Children are expensive, but come tax preparation time, those little angels can save you a pretty penny or two on your tax bill. In addition to claiming a standard exemption for your dependents, you can also save taxes by claiming tax deductions and credits because of your children.
Credits and Deductions Generally
Children can provide tax benefits in the form of both deductions and credits.
A tax deduction is a reduction in your taxable income, while a credit is a dollar-for-dollar reduction in your tax liability. For example, if you have a $3,000 tax deduction and a $3,000 tax credit, based on a 20 percent tax rate, your $3,000 tax deduction will save you $600 ($3,000 x 20 percent), and your tax credit will save you a full $3,000. If you have $50,000 of income, you will subtract the deduction first, giving you $47,000 in taxable income. With a 20 percent tax rate, you owe $9,400 in taxes ($47,000 x 20 percent). Then, you subtract your $3,000 credit, which leaves you owing $6,400 in total taxes.
Child Tax Credit
The Child Tax Credit is available to married spouses filing jointly if their combined income is less than $110,000. For single taxpayers, the credit is available for income less than $55,000. The Child Tax Credit is worth $1,000, but it is not refundable, meaning it cannot take you below zero (unlike the earned income tax credit, which is refundable, meaning you can receive a rebate even if you pay zero taxes). Generally, the Child Tax Credit is available for each child younger than 17 years old that lived with you for more than half of the year.
Child and Dependent Care Tax Credit
If you are a working parent and you pay a daycare or nanny to watch your younger-than-13-kids while you work, you can claim a tax credit up to $3,000 (or $6,000 if you have more than one child). The amount you claim cannot exceed either $3,000 or $6,000 or the amount you actually spent on child care costs, whichever is less. So if you spent $600 during the year on child care, you can claim $600. But if you spent $3,200 on one child, you can only claim $3,000. If you are married, you and your spouse must have earned income during the year or you don't qualify for the credit.
If you are married filing jointly, you and your spouse each can claim a personal exemption, which is basically the equivalent of a deduction. As of 2009, the personal exemption equals $3,650 per person. Additionally, you can claim a similar exemption for each dependent that is either (a) 19 years old or younger or (b) 24 or younger and a full-time student.
Other Deductions and Credits
If your child goes to college, you can claim either the Hope or Lifetime Learning Credit up to a certain amount of your child's tuition and expenses. Additionally, you might be able to deduct other costs exceeding the credits, including interest paid on student loans.
If your child runs up massive medical bills, you can deduct a certain portion of those medical costs. The formula for deducting medical costs is complex, and the amount you can deduct depends on a percentage of your income, but you should keep this in mind if your child has surgery, visits the ER or has other medical needs.