The Tax Rule Changes That Families With Dependents Need To Know About

February 07, 2019

If you are one of those go-getters who has already filed your 2018 income taxes, you may have noticed the effect of the 2017 the Tax Cuts and Jobs Act changes – they are wide-reaching, but how much it affects your tax bill will depend largely on your life circumstances. For families with minors, there are some significant changes that may reshape their tax strategies. Here’s a summary:

No more exemptions

The first thing a family with dependents may notice is the elimination of exemptions. In years past, you would occasionally hear people congratulate the birth of a child with the mention an additional tax deduction. Come to think of it, this was probably more common among finance nerds, but it’s definitely something I’ve said before.

Anyway, in 2017, you could count on receiving an exemption of $4,050 for each person living in your household. With those exemptions gone, larger families have taken additional notice to determine if the Tax Cuts and Jobs Act truly yielded tax savings to them. The new tax code offsets the removal of exemptions with an increased standard deduction and a substantial change to the child tax credit, but it is worth noting that these credits are set in place only until 2025.

Child tax credit

Speaking of the child tax credit, this was another big change. Remember that tax credits are the nugget of gold at the end of the 1040. They offer a dollar for dollar reduction of your tax bill, rather than just a reduction in your taxable income like deductions. In years past, the child tax credit was $1,000 per child, but was limited to lower income earners – the credit phased out if you had AGI over $110,000 and were married filing jointly or $75,000 if you were single.

The new tax law increased the credit and made it applicable to more people. Starting in 2018, the credit can be as large as $2,000 per child with higher income limits: if you are married filing jointly, you’ll still qualify as long as your AGI is less than $400,000 or $200,000 if single.

In order to qualify for the credit you must have a “qualifying child” according to Publication 972: they must be under the age of 17 and living with you at least half of the year.

Kiddie tax

Income earned by a child is also taxed, but how much depends on what type of income it is – earned, such as through a summer job, or unearned such as dividends or interest on investments in the child’s name. In years past, income for a child that exceeded a certain level was taxed at the parent’s rate – this discouraged families from gifting investments to their minor children in order to avoid or lower the taxes on that income.

The new tax law changed how earnings over a certain level is taxed to children, and not in a favorable way. It makes the rules much more simple, but essentially, once it exceeds the threshold, a child’s income will be subject to the same tax rates as estates and trust.

This is a significant tax increase for many families who have shifted income to minor children in order to pay a lower tax rate. For earned income, the tax rate in 2018 now jumps to 24% for income over $2,550 and hits 37% for income above $12,500. For long term capital gains and qualified dividends, taxation starts at the $2,600 level and hits 20% at income of $12,700.

With this change it may make sense to realize any long-term capital gains on an asset gifted to a minor and use those funds to buy tax-advantaged investments like municipal bonds. To determine if a change is necessary in this area, consult Topic 553 and consult a tax professional.

Don’t miss these other tax benefits either

While the following provisions did not change substantially, you should determine if you are eligible to reap the benefits of these credits and deductions.

The Child and Dependent Care Credit

This credit allows you to reduce your tax burden by claiming day care and after school programs. This blog breaks down the benefit and the decision between using the credit or a flexible spending account.

Student loan interest deduction

You may be able to deduct up to $2,500 in student loan interest paid on qualified student loans. This blog dives into the specifics.

Education tax credits

The Lifetime Learning and the American Opportunity Credits can also offer tax relief for education costs. We offer a deeper dive into these credits here.

Even with exemptions gone, there are still opportunities to lower your tax bill when it comes to dependents. Careful planning will help you take full advantage of these opportunities.