Thursday, November 29, 2012

Tax benefits of Children Part 1: EITC

This is the first post in a series of how having a child benefits you on your taxes. EITC, Child Tax Credit, exemptions etc.

I do not think planning to have more kids is a good tax planning strategy of course, but that bundle of joy gets you a few extra tax benefits along the way!

Credit General Information
In general, a credit is better than a deduction. Deductions reduce income, credits reduce tax owed.

Example: If you have a $100 deduction and a 28% tax rate, then your tax owed will be reduced by $28.
Likewise, If you have a $100 credit (regardless of tax rate), then your tax owed will be reduced by $100.

Earned Income Tax Credit
The Earned Income Tax Credit is meant to provide a extra tax relief for working families and individuals.
The maximum credit for 2012  is $5,891 (Married, 3+ kids, earned income between $13,050-$22,300).

1. Income Limit: If your earned income* exceeds the limit, you are not eligible for the credit.

# of Kids Individual Married file jointly
0  $13,980  $19,190
1  $36,920  $42,130
2  $41,952  $47,162
3+  $45,060  $50,270

*Earned income includes: wages, tips, self employment earnings. NOT earned income: retirement income, unemployment, child support, interest & dividends.

2. Number of Kids: your Child is a child if it meets the following tests:
  • a. Relationship Test (child, stepchild, foster child, sibling, half-sibling, or a descendant thereof)
  • b. Age Test (<19, or <24 if a full time student, or any age and disabled)
  • c. Residency (they lived with you more than 6 months)
  • d. They aren't married, if married they don't file a joint return with their spouse (unless its for a refund).

3. Investment income: Cannot exceed $3,200 (interest, dividends, capital gains, some rents and royalties.)

4. You or your spouse must be at least 25, but less than 65 years old.

Credit Amount
Use the table to find your income amount, and how much your credit is worth!

The IRS has yet to officially release a table, but here is a link to a draft: Unofficial EITC Table

Note that this is a VERY watered down version of the credit rules.
Other considerations not mentioned in this post include:
  • Treatment of Scholarship/grant income
  • Income is actually your AGI number, which includes a series of deductions (including student loan interest deductions, moving expense deductions etc.)
  • Treatment of the credit if you have foreign investment income etc.

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