Tuesday, December 26, 2006

Deductions and Credits for Your Children**

**The tax laws are loaded with deductions, credits and exemptions for your dependents. You may qualify for a lot more than just the $3300 dependent deduction. Some of these are deductions from taxable income and and some are even better—they are deductible from the tax itself. A credit reduces your tax 100% of the credit amount, but a deduction only reduces it to the extent of your tax bracket; e.g. 35 cents on the dollar if you are in the 35% bracket, less for lower brackets.

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CHILD AND DEPENDENT CARE EXPENSE: (Form 2441 and Line 48, Form 1040)
This is a credit allowed for child care expense such as day care. If married filing jointly, both spouses must work and have earned income to qualify. The credit maximum is $ 5000.

CHILD TAX CREDIT (Line Line 48, Form 1040 and ADDITIONAL CHILD TAX CREDIT (line 68, Form 1040 and Form 8812)
[1] There is a maximum credit of $ 1000 per qualifying child which can reduce your tax, but cannot provide a refund if the total of your “nonrefundable credits” reduce your tax to zero.
[2] There is also a “refundable” ADDITIONAL child tax credit which you may claim on line 68, form 1040 if all or part of the “nonrefundable” credit reduced your tax to zero. File Form 8812 to claim this refundable credit. The credit is the smaller of the disallowed regular child tax credit or 15% of your ‘earned’ income in excess of $ 11,300.

TUITION AND FEES DEDUCTION (IRC code § 222, Line 35 Form 1040)
This was one of the deductions that expired and was renewed after the tax forms had already been printed. So far I haven’t seen the dollar amounts for 2006 returns, but in 2005 you could deduct up to $4000 if you made $65,000 or less (single) or $130,000 Married Filing Jointly. These may remain the same or some slightly larger amounts may be substituted for the 2005 figures. You should claim this deducion on line 35 of Form 1040 and enter a Code “T” to the left of the entry space for line 35. (Enter code “B” if you claim both a Tuition and Fee Deduction and a Domestic Production deduction.

HOPE CREDIT (Form 8863 and line 50 of Form 1040)
You can claim up to $ 1650 credit per eligible student. (Two eligible students = $3300)
It is only available for the first two years of postsecondary education.
It is only available for two years per eligible student.
The student must be in a program that leads to an undergraduate degree or other recognized credential. The student must be enrolled at least half time.
The credit is reduced or eliminated if you make over $90,000 filing jointly or $45,000 if single or Head of HH. No credit is allowed if you are married filing separately. If you make too much to claim it, your child could claim it if you do not claim the child as an exemption.

LIFETIME LEARNING CREDIT ( Form 8863 and Line 50 of Form 1040)
You can claim up to $ 2000 credit per return. If you have two or more students you can’t claim more than $ 2000, but if the first one has less than $2000 expense you can use the second student’s expenses to reach the $2000 limit. This credit is not limited to two years and can be for courses to acquire or improve job skills, not necessarily leading to a degree or other credential.

STUDENT LOAN INTEREST (Line 33 of Form 1040)
If you make less than $135,000 (filing jointly) or $60,000 (single or HOH) or $10,000 (filing separately) you may claim all or part of your student loan interest—up to $ 2500.
The interest can be on qualified loans for yourself, your spouse or a dependent you claim.
The student must be enrolled at least half time in a program leading to a degree or other recognized credential. The loan must be in the name of the person claiming it meaning that you can’t claim it if the loan is in the name of your dependent—it must be in your name. The student cannot deduct it, even if it is in his name, if his parents pay the interest.

EDUCATION SAVINGS ACCOUNTS (also called college savings plans and 529 plans)
There is no deduction or credit but earnings in these plans are not taxable.
These are plans provided by individual states, so you would need to know if your state has a 529 plan available. These plans allow contributions to pay for education expenses for a qualified beneficiary. There no income phase-out, so you may still qualify if you make several million dollars a year. References - IRC code §530 and IRS Pub 970, Form 1099Q.

These accounts are similar to Roth IRAs used to pay for qualified educational benefits of a designated beneficiary. The contribution limit is $ 2000 per beneficiary. There is a phase out based on your income. It completely phases out if your income is $95,000 or more ($190,000 filing jointly). References: - IRC code §530 IRS Pub 970, Form 1099Q)

When you redeem Savings Bonds, the interest may be excluded.
It must be interest form series EE and I bonds.
Full exclusion is allowed provided the total of both principal and interest on the redeemed bonds do not exceed the qualified education expense. Otherwise only a portion may be excluded (calculate exclusion on Form 8815). This deduction is subject to a phase-out if your income exceeds $63,100 on a joint return or $ 94,700 filing jointly. It completely phases out if you make $78,100 ($ 124,700 filing jointly)

The 10% early-withdrawal penalty does not apply if IRA withdrawals are made to pay for qualified education expenses. The withdrawal is still taxed, but the penalty is not charged. You must report the exclusion on Form 5329.

Link to IRS forms and publications:
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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.

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