Money Guide for Self-Employed Parents

Learn which tax deductions and other benefits apply to your family

If you are self-employed and a parent, you qualify for a number of additional tax deductions and other benefits. Most of the benefits derive from deductions and tax credits on your income tax. Deductible expenses include health care, childcare, and education. As a parent, you may also qualify for special benefits. With this in mind, the following expenses could decrease your annual tax liability.

Key Takeaways

  • The child and dependent care tax credit allows you to deduct up to $1,050 in childcare expenses ($2,100 for two or more children) every year the child qualifies.
  • Families can deduct most healthcare expenses over 7.5% of their adjusted gross income (AGI).
  • Some deductions for education expenses can be filed retroactively for previous tax years, starting as far back as 2018.
  • Self-employed parents can employ their children and pay them a small salary that is tax-free.

Child/Dependent Tax Benefits

Child Tax Credit and Other Dependent Credit

With an estimated 16 million self-employed workers in the U.S., these deductions can impact millions of households. See which of them apply to you.

You can claim a child tax credit of $2,000 for each child under the age of 17 and $500 for children 17 and older or other dependents. In order to claim the full credit, your modified adjusted gross income (MAGI) must have been $200,000 or less if you file single or $400,000 if you are married filing jointly. The maximum refundable portion of the credit in 2022 is $1,500 with this refundable portion increasing to $1,600 in 2023.

Childcare Benefits

Paying a daycare center, babysitter, or even summer camp fees for a child can be a lot cheaper with tax benefits. Taxpayers with a child under the age of 13 or a disabled dependent of any age is eligible for a non-refundable tax credit worth:

  • Up to 35% of $3,000 in qualifying expenses (for a maximum benefit of $1,050) for one dependent, or
  • Up to 35% of $6,000 in qualifying expenses (for a maximum benefit of $2,100) for two or more dependents.

This tax credit is intended for both employed and self-employed parents and guardians who earn income regularly. Individuals and couples who have been unemployed for a part of the year can also use it. To qualify, all the following conditions must be met:

  • You must have earned income in the past tax year (both your spouse and you if you are filing together).
  • You must be the child’s (or dependent’s) custodial parent or caretaker.
  • You must either work and earn an income, or actively be looking for employment.
  • Your child or dependent must be under age 13—unless they have a physical or mental disability that makes them unable to care for themselves.
  • The provider(s) of childcare must not be your dependent or spouse, nor the child’s parent.

The IRS has a broad spectrum of expenses it considers childcare-related, which are not limited to daycare and babysitters. The full list of potentially eligible expenses includes the following:

  • Babysitter or licensed childcare center
  • Maid, housekeeper, or cook who cares for the child or dependent
  • Summer camps, day camps, and even sports camps can qualify if they care for the child or dependent while the parents are working. Overnight camps are not included and do not qualify
  • Before-school and after-school care for children under age 13
  • Nurse, or other care providers for disabled children or dependent.

Medical Expenses

Since Jan. 1, 2020, all qualified health expenses that exceed 7.5% of your AGI, including premiums, are tax-deductible. This applies to unreimbursed medical expenses and doesn’t cover cosmetic treatments.

Qualified health expenses that apply to children and their parents are as follows: 

  • Preventing, diagnosing, and treating mental or physical ailments
  • Surgery and body modification strictly for health purposes (and not cosmetic)
  • Transportation to a healthcare provider
  • Health insurance premiums
  • Prescribed medication

The IRS revised its previous decision and lowered the minimum AGI requirement for medical expense deductions from 10% to 7.5%.

Qualified self-employed individuals can write off 100% of their health insurance premiums. Taxpayers can apply this deduction on the first page of Form 1040—this is available to self-employed individuals regardless of whether they itemized or not.

Education Expenses

Since education is not considered a necessary expense in most cases, there are fewer avenues to decrease your annual tax liability through your child’s school and college fees. However, there are still several cases that could apply.

College Tuition Fees and Expenses

This deduction expired at the end of 2020. You could deduct expenses of up to $4,000 for 2020 and all years prior if your income was $65,000 or lower ($130,000 for married couples). 

However, individuals with income between $65,001 and $80,000 ($130,001 and $160,000 for married couples) only qualified for a $2,000 deduction. If you didn’t claim the deduction for a prior year, you need to file an amended tax return with Form 1040X.

