Everyone hates taxes but one good thing about the U.S. tax code is the astounding number of tax credits and deductions that are geared towards taxpayers with children. These credits and deductions run the gamut from simply having children to college education credits and deductions.
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Most of these credits and deductions phase out or get reduced over certain income levels, but these income levels are high enough to permit most Americans to claim these credits and deductions on their tax returns. (For further reading, check out Tax Credits You Shouldn't Miss.)
Credits vs. Deductions
The first thing to understand is the difference between a tax deduction and a tax credit. A deduction reduces a taxpayer's taxable income by the amount of the deduction, while the tax credit is a dollar for dollar credit against taxes owed. This generally makes a tax credit more valuable than a deduction.
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The first set of credits and deductions are given to taxpayers just for having kids. Taxpayers get a personal exemption of $3,800 in 2012 for each dependent child under the age of 19, or under the age of 24 if they are a full time student. This exemption reduces taxable income by that amount. Taxpayers also get a $1,000 tax credit for each qualifying child under the age of 17. This credit starts to phase out when adjusted gross income exceeds certain levels that are particular to each taxpayers filing status (married filing jointly, single, etc.).
The earned income tax credit is for taxpayers that have earned income below a certain level. It is available regardless of whether a taxpayer has children, but the maximum income allowed while still being eligible for the credit is higher if a taxpayer has children.
In 2012, a taxpayer married filing jointly who has three children is eligible for the earned income tax credit as long as adjusted gross income and earned income is below $50,270. (For more on tax savings and kids, see New Baby, New Tax Break.)
The next group of credits and deductions are designed to promote education and soften the cost of that education for the taxpayer. There are a number of different programs under which taxpayers may be eligible. The first is the Coverdell Education Savings Account (ESA). The contributions are not tax deductible, but earnings grow tax free, and withdrawals are not taxable if used for qualified education expenses. This is also one of the few tax breaks from the IRS that can be used for College or qualified secondary and elementary education expenses.
Although the Coverdell Education Savings Account is not a deduction or credit, it is a benefit anyway because it helps reduce future costs. (Find out more in our Educations Savings Account Tutorial.)
The Higher Education Tuition Deduction is a deduction up to $4,000 for qualifying education expenses at the college level. This reduces your income subject to tax when you file your return.
The American Opportunity Credit is a credit up to $2,500 for qualified college educational expenses paid for each eligible student in 2012. Expenses include tuition, fees, books and other supplies. This credit is an expansion of the Hope credit for 2009 and 2010 which bumped the $1,800 limit up to $2,500 and increased the period it can be claimed from the first two years of college to the first four years.
The Lifetime Learning Credit is a credit up to $2,000 for qualified college educational expenses paid for each student eligible. Like the Hope Credit, the maximum tax credit is doubled to $4,000 for students attending eligible schools in a Midwestern disaster area.
No Double Dipping
One thing to note about the deduction and education credits above is that taxpayers can only claim one of them per student. For example, you can only claim either the expanded Hope credit or Lifetime Learning credit in the same year for the same student. Taxpayers should calculate the benefit for each credit they are eligible for and then claim the one that reduces taxes the most.
Get Proper Advice
These credits and deductions can be complex so please consult a tax advisor prior to claiming them. An excellent resource is the IRS web site, which has the entire set of rules in Publication 970, including eligibility and income levels at which the credits and deductions begin to phase out.
The U.S. tax code has evolved over the last generation to include many tax deductions and credits that provide benefits to taxpayers with children. These deductions and credits can significantly reduce the tax burden and should be claimed by those eligible. (Have all your tax questions answered, check out our Income Tax Feature.)
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