Making saving taxes a family tradition
While the Tax Cuts and Jobs Act (TCJA) has reduced or eliminated many tax breaks for the next several years, most child- and education-related breaks remain
intact. Some have even been enhanced. Be sure you and your family take advantage of available credits, deductions, and other tax-saving opportunities to make saving taxes a family tradition.
Child, dependent and adoption credits
Through 2025, the TCJA expands tax credits for families, doubling the child credit and adding a “family” credit for dependents who don’t qualify for the child credit. Tax credits reduce your tax bill dollar for dollar, so for many taxpayers, these expanded credits will make up for the TCJA’s suspension of dependency exemptions:
For each child under age 17 at the end of 2019, you may be able to claim a $2,000 credit. The credit still phases out for higher-income taxpayers (see Chart 2), but the income ranges are much higher than before the TCJA. So more taxpayers are now benefiting from the credit.
- For each qualifying dependent other than a qualifying child
(such as a dependent child age 17 or older or a dependent
elderly parent), a $500 family credit is now available. But it’s
also subject to the income-based phaseout.
- If you adopt in 2019, you may qualify for the adoption credit —
or for an employer adoption assistance program income exclusion.
Both are $14,080 for 2019, but the credit is also subject to an
income-based phaseout. (See Chart 2.)
Dependent care breaks
A couple of tax breaks can help offset the costs of dependent care:
Tax credit. For children under age 13 or other qualifying dependents, you may be eligible for a credit for a portion of your dependent care expenses. Generally, the credit equals 20% of the first $3,000 of qualified expenses for one child or 20% of up to $6,000 of such expenses for two or more children. So, the maximum credit is usually $600 for one child or $1,200 for two or more children.
FSA. For 2019, you can contribute up to $5,000 pretax to an employer-sponsored child and dependent care Flexible Spending Account. The plan pays or reimburses you for these expenses. You can’t claim a tax credit for expenses reimbursed through an FSA.
The “kiddie tax” generally applies to most unearned-income of children under age 19 and of full-time students under age 24 (unless the students provide more than half of their own support from earned income). Before 2018, unearned income subject to the kiddie tax was generally taxed at the parents’ tax rate.
Through 2025, the TCJA makes the kiddie tax harsher. Now a child’s unearned income beyond $2,200 (for 2019) will be taxed according to the tax brackets used for trusts and estates, which for 2019 are taxed at the highest marginal rate of 37% once taxable income exceeds $12,750. (See Chart 8 on page 30.) In contrast, for a married couple filing jointly, the 37% rate doesn’t kick in until their 2019 taxable income tops $612,350. In other words, children’s unearned income often will be taxed at higher rates than their parents’ income.
- If you’re saving for education expenses, consider a Section 529 plan. You can choose a prepaid tuition plan to secure current tuition rates or a tax-advantaged savings plan to fund education expenses:
- Although contributions aren’t deductible for federal purposes, any growth is tax-deferred. (Some states do offer breaks for contributing.)
- Distributions used to pay qualified postsecondary school expenses (such as tuition, mandatory fees, books, supplies, computer equipment, software, Internet service and, generally, room and board) are income-tax-free for federal purposes and typically for state purposes as well, making the tax deferral a permanent savings.
- The TCJA permanently allows tax-free distributions for elementary and secondary school tuition of up to $10,000 per year per student.
- The plans usually offer high contribution limits, and there are no income limits for contributing.
- There’s generally no beneficiary age limit for contributions or distributions.
- You can control the account, even after the child is of legal age.
- You can make tax-free rollovers to another qualifying family member.
- A special break for 529 plans allows you to front-load five years’ worth of annual gift tax exclusions and make up to a $75,000 contribution (or $150,000 if you split the gift with your spouse) per beneficiary in 2019.
Case Study: Why Roth IRAs are Tax-Smart of Teens
Zach, 16, is starting his first part-time job this year. Zach’s parents would like to get him in the habit of saving for the future, and they ask their tax advisor for the most tax-advantaged option. She suggests a Roth IRA, which can be perfect for teenagers because they likely have many decades to let their accounts grow tax-free.
Roth IRA contributions aren’t deductible, but if Zach earns no more than the standard deduction for singles ($12,200 for 2019) and has no unearned income, he’ll pay zero federal income tax anyway. So the tax-free treatment of future qualified distributions will be well worth the loss of any current deduction.
If Zach doesn’t want to invest too much of his hard-earned money, his parents could give him some of the amount he’s eligible to contribute. For example, if Zach earns $6,000 for the year, his parents could give him $5,000 so he could contribute the full $6,000 he’s eligible to contribute but still have $5,000 to spend as he wishes (or save for a shorter-term goal).
The biggest downsides of 529 plans may be that your investment options — and when you can change them — are limited.
Coverdell Education Savings Accounts are similar to 529 savings plans in that contributions aren’t deductible for federal purposes, but plan assets can grow tax-deferred and distributions used to pay qualified education expenses are income-tax-free. ESAs are worth considering if you’d like to have direct control over how your contributions are invested or you want to pay elementary or secondary school expenses in excess of $10,000 or that aren’t tuition.
But the $2,000 contribution limit is low, and it’s phased out based on income. Also, contributions can generally be made only for beneficiaries under age 18. When the beneficiary turns age 30, the ESA generally must be distributed within 30 days, and any earnings may be subject to tax and a 10% penalty.
Education credits and deductions
If you have children in college now, are currently in school yourself or are paying off student loans, you may be eligible for a credit or deduction:
American Opportunity credit. The tax break covers 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of expenses. The maximum credit, per student, is $2,500 per year for the first four years of postsecondary education.
Lifetime Learning credit. If you’re paying postsecondary education expenses beyond the first four years, you may benefit from the Lifetime Learning credit (up to $2,000 per tax return).
Student loan interest deduction. If you’re paying off student loans, you may be able to deduct the interest. The limit is $2,500 per tax return.
Warning: Income-based phaseouts apply to these breaks. If your income is too high for you to qualify, your child might be eligible.
Achieving a Better Life Experience accounts offer a tax-advantaged way to fund qualified disability expenses for a beneficiary who became blind or disabled before age 26. For federal purposes, tax treatment is similar to that of Sec. 529 college savings plans. Under the TCJA, through 2025, 529 plan funds can be rolled over to an ABLE account without penalty if the ABLE account is owned by the beneficiary of the 529 plan or a member of the beneficiary’s family. Such rolled-over amounts count toward the overall ABLE account annual contribution limit ($15,000 for 2019).