Financial Focus: The Path to Your 2021 Tax Return – Children (Part 2 of 7)

Professor Anthony Rivieccio

If you read part one of our seven-part series on how to get all your tax money back, we will now discuss one of the best, one of the most complicated and one of the most fruitful ways: children.

According to the IRS, children are not your babies but people that are growing fast! What the IRS wants to know is whether they are your dependents. Do they produce income? Do you maintain their support? How old are they? Are you separated or divorced? Do both of you share the burden? Maybe only one? Therefore, what is a dependent?

Children and Dependents

In general, according to the IRS, “If your child was age 18 or younger at the end of the year or if your child is a student and age 23 or younger at the end of the year then you can claim your child as a dependent if your child did not provide over half of his or her own monetary support during the year.

In general, if your child is age 19 or older or age 24 or older and a student at the end of the year, then you can only claim your child as a dependent if the child made less than $4,150 during the year, and you provided over half of their support.

This rule also applies to other qualifying relatives who are not children, such as a parent, brother, or aunt. If the qualifying relative made more than $4,150 in income during the year you cannot claim the relative as a dependent, even if you are providing over half of their support.

There are a lot of special rules and detailed definitions for claiming a dependent that are found in the Form 1040 instructions. The above are just the general rules that apply to most people in claiming a dependent. If your situation is not typical, please reference Form 1040 instructions for full details on whether you can claim someone as a dependent.”

Divorce

According to the IRS, “In the case of divorce or separation, the parent who had custody of a child for the greater part of the year (e.g. the custodial parent) almost always is entitled to claim the child as a dependent, even if the noncustodial parent is providing the money for the child’s support.

However, a noncustodial parent can claim the child as a dependent if the custodial parent signs a document, such as Form 8332, releasing his or her right to claim the child as a dependent for a single year or for multiple years or if the pre-2009 divorce or separation agreement gives the noncustodial parent the right to claim the child as a dependent.

If the divorce or separation agreement went into effect after 2008, the custodial parent must sign Form 8332 or a similar document in order for the noncustodial parent to claim the child as a dependent.

If the child lived with each parent for the same amount of time during the year, the IRS will treat the child as the dependent of the parent who had the higher adjusted gross income during the year.

If you’re the parent who had custody of your child for the greater part of the year, then you can claim the Earned Income Credit, Dependent Care Credit, and Head of Household filing status, even if your divorce decree allows your ex-spouse to claim your child as a dependent or if you are allowing your ex-spouse to claim your child as a dependent.

The parent who claims the child as a dependent gets the Child Tax Credit, but only the custodial parent can claim the child for the Earned Income Credit, Dependent Care Credit and Head of Household filing status.”

Child Care Credit

According to the IRS, “Child care and dependent care expenses may be eligible for a tax credit. The child care expenses need to be employment-related.

The child care expenses must make it possible for you (and your spouse, if married) to go to work or look for work. Babysitting and child care expenses that aren’t related to your job aren’t eligible for the credit. Examples of qualified child care and dependent care expenses include payments to day care centers, work-related babysitting, day camps, after-school programs, nursery school, pre-school, domestic help, and nannies. Examples of expenses that do NOT qualify are overnight camps, transportation costs, and expenses to attend kindergarten or a higher grade.

You are eligible for the credit if you (and your spouse, if married) have earned income and maintain a household for a dependent age 13 or under or for a spouse or other dependent (regardless of age) who is mentally or physically unable to care for himself or herself. If your spouse is a full-time student, you still qualify for the Child Care Credit, even if your spouse has no earned income.

If both of you are students with no earned income, you can’t take the credit. The total amount of child care expenses that can be used for the credit is $3,000 for one child or $6,000 for two children. If you are reimbursed for child or dependent care expenses through your employer, the expense ceiling of $6,000 ($3,000 for one eligible dependent) is reduced by the amount of reimbursement or employer assistance.

To qualify for the credit, you must pay for more than one-half of the cost of running your household for the year and you and the qualifying child or individual must live in the same residence. In the case of divorce, the parent with custody is entitled to the Child Care Credit, even if the custodial parent has waived the right to take the dependent exemption to the noncustodial parent.

