And what's the difference between the child tax credit and a dependent credit?
As we rapidly approach tax season, many of us are anxious to learn how to make the most of our returns, especially during such a tumultuous time in history. For parents, the child tax credit is an exciting prospect.
But what is the child tax credit, and how can we make sure we get it?
I sat down with Mary Tonita Austin, Founder and CEO of MT Austin and Associates, LLC, a financial services company, and founder of The Wealth Activator. Austin is an expert in comprehensive accounting services for individuals, non-profits and small business owners, and she shared information about the child tax credit.
What exactly is a child tax credit?
Austin: A tax credit is a way to reduce your taxable income. So, when you file your taxes you list your income [and provide] the W-2 or, if you have a business, you have to state what your wages or your gross income were for that year. And you can reduce that by deductions. Then the next thing that reduces your taxable income is your credits.
So, credits are almost like money. There are a few credits that are technically called "refundable credits," which means that depending on your income tax liability, you will actually get that as cashback in your refund, whereas deductions just decrease the amount of income that they're going to tax you on.
For 2020, the child tax credit is $2,000 per dependent child, and dependents are under the age of 17. It does get phased out, or reduced as your income increases.
The new tax law added another dependent credit, which a lot of people don't know about. So, those are for older children or parents or in-laws who may live with you and are too old to be technically dependents. There's a $500 credit that you can get for them. So, it's a little something...[afterall] they're eating food in your house and using electricity, but...you're not getting the full dependent credit for them.
How can somebody figure out the nuances of whether or not an older child or a parent counts for this $500 credit?
Austin: You could go to the IRS website and use their tool to determine if the person in your home qualifies as a dependent or "other dependent" and how much credit you can get for each person.
It's typically anyone who probably would have been a dependent if they hadn't aged out of the child tax credit and still live in your house and eat your food.
So, an example might be an older child who has aged out of the child tax credit but, because their dorm closed for the pandemic, is living at home with you?
Austin: Well, if a child is attending college and you're still providing half their support, they are still a dependent, but if they've graduated and are still living with you they would be an "other dependent." Another example would be elderly parents who are living with you and are retired, or a child not in college but is over 16 and still eating you out of house and home! So, depending on the age of the student, you can still claim them on your tax return and get a credit for them as an "other dependent."
But that gets a little tricky because some students are working. They may be making a good amount of money, and they may want to file their own tax return.
If they file their own tax return, then you cannot claim them as a dependent?
Austin: You can claim them if they're filing their own return but if you do, they have to understand that they're being claimed as a dependent. I see a lot of people get tricked up with that. Their kid is like, "Oh, I'm all independent, and I'm going to file my own return because I worked at Macy's for the summer," which is fine because they want to get [a] little refund...But if their parent has already claimed them as a dependent, then whoever files last is going to get jammed up.
So, the parent and the child have to know how each other are filing, and usually, the parent gets a better refund for claiming them, especially if they're underage. But I would definitely want to let them know, "Don't go filing without checking that box that says I'm claimed as a dependent on another person's tax return."
If somebody is unsure about deductions and credits, this is where contacting a tax professional like yourself comes into play, right?
Austin: Yes. A few years ago, it was much easier to navigate all these laws, but when they made that major tax law change, it really made it difficult for the average person to follow and to know if they were claiming all the credits and the deductions that they were allowed to claim.
There were also some deductions that the federal government restricted that the states will still allow. If you're not knowledgeable and you're not just a plain "it's just me and no kids, and I just have a W-2," then you might want to really invest in finding someone that knows the laws to file.
So, making an initial investment into a tax professional can pay off.
Austin: Sure. Just that other dependent credit alone can fund your tax preparer.
I think that it feels particularly important to work with a nice, warm, nonjudgmental financial expert. How can somebody go about finding a tax professional with whom they feel comfortable?
Austin: I would say the same way you would look for a therapist. Ask a friend or somebody that you trust or value who is raving about their accountant. I have been in business for 20 years, and I have not used marketing until all this social media stuff happened. So, for a good 15 years, it's been word of mouth.
Are there any other ways that parents can save on their taxes?
Austin: Well, if you haven't, it would be a good time to have an HSA, a health savings account or medical savings account because under the new CARES Act, they're now allowing birth control, pads, tampons, feminine products as deductibles. So, this is an account where you pretty much have tax-free money to pay for those copays and deductibles and all the out-of-pocket medical costs, and they are including certain essential nonprescription items that are deductible for that.
And also to remember, if you have an account that doesn't rollover, you have until the following quarter to spend that money. So, you have until March. That's a good time to stock up on contact solutions, Band-aids, ointments—anything that you need before so that you can use that money and not lose it.