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Tax Tips for Parents
- The custodial parent has the right to claim the child as a dependent unless that right is released to the noncustodial parent. If released, the waiver needs to be in writing, signed, and attached to the noncustodial parent's return. The waiver can be for one year, permanent, or any other way you want to do it. Form 8332 is the official IRS waiver, but you can also write up your own waiver and use it as long as it spells out who gets the deduction and is signed by the custodial parent. One item to note is that the custodial parent still has the right to claim Head of Household status, the Earned Income Credit, and Dependent Care Credit even though they have released the right to claim the child as a dependent. However, if waived, the noncustodial parent claims the $1,000 Child Tax Credit along with the dependency exemption.
- When can you claim your child as a dependent? If your child is younger than 19 at the end of the year (younger than 24 if a full-time student) and receives at least half of his or her support from you, then the child is a dependent. You can still claim your child as a dependent regardless of age if he or she has less than $3,950 of gross income and you are providing support. In considering whether you provide half of your child's support, factor in the "free rent" he or she receives from you if still living at home.
- If you are helping an adult child pay their mortgage and real estate taxes, don't directly pay the bills. Make a gift to your child and have them pay the mortgage and taxes. Unless you are a co-owner in the house, you are not entitled to take any mortgage interest or real estate taxes paid for your child's residence. Also, if you directly paid the bills, your child would not be able to deduct the interest and taxes on their return.
- Child care from relatives. If you pay your parents, adult child, or any other relative to watch your children while you are at work, those expenses are qualified child care expenses and can be used for the Child Care Credit. The person can't be a dependent on your tax return and must be age 19 or older. Your parents or whoever you pay for the child care will need to pick up the payments as income on their tax return.
- Take advantage of your company's cafeteria plan and other tax-free benefits. For example, your company's dependent care program is a great deal if you are in the 27% tax bracket or higher. The dependent care credit only gives you a tax credit of 20% of your child-care expenses, but through your company's cafeteria plan you will be getting a tax benefit equal to the tax bracket you are in plus a reduction in Social Security and Medicare tax and your state income tax. So if you are in the 30% tax bracket, you will be getting a tax benefit of 30% plus 7.65% in Social Security and Medicare taxes as well as a reduction of your state income tax.
- If you had a baby last year, you need to get a Social Security Number for your child before you file your tax return. The IRS will not allow you to claim a dependency exemption, Child Tax Credit or Earned Income Credit without a valid Social Security Number for your baby.
- If your child receives Social Security Benefits, the benefits are reported on your child's tax return and not your tax return. Social Security Benefits will almost always not be taxable to a child since a child's income is usually not high enough. Most children don't even have to file a tax return unless the child has W-2 wages or enough investment income to create a filing requirement. So if the only income your child has is Social Security Benefits, you do not need to file a tax return for your child.
- Newborn child: You can take a dependent exemption on your tax return for each of your dependents who was alive during some part of the tax year. This includes a baby born in the tax year or a dependent who died during the tax year. So if your child is born on December 31st, you are eligible to claim the full dependent exemption for that year.
- Dependents cannot claim exemptions for dependents. If you can be claimed as a dependent on someone else's tax return, you cannot claim any exemptions for dependents. For example, a student living at his parents' home has a two year old daughter. If his parents are eligible to claim the student as a dependent on their tax return, then the student cannot claim his two year old daughter as a dependent on his own tax return. Most likely, the parents would also be eligible to claim the grandchild as a dependent on their tax return too.
- Preschool and nursery school costs count as child care expenses for the Child Care Credit. For students in first grade or above, the portion of any payments that are considered tuition are not eligible for the Child Care Credit. But if part of the amounts you pay are for daycare for a first grader or above, then those amounts are eligible for the Child Care Credit.
- Head of Household: Don't file as Single on your tax return if you qualify to file as Head of Household. You will get a bigger refund if you file as Head of Household. If your ex-spouse claims your child as a dependent on his or her tax return, but the child lives with you, then you probably can still file as Head of Household. Also, if you can claim a parent, grandparent, nephew, niece, brother or sister as a dependent on your tax return, you can probably file as Head of Household.
- One of the tests to determine whether you can claim a child over age 23 or a parent as a dependent on your tax return is if you provide over half of their support. If the adult child or parent lives with you, factor in the value of free rent when analyzing whether you provide over half their support. Determine what a person other than a relative would pay to be renting a room in your house than include that value in calculating whether you provide over half their support. There are other tests that have to be met besides the support test in determining whether you can claim your adult child or parent as a dependent so look at those tests also.
Ex-spouse incorrectly claims child. In a divorce situation, the custodial parent is the one who can claim a child as a dependent on their tax return unless the custodial parent has signed a written document allowing the other parent to claim the child. So if your child lives with you for seven months of the year and with your ex-spouse for five months of the year, you are the custodial parent. If your ex-spouse e-files his or her tax return before you do and incorrectly claims your child as a dependent, then when you e-file your return your tax return will be rejected by the IRS because the IRS records show your ex-spouse already having claimed your child. If that happens to you, file a paper return instead of e-filing and attach a note explaining your situation and why you are entitled to claim your child as a dependent. The same thing will need to be done if your ex-spouse incorrectly claims the Earned Income Credit for your child and you are the one who should get the Earned Income Credit. The Earned Income Credit goes to the custodial parent even if the custodial parent has signed a written document allowing the other parent to claim the child as a dependent.
Kiddie Tax: If your child is under age 18 and has over $2,000 of unearned income (interest, dividends, capital gains, etc.) then part of their income will be subject to the "kiddie" tax. The "kiddie" tax would also apply if your child is a full-time student age 19-23, with earned income that is less than half their support. The kiddie tax is calculated on Form 8615 if your child files his or her own tax return and is calculated on Form 8814 if you report your child's income on your own tax return.
If your child has less than $1,000 in unearned income, then no tax return needs to be filed for the child and nothing need to be reported on your tax return. If your child has more than $1,000 in unearned income you can either report the child's income on your tax return by using Form 8814 or you can file a separate tax return for your child and use Form 8615. If you use Form 8814, your child will not have to file a return.
Filing a tax return for your child and using Form 8615 often saves more in overall taxes than using Form 8814. If you have items on your tax return that are affected by adjusted gross income such as IRA deductions and itemized deductions, then using Form 8814 and adding your child's income to your tax return could reduce your IRA deduction or itemized deductions.