Federal tax reform through the Tax Cuts and Jobs Act brought about the biggest tax changes in three decades, including some significant changes for families with children. Some families will come out ahead, while other families may not after the elimination of the person exemption, which was $4,050 per person in 2017. Here are several of the changes that may affect your tax situation.
Personal Exemptions, Standard Deduction Changes
For 2018 through 2025, the standard deduction has nearly doubled from prior years. Those filing single have increased from $6,350 to $12,000; head of household from $9,350 to $18,000; and married filing joint from $12,700 to $24,000.
Here are two examples of how the new tax law affects families with children:
Example 1: A couple with three children who file a joint tax return and do not itemize
2017: They would have received a $32,950 reduction in taxable income ($20,250 deduction from five personal exemptions and a $12,700 standard deduction).
2018: They will receive just $24,000 (the new standard deduction), or an $8,950 increase in taxable income.
Example 2: A couple with one child who file a joint tax return and do not itemize
2017: They would have received a $24,850 reduction in taxable income ($12,150 from three personal exemptions and a $12,700 standard deduction).
2018: They will receive the same $24,000 (the new standard deduction) as the family with three children, or an $850 increase in taxable income.
This can’t be fair right? Keep reading.
Child Tax Credit Increases
Previously, the $1,000 child tax credit for qualified children under the 2017 laws began phasing out for married couples with adjusted gross income of $110,000 ($75,000 for head of household) or more and was completely phased out when adjusted gross income reached $130,000. The additional child tax credit phased out in $20,000 increments thereafter (two children would be completely phased out with adjusted gross income in excess of $150,000, three children at $170,000, etc.). That has since changed and the phase-out rules from 2018 through 2025 have increased to $400,000 for married couples and $200,000 for others.
The new credit has been increased to a $2,000 maximum per child, with up to $1,400 of that amount refundable. Those with several children could find themselves receiving a refund without incurring a federal income tax liability.
In the example above, the couple with three children may have an increase of their taxable income of $8,950, but if their taxable income was under $110,000, their credit would have increased by $3,000 ($6,000 in 2018 versus $3,000 in 2017). For 2018, income at $110,000 for married filers is taxed at 24%. Thus, the $3,000 additional credit will result in $12,500 (24% divided by $3,000) of equivalent deductions. So while the three child family could have a higher overall tax burden, favorable tax credits and reduced rates could reduce their overall out-of-pocket tax liability.
In addition to the child tax credit, a new $500 non-refundable credit is available for 2018 through 2025 for qualifying dependents such as children that are 17 or older or other dependents (including elderly parents). Like the child tax credit, it will phase out when adjusted gross income from 2018 through 2025 exceeds $400,000 for married couples and $200,000 for others.
529 Plans Can Now be Used for K-12 Education
Withdrawals from 529 plans are tax-free to the extent they are qualified education expenses. Effective January 1, 2018, qualified expenses now include up to $10,000 in tuition expenses at private, public or religious elementary, middle and high schools per year, per beneficiary.
Keep in mind 529 plans are operated by states, so you will need to check with your state to see if the change is allowed by your plan. The Commonwealth of Pennsylvania has conformed to the federal tax code and allowed these distributions as qualified expenses.
Do you have questions about the tax reform changes for families with children? Contact us to get an assessment of your family’s 2018 tax situation.