent on meals and lodging while away from home)
  • Other expenditures directly associated with adopting a qualified kid

If you used these funds to adopt a kid who is already in your spouse’s family, you will not be eligible for this credit.

Although you cannot get your money back if the credit is enough to cover your whole tax bill, you can use the remainder to offset future tax bills for up to five years. For filers with modified adjusted gross incomes between $214,520 and $254,520, the benefit begins to be reduced.

Tax Credit for Child and Dependent Care

The Kid and Dependent Care Tax Credit allows working parents to deduct 20%-35% of their day care costs (up to $3,000 for one child, or $6,000 for two or more children) from their taxable income.

The kid must be younger than 13 years old, or of any age but unable to care for themselves due to physical or mental disability.

Earned Income Tax Credit (EITC)

When a taxpayer’s earnings fall below a specific threshold (which varies by filing status and the number of qualifying children), they are eligible to receive a refund via the Earned Income Tax Credit.

Tax Planning

After you’ve handed in your annual tax return, thoughts naturally wander to next year’s. By strategically utilizing tax deductions, tax credits, and income shifting between high and low tax years, tax planning can significantly minimize your tax liability. Take a look at these potential approaches.

Accounts for Flexible Savings

Employer-sponsored FSAs allow workers to pay for qualified medical and childcare costs using pre-tax cash.

You may put up to $2,750 into a health care FSA in 2020. Contributions are exempt from federal income tax, SSI, and Medicare. If you utilize the funds to pay for healthcare costs not covered by insurance, you can access them without paying taxes on them. Everything from dental care to prescription glasses and hearing aids falls under this category.

Daycare, preschool, summer day camps, and before- and after-school programs are all eligible expenses for reimbursement from a dependent care FSA. An annual maximum contribution to a dependent care FSA is $5,000 ($2,500 if filing separately). If you use the funds to pay for eligible dependent care costs, you can withdraw them at any time without paying taxes on the contributions or the earnings.

ABLE Accounts

With the help of the Achieving a Better Life Experience (ABLE) Act, families of people with disabilities can set up up to $15,000 every year. Although contributions to an ABLE account are not tax deductible on federal tax returns, earnings on investments within the account are exempt from federal income tax and withdrawals made from the account are also exempt from federal income tax as long as the funds are used to pay for qualified disability-related expenses.

Your contributions to an ABLE account may be tax deductible in the state in which you live. An individual’s impairment must have begun before they became 26 years old for them to be eligible for an ABLE account.

529 Plan

Parents may help their children save for college costs by contributing to a Qualified Tuition Plan, sometimes known as a 529 Plan after the section of the tax code that permits them.

The majority of 529 plans are managed by the state government, universities, and select banks. Contributions to a 529 plan are not deductible for federal income tax purposes, but profits on the account and withdrawals used to pay for eligible school expenditures (such as tuition, fees, books, computer equipment, internet connection, and room and board) are exempt from federal income tax. It’s common for states to reduce or eliminate taxes on residents who put money into state-run retirement programs.

Before 2018, 529 plans could only be used to pay for higher education costs, but as of that year, you may spend up to $10,000 annually to cover primary and secondary school tuition at a public, private, or religious institution.

Bottom Line

Though the U.S. tax law can be a pain to decipher, it’s well worth the effort if you have children to take advantage of the many tax credits and deductions available to you.

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