Most parents wouldn't trade the experience of raising children for anything in the world.
If only it weren't so darn expensive. Between the medical bills, child care and college tuition, it's a wonder parenting hasn't gone the way of the wet nurse. Fortunately, the government offers some generous tax breaks to help ease the financial burden. It's up to taxpayers, of course, to take full advantage of them -- and in some cases this can be difficult, since it may involve figuring out which breaks are more beneficial than others.
There are a few things parents should understand. First, most child-related deductions and credits are available whether families take the standard deduction or itemize deductions. Second, there's a difference between deductions and the more coveted tax credits. Don't confuse the two. A deduction, such as the college tuition and fees deduction, merely decreases taxable income. A tax credit, such as the child-tax credit, allows taxpayers to subtract the amount dollar for dollar from their tax bill, or add the amount to their refund.
The most generous tax breaks come with income limits. The tax credits in particular are geared more for middle- and lower-income families. If you don't qualify for a credit or deduction, you can still save money by setting aside pretax dollars in flexible-spending accounts for medical and child-care expenses.
Here's a brief summary of the most common tax breaks available for parents. Some of the rules can be complicated, to say the least; when in doubt, consult a tax adviser.
Exemptions. Let's start with the basics. Every member of a household potentially counts toward a tax-deductible exemption on the family tax return. In 2013, each exemption equates to a $3,900 deduction. So a married couple with two kids qualifies for four exemptions totaling $15,600 in deductions.
Tuition and fees. Helping a child pay for college? Uncle Sam will cut you some slack. In 2013, parents can deduct up to $4,000 in tuition expenses and mandatory enrollment fees provided their modified AGI doesn't exceed $130,000 for married couples or $65,000 for single parents. That deduction gets cut in half to $2,000 for married couples making between $130,000 and $160,000, and for single parents earning between $65,000 and $80,000. The deduction is wiped out entirely for those with higher modified AGIs. Parents should also note that the college tuition and fees deduction can't be used in conjunction with the education credits, which we will discuss later. Note that this tax break is scheduled to expire at the end of 2013, but it will probably be renewed for 2014.
Student-loan interest. Even if parents set aside money for their child's college tuition, chances are they'll still need to borrow money. Thankfully, a portion of qualifying student-loan interest (loans from family, for example, don't count) is also tax deductible. The IRS allows parents to write off up to a maximum of $2,500 in loan interest. For 2013, this deduction phases out for married filers with modified AGIs between $125,000 and $155,000 and for single filers between $60,000 and $75,000. The only rule here is that students must be enrolled at least part time in a degree program to qualify. For more on student loans, see our story.
Child-tax credit. In a parent's eye, a child is priceless. However, Uncle Sam puts the figure at $1,000, in the form of a tax credit. And unlike some other credits and deductions, the government doesn't limit how many children qualify. So if you have four little darlings under the age of 17, expect to get $4,000 wiped off your tax bill.
Like most credits, this one also has income restrictions, but they vary depending on how many children parents are claiming. The child-tax credit starts to phase out at modified AGIs that exceed $110,000 for married couples filing together, $55,000 for married filing separately and $75,000 for single parents.
Child and dependent care credit. Two-income households with children under 13 years old qualify for a dependent-care credit to help cover child-care expenses. The IRS allows working parents and those looking for a job (students and disabled parents also qualify) a credit of 20% to 35% on expenses up to $3,000 in child care for one kid and $6,000 for two or more kids. This translates into a maximum credit of $1,050 for one child and $2,100 for two or more kids.
The credit for parents earning more than $43,000 shrinks to just $600 for one child and $1,200 for two or more kids. Higher-income taxpayers should set aside pretax dollars in an employer's flexible spending account instead. We'll talk more about these later.
American Opportunity credit. As we mentioned earlier, there are two education credits. The American Opportunity credit is for parents who are helping a child pay for college, and is worth up to $2,500 per student per year. To qualify, the student must be in his or her first four years of post-secondary education. (This credit can be used four years for each student, but there is no limit on the number of children who can qualify in any given year.) This credit phases out for married joint filers with modified AGIs between $160,000 and $180,000, and $80,000 and $90,000 for single parents.
Lifetime Learning credit. The Lifetime Learning credit is less restrictive than the American Opportunity credit. It covers students who have piled up more than four years of college credit and any other family members taking classes. Here's the hitch: It can be claimed only once on any given tax return. Some families, however, will be able to claim the American Opportunity credit for one student and the Lifetime Learning credit for another. The latter is worth up to a 20% credit on tuition and other qualified expenses of $10,000 for a maximum credit of $2,000. For 2013, the Lifetime Learning credit is phased out for married joint filers with modified AGIs between $107,000 and $127,000, and $53,000 to $63,000 for single parents.
Adoption credit. No one said adopting a child would be easy or inexpensive. There's the waiting game, the agency interviews and the lawyer fees. To help ease the process, in 2013 the IRS allows new parents an adoption credit worth up to $12,970. And if parents adopt a special-needs child, they can take the full credit even if their expenses totaled less than the value of the credit. In 2013, the credit starts to phase out when modified AGI exceeds $194,580.
Medical costs. Whenever possible, take advantage of an employer's cafeteria plan, also known as a flexible spending account program, to help pay for medical expenses. These allow employees to use pretax dollars to cover all out-of-pocket medical costs not reimbursed by a health plan. There are no income limitations. Most employers, however, limit contributions to $3,000 or $4,000.
Child care. As we mentioned earlier, parents earning more than $43,000 are generally better off signing up for an employer's dependent-care spending account. Just like the medical accounts, these plans allow taxpayers to set aside pretax dollars for child-care expenses. The IRS limit is $5,000.
The only danger with flexible spending accounts is that any money that isn't used is lost. So budget accurately. And don't forget to save those child-care receipts. Your employer probably won't allow you to simply fill out a form stating that tuition at your local daycare center is $5,000.
Finally, you may have noticed that we haven't discussed ways divorced parents can divvy up all these tax deductions and credits. As a rule of thumb, the parent with custody for the greater part of the year gets to claim them. Of course, sometimes parents share custody, and this can get a little complicated. Whenever possible, try to work these things out early and have them noted in the divorce agreement. This will save everyone one less headache come April.