Tax Planning for Working Families
Tax season. Those two words can launch a wide range of emotions, largely dependent on whether you will receive a refund or owe money to the IRS and/or your state when your tax return is filed.
If you are a working parent, gathering documents and filing your income tax return is probably just one more thing added to an already busy schedule. However, taking time to make a plan and expand your tax knowledge will often result in paying less tax this year and in future years.
Here are some practical tips and ideas to help you pay no more tax than you are legally obligated to pay.
Look at Where You’ve Been
As a starting point, review your tax situation from last year. Taking inventory of your tax history will be helpful in evaluating ways to improve your tax situation going forward. Ask yourself the following questions:
- What tax strategies have I utilized in the past?
- What opportunities do I think I may have missed?
- What was my tax bracket last year, and what was my effective tax rate (income divided by tax)?
- What, if any, significant changes occurred last year that impact my tax picture (e.g. marital status, new dependents, job change, increased salary, starting a part-time side business)?
Know Where You’re Going
Think about what parts of your tax situation will be different in the current year, compared to the prior year, and the following year. Here are some suggested areas to consider:
Are you making IRA, Roth IRA, 401(k), or other retirement plan contributions? Is there room in the budget to increase your contributions to pre-tax retirement accounts and lower your taxable income? If you are currently in a lower tax bracket, have you considered making Roth contributions rather than pre-tax contributions? If you anticipate a lower income year, could you convert some pre-tax IRA/401(k) balances to Roth IRA/401(k)?
Health Care Costs
Are you taking advantage of all available pre-tax health care arrangements? Does your employer offer a health care Flexible Spending Account (FSA), a high-deductible health insurance plan with a Health Savings Account (HSA), or a Health Reimbursement Account (HRA)?
Does your employer offer dependent care benefits such as a Dependent Care Flexible Spending Account (FSA)? If you are paying for childcare expenses so that you, the parent(s), can work, are you claiming the Child and Dependent Care Credit?
Should you take the standard deduction or itemize? For the tax year 2020, the standard deduction has increased to $12,400 for individuals and $24,800 for married couples filing jointly. Some taxpayers will still itemize their deductions and have the potential of claiming deductions for medical expenses (in excess of 7.5% of adjusted gross income (AGI)), state and local taxes (capped at $10,000), mortgage interest, and charitable donations. An effective strategy can be “bunching” charitable deductions in certain tax years to exceed the standard deduction and then claiming the standard deduction in the alternate year(s). Making use of a donor advised fund can be an efficient way to bunch charitable deductions.
Tax Credits for Working Families
Several tax credits are available that benefit working families. These tax credits for working families have certain rules and are subject to limitations, so be sure to know the details. More information is available at IRS.gov.
Child Tax Credit
The Child Tax Credit is up to $2,000 per dependent child under age 17. Of this $2,000 credit, up to $1,400 of the credit can be refundable, meaning that it could be paid to you as a refund if your federal tax liability has been reduced to $0. The credit begins to phase out for high-income taxpayers ($200,000 of modified adjusted gross income for single filers and $400,000 of MAGI for married couples filing jointly).
Family Tax Credit
The Credit for Other Dependents, also nicknamed the “family tax credit,” is a non-refundable credit of up to $500 for dependents who do not qualify for the Child Tax Credit. This could apply to parents who claim children age 17 or older as dependents. It could also apply to taxpayers who are caring for elderly parents or other relatives, provided they meet the requirements for claiming these individuals as dependents. The same phase-out rules apply as for the Child Tax Credit.
Credit for Child and Dependent Care Expenses
The Credit for Child and Dependent Care Expenses is available for working parents who pay certain childcare expenses so that they can work. The credit is 20-35% of qualified expenses (eligible percentage is based on income), and childcare expenses up to $3,000 for one child, and up to $6,000 for two or more children, are used in determining the credit amount. Qualifying individuals must be under age 13 when the care is provided. Also, the child and dependent care expenses must be paid so that you (and your spouse, if filing jointly) can work or look for work.
The Takeaway for Working Families
Although the tax code is complex, there are certain provisions that are very valuable to know. Taking time to review your past tax returns, and plan for future tax filings, can be a worthwhile exercise because it can mean that more money stays in your pocket at the end of the day.
Source: IRS.gov | This is provided for informational purposes only and should not be construed as personalized tax advice. Discuss your specific circumstances with your tax professional.