College Tax Credits

Taxpayers with a modified adjusted gross income (MAGI) of $90,000 or less (and married couples with a MAGI of $180,000 or less) are eligible for the American Opportunity tax credit. This credit can reduce your taxes by up to $2,500 per year for four years of college.

If this option isn’t available, you can try the Lifetime Learning Credit. It can lower your tax by 20% of the first $10,000 you spend on enrollment and tuition fees with a cap of $2,000.

Single taxpayers must have a MAGI of $90,000 or less to qualify ($180,000 for married couples). For 2022 and 2023, the Lifetime Learning Credit is phased out for taxpayers with modified adjusted gross income in excess of $80,000 ($160,000 for joint returns).

Coverdell Education Savings Account (ESA)

You can invest $2,000 per child each year into a Coverdell ESA. These contributions are not deductible, but all distributions you make through this savings account are tax-free to the beneficiary—as long as they are used to pay the costs of lower, middle, or higher education.

The contributions can be made for children under 18. If your child does not go to college when the time comes, you can transfer the funds to another child or relative. High-income individuals and families are not eligible for an ESA.

Student Loan Interest Deduction

Interest on loans for college tuition or vocational school is also deductible. The deduction limit for qualified students is $2,500, but higher-income families are phased out. The tax deduction gets reduced and eventually phased out, depending on your income.

For 2022 and 2023, individuals with an income of $70,000 or higher ($145,000 for married couples) will see a gradual reduction in the amount of interest that's deductible. You can't claim the deduction at all if your income is $85,000 or more ($175,000 for married couples filing a joint return).

Child Support for Self-Employed Parents

Income received from child support is not taxable according to the IRS. Child support payments are typically calculated based on the net income of the paying individual. If that individual is self-employed, a number of issues can arise.

This is due to the subjectivity found in calculating net income for the self-employed. Generally speaking, self-employed income is calculated by deducting expenses required to operate the business from the total income generated by the business. Under such a scenario, the self-employed parent could potentially deflate income by claiming unnecessary business expenses, thereby reducing a child support obligation.

Income used to calculate child support payments for self-employed parents varies widely by state. Certain courts do not permit the consideration of tax exemptions or expenses that would have been incurred irrespective of the business, such as utility bills.

Due to the inherent subjectivity and potential for manipulation in claiming net income, the self-employed parent could be required to legally prove their income. The means to achieve this would vary depending on the applicable jurisdiction but is likely to require financial records, tax documents, and even bank statements to justify income.

If the spouse of the self-employed parent suspects inaccurate income reporting, they may turn to a certified fraud examiner to uncover concealed assets or a forensic accountant to examine financial records for exclusions.

Hiring Your Child

Sole proprietors (or partners, if they're both the parent of that child) and self-employed individuals can hire their children if they are under 18 years of age. You can pay your child up to the standard deduction—$12,950 for 2022 or $13,850 for 2023 for single filers—and they will not owe income tax or most employment taxes. You can even deduct this wage as a business expense.

Do Parents Pay Taxes on a Child's Income?

Dependent child pay is considered earned income for that individual. The child is subject to its own income tax assessment at their own individual tax rate. Be mindful that state tax treatment may vary.

Does My Child Need to File a Tax Return?

If your child earned less than the standard deduction amount during the tax year, the child will not be subject to taxes and does not need to file. If they earned more than the standard deduction amount, they may have a tax liability or may be owed a refund. In addition, a child who earns more than $1,150 in 2022 in unearned income such as dividends or interest must file a tax return.

How Much Can I Make Being Self-Employed Before Filing Taxes?

The IRS requires if you have net earnings of $400 or more, you must file a federal income tax return. You may not owe much (or anything) in regards to income taxes, but the IRS sets this limit arbitrarily low to ensure self-employed individuals remit self-employment taxes subject at much lower income thresholds.

The Bottom Line

Self-employed parents have many avenues through which they can strategically approach their federal income taxes. If they have a child, the taxpayer is still eligible for many child or dependent tax credits. In addition, the taxpayer may receive favorable tax benefits when their child goes to higher education or incurs medical costs.

Article Sources
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