Payments to relatives count for the credit as long as the relative is not your dependent. So grandparents, uncles, aunts, and your adult children (19 or older) qualify as child care providers if you do not claim the relative as a dependent on your tax return. Keep in mind that if you claim the Child Care Credit for payments to a relative as a child care provider, the IRS will expect that relative to report the child care payments received as income on the relative’s tax return.

Child Tax Credit

According to the IRS, “Under the new tax laws that start with the 2018 tax return, the child tax credit has increased and the income phaseout has increased significantly so a lot more people are eligible to receive the child tax credits. A new $500 credit has been added for qualifying dependents who are older than age 16.

A $2,000 per child tax credit is available for each qualifying child under the age of 17. A qualifying child is a child, grandchild, stepchild, or foster child that you claim as a dependent on your tax return. The credit begins to be phased out for taxpayers with adjusted gross income above $400,000 ($200,000 for single and head of household).

If your potential Child Tax Credit is more than your tax, you may be eligible for the Additional Child Tax Credit. As a rule of thumb, most people who qualify for the Additional Child Tax Credit have three or more dependents age 16 or younger, and are not receiving the full $2,000 Child Tax Credit for each dependent since their credit is more than their tax. However, the refundable Additional Child Tax Credit is limited to $1,400 per qualifying child.”

Earned Income Credit (EIC)

According to the IRS, the Earned Income Credit (EIC) is a refundable credit for lower income taxpayers. There are a number of factors that determine if you qualify for the Earned Income Credit. If you qualify, the credit will be added to your refund and be included in your tax return.

In order to qualify for the EIC, you must have earned income, such as wages, tips or self-employment income. Your investment income, such as interest, dividends and capital gains, cannot be over $3,450. If you are younger than age 25 or older than age 64 and you do not have any qualifying children for the EIC, then you are not eligible for the EIC. If you have an ITIN instead of a Social Security number, you aren’t eligible for the EIC.

If your home was not in the United States for more than half the year, you aren’t eligible for the EIC. However, if you are a military member on extended duty overseas, you are still considered to have a home in the United States. If the IRS sent you a notice saying you can’t claim the EIC because of having your EIC disallowed on previous tax returns, then you aren’t eligible for the EIC.

The IRS can ban taxpayers from claiming the EIC for ten years if the IRS believes an EIC claim was fraudulent, or the IRS can do a two-year ban if the IRS believes an EIC claim was reckless or intentionally disregarded the rules. If you are a nonresident alien (a noncitizen who does not live in the United States) at any point during the year, you aren’t eligible for the EIC. If you are a qualifying child for the EIC for another person, such as your parents, you aren’t eligible for the EIC.

If you are claimed as a dependent by your parents or anyone else, you aren’t eligible for the EIC. If your filing status is Married Filing Separately, you aren’t eligible for the EIC.

To claim the EIC, your earned income and your adjusted gross income (AGI) must each be less than:

$49,194 ($54,884 if married filing jointly) with three or more qualifying children
$45,802 ($51,492 if married filing jointly) with two qualifying children
$40,320 ($46,010 if married filing jointly) with one qualifying child
$15,270 ($20,950 if married filing jointly) with no qualifying children

If your ex-spouse claims your child as a dependent, but you are the custodial parent whom your child lives with the majority of the year, you can still claim your child for the EIC. Then you will still be eligible to claim your child for the EIC and Child Care Credit even though your ex-spouse claims your child for the dependent exemption.

A qualifying child for the EIC is a child who meets the following three tests:
Is a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, your grandchild, niece, or nephew)

Lived with you in the United States for more than half of 2020. Temporary absences for special circumstances, such as for school, vacation, medical care, military service, or detention in a juvenile facility, count as time lived at home. A child is considered to have lived with you for all of 2020 if the child was born or died in 2020 and your home was this child’s home for the entire time he or she was alive in 2020.

Was under age 19 at the end of 2020, or was under age 24 and a student at the end of 2020, or any age and permanently and totally disabled.”
Join us next week when we cover part three: Itemized Deductions. While this area is now a bit “harder” you should learn the new rules (some good) about medical expenses, city and state taxes, home ownership, charity and job expenses.

Professor Anthony Rivieccio, MBA PFA, is the founder and CEO of The Financial Advisors Group, celebrating its 25th year as a fee-only financial planning firm specializing in solving one’s financial problems.