Individuals eligible for federal income tax credits can significantly lower their tax obligations. Tax credits usually provide greater tax savings than deductions, because credits reduce your tax bill dollar for dollar. A deduction reduces only the amount of income that’s subject to tax. The following provides five major credits for you to consider when filing the 2020 tax return.
1. Higher Education Credits
The tax law gives parents a choice between two possible tax credits for higher education expenses:
American Opportunity Tax Credit (AOTC): The AOTC offers a maximum annual credit of $2,500 per student for each of the first four years of study. The AOTC phases out based on your modified adjusted gross income (MAGI). For 2020, the AOTC phases out at between $80,000 and $90,000 of MAGI for unmarried individuals and between $160,000 and $180,000 for married couples filing jointly.
Lifetime Learning Credit (LLC): Conversely, the LLC features a maximum annual credit of $2,000 per tax return, regardless of the number of students in the family. This credit also phases out based on MAGI levels even lower than the ranges for the AOTC for 2020. For 2020, the LLC phases out at between $59,001 and $69,000 of MAGI for unmarried individuals and between $118,001 and $138,000 for married couples filing jointly. However, the LLC is not limited to four years of study.
If eligible for a higher education credit, you must choose one; you cannot claim both. The AOTC is generally more favorable than the LLC on 2020 returns, but the best choice for you will depend on your personal situation. Also, note that for 2021 the new Consolidated Appropriations Act makes the income phaseout ranges for the AOTC and the LLC the same.
2. Child Credit
The Tax Cuts and Jobs Act (TCJA) enhanced the child credit for 2018 through 2025. Under the TCJA, this credit was doubled from $1,000 to $2,000, and the thresholds for phasing out the credit were increased significantly. Furthermore, $1,400 of the child credit is currently refundable, up from a maximum of $1,000.
To qualify for this credit, the child must be:
• Under age 17 at the end of the applicable tax year,
• Your own child, a stepchild, or a qualified foster child,
• An individual who didn’t provide more than half of his or her own financial support during the tax year,
• Your tax dependent as defined by prior law,
• A U.S. citizen, a U.S. national or a U.S. resident alien, and
• An individual who lived with you for more than half of the applicable tax year.
In addition, taxpayers can claim a $500 family credit for each qualifying dependent other than a qualifying child, such as a dependent child age 17 or older, or a dependent elderly parent. The child and family credits have an income-based phaseout, but the TCJA increased the income ranges.
3. Dependent Care Credit
Separate from the child credit, you can claim a credit for the cost of caring for under-age-13 children and other qualifying dependents, such as an elderly relative who needs nursing care. The dependent care credit is 20% for taxpayers with an adjusted gross income (AGI) above $43,000.
The credit applies to the first $3,000 of qualified expenses for one child or $6,000 for two or more children. Thus, you may claim a credit of $600 for the cost of caring for one child or $1,200 for two or more children. But qualified expenses can’t exceed your earned income (if you’re single) or the earned income of the lower-earning spouse.
You may claim the credit for the expenses paid to the following types of providers:
• Day care centers
• Nursing care centers
• Certain in-home or outside caregivers
In addition, the cost of summer day camp—but not overnight camp—qualifies.
4. Adoption Credit
The tax law provides a nonrefundable credit for qualified adoption expenses. For 2020, taxpayers can claim a maximum credit of $14,300 for the qualified expenses incurred to adopt an eligible child. An eligible child is defined as someone under age 18 or physically or mentally incapable of caring for himself or herself.
The credit covers the following reasonable and legal costs directly related to the adoption:
• Adoption agency fees
• Court costs
• Attorneys’ fees
• Travel costs, including meals and lodging
• Extra expenses needed to adopt a foreign child
Like most credits, the adoption credit has an income-based phaseout as well.
5. Retirement Saver’s Credit
The retirement saver’s credit encourages some taxpayers to set aside money for the future. This nonrefundable credit applies to the first $2,000 voluntarily contributed to a qualified plan, such as a 401(k), a traditional IRA, or a Roth IRA.
The credit may equal 10%, 20%, or 50% of the qualified contribution, depending on the saver’s AGI. The income levels are not very high, and they are adjusted annually for inflation. For example, an unmarried taxpayer cannot claim a credit if he or she has an AGI of more than $32,500 in 2020, and a married couple filing jointly maxes out at $65,000. The head of household can claim the credit if he or she has an AGI under $48,750.
If you qualify, you can only claim a maximum credit of $1,000 (50% of $2,000). Other special rules may apply. For instance, a taxpayer under age 18 last year or a full-time student can’t claim the credit.
Ready, Set, File
This list does not include all potential tax credits. If you want more information about tax credits and other tax breaks available for the 2020 tax year, contact a Hantzmon Wiebel team member for more details.
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