Tax Hacks Every Parent with Children Need to Know
Hello everyone! My name is Matthew and I am Catalina’s husband. Catalina and Sara asked me recently if I would like to write for the blog and I feel very privileged to get to be a part of it. Now, I don’t have all of the Mommy expertise and experience that Catalina and Sara have, but I have learned a thing or two over the years as a dad! A little background on myself, outside of getting to be married to the most amazing and beautiful woman and being a dad to two of the best gifts God could have ever given me, I spend a lot of time as a Certified Public Accountant.
With it now being February already (the years just keep moving so fast!) I figured I could write about some accountant-type stuff I have learned as a dad and a CPA. I know many of us are receiving our W-2s right now from our employers and many envelopes in the mail that have a stamp that says “Important Tax Information Enclosed” so we do not think it’s junk mail. So what better time to talk about kids and taxes!
Now I think it would be best for us all to avoid a lot of the tax mumbo jumbo and talk parent to parent about some things to be considering when doing your taxes, open enrollment at your place of employment or overall planning for the future. I think this is important, because there was a lot of cases where I wish I would have known about these tax-saving or tax-planning tips sooner in life.
The first thing I would like to mention is that all the tax reform information you keep hearing about on the news is not effective until 2018 (or when you are filing your tax return in early 2019). So much of what we will discuss today is relevant to your 2017 tax return or when signing up for benefits through open enrollment for 2018.
Below, I have categorized tips for education planning, open enrollment, and general tax credits.
Tips for education planning
1. 529 Plan – If you have not had to start covering a lot of education-related expenses, then it is a great time to start planning for all the future school costs your children will incur! We all know saving for college is a huge priority and for some parents who choose to send their children to a K-12 private school instead of a public school (which could be for a huge variety of reasons!) the realization has probably kicked in that tuition is not cheap! Since this is more about planning for the future, we will consider the 2018 rules here. The recent tax reform law has brought many great changes to 529 plans. Think of a 529 plan like a 401k plan that you participate in at your place of employment. Instead, you are contributing your hard-earned dollars into an account that will be specifically used for tuition and qualifying educational costs. While in the past, 529 plan funds could only be used for college. Beginning in 2018, you can use 529 plan funds to pay for K-12 tuition to $10,000 per year. The benefits of a 529 plan is that all contributions (after tax) will go into an account, which can then accumulate earnings on a tax-free basis (which means you won’t pay tax on any investment income you earn!). So the longer you save and the better the market does, the more tax-free earnings can be used to pay for education costs. Furthermore, more than 30 states offer tax deductions for 529 plan contributions. For more information on 529 plans, see this great article on CNBC
2. Coverdell Education Savings Account – Coverdell accounts are not talked as much as 529 plans, but they are still a great way to save for education costs! Unlike 529 plans, Coverdell Plans have always been able to be used for K-12 tuition costs. Contributions are also made with after-tax dollars and all earnings on contributions are tax-free when used to pay for qualified education expenses. Contributions are limited to $2,000 per year and per child (if you have two children you could contribute up to $4,000 broken into two different accounts). The main difference between a Coverdell account and a 529 plan is that Coverdell accounts allow you to self-direct your investments while 529 plans require you to invest into various investment vehicles such as a mutual fund (similar to a common 401k plan). The flexibility of a Coverdell account could allow you to take more risk in your investments (and this is by no means investment advice!). Still confused about the difference between a Coverdell and 529 plan? Find a great summary here.
3. Health Savings Account (HSA) – Are you having a baby this year? This is a great way to save some money! With a new bundle of joy comes many bills from the hospital. Luckily, many employers who offer high deductible medical insurance plans also offer HSA accounts. Amounts withheld from your paycheck are done so pre-tax and deposited into your HSA account, which can then be used to pay for qualifying medical expenses. Furthermore, if you over deposit, unlike a Flexible Spending Account (FSA), HSA funds rollover and accumulate year to year. Annual HSA contribution limits for 2018 are $6,900 for families.
4. Dependent Care Flexible Spending Account (DCFSA) – Many employers also set up FSAs that help with dependent care costs. A Dependent Care FSA is a pre-tax benefit account used to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child daycare. It is a great way to save money when paying for care so you can continue to work. You can set aside up to $5,000 per year in a DCFSA that not only is pre federal tax but is also pre-employment tax (7.65% in Social Security and Medicare tax). It is important to remember that if you are taking advantage of this benefit that many employers provide, then it would impact your ability to realize the Child and Dependent Care Tax Credit. However, typically a DCFSA would offer the biggest tax break. A more thorough explanation can be found here
Tips for general child tax credits
5. Child and Dependent Care Tax Credit – While all of our situations and family life differ, many of us have two working parents to make that budget work each month (you know you love your Mint app! The Child and Dependent Care Tax Credit allows for parents who are filing married filing jointly tax returns to claim a tax credit if both parents are reporting ‘earned income’ and paying for qualifying care expenses (can we get a shot out to those baby sitters and day cares who make it all possible!). As with most credits, there are phase-outs (phase-outs are essentially reductions in the available credit the higher your income is) at certain income levels, but the maximum credit is $3,000 for one person and $6,000 for two or more persons and it is calculated by taking 35% of those qualifying expenses. Please remember this is a big tax break for many parents as a credit offsets tax liabilities dollar for dollar and can result in a refund whereas deductions would only reduce your tax liability by your effective tax rate. For example, a deduction reduces your taxable income before your tax rate is applied so a deduction only results in a tax saving depending on what tax bracket the deducted income would have fallen into ($1,000 deduction at a rate of 25% results in a federal tax savings of $250). For more information, please refer to this greater summary on TurboTax
6. The Child Tax Credit – Another great way to take more credits on your tax return is to simply have more children! This credit is a simple $1,000 per child but phases out after you reach higher income levels ($75,000 for Single filers and $110,000 for married filing jointly). It is crazy to think about, but over the years, I have run into other accountants that have an “accountant’s prayer” that their babies come before their due dates in order to catch a tax break! For more information, please refer to this great summary on TurboTax
7. School Benefits – There are many other tax benefits through school such as the American Opportunity Credit and Lifetime Learning Credit along with tax benefits related to tuition and fees. While a lot of these credits and deductions change with time (including with tax reform), I encourage you to spend time looking at various opportunities. Please refer to great summary on TurboTax.
Well, those are all the tips and tricks I have for you this year. I hope that what can often come off as confusing and convoluted may have been a little easier to understand when spoken parent to parent. I know a lot of this information is also scattered and, if anything, maybe we made it a little bit easier to find helpful material.