If you have kids, you already know how expensive they are. Clothes, new clothes, newer clothes, medical expenses, diapers/toys/video games depending on age, school supplies, and, of course, birthday, Christmas and more presents. And that’s just barely getting started. But what you may not know is that, when it comes to the IRS, kids can save you money—or at least get some of it back!
Today, we’re going to look at one of best ways to reduce your total tax bill: The Child Tax Credit (CTC). The CTC is one the most popular tax credits Congress ever created. Right now, Congress is considering updating the CTC for 2023, I’m going to tell you how.
Tax Credits vs Deductions
Before we begin you may be asking yourself, “What is a Tax Credit?”
In order to explain tax credits, it’s easier to show you difference between a Tax Credit and a Deduction. Tax credits reduce the taxes you owe, dollar-for-dollar. Whereas a deduction will lower your income that you have to pay tax on. This sounds like the same thing, but it’s not.
Here’s an illustration:
Let’s say you make $50,000 and are in a 20% tax bracket. This means you owe the IRS $10,000 in tax (20% x $50,000). If you are entitled to a tax credit of $3,000, you will now owe the IRS only $7,000 ($10,000 minus $3,000). If you had a $3,000 deduction instead of a tax credit, your net income would now be $47,000 ($50K – $47K), and the tax you owe is now $9,400 (20% x $47,000).
| Illustration above | Tax Credit | Deduction |
|---|
| Gross Income | $50,000 | $50,000 |
| Deduction | $0 | $3,000 |
| Net Income | $50,000 | $47,000 |
| Tax Rate | 20% | 20% |
| Tax Due (before credit) | $10,000 | $9,400 |
| Tax Credit | $3,000 | $0 |
| Total Tax Due (after credit) | $7,000 | $9,400 |
Simply put, deductions lower the money you get taxed on. Tax Credits lower your taxes due. That’s why tax credits are more valuable.
Types of Tax Credits
There are two types of tax credits:
- Refundable tax credits
- Non-refundable tax credits
A refundable tax credit will allow you a refund after your taxes go to zero. A non-refundable tax credit can make the taxes you owe go to zero but will not give you a refund beyond that. Any extra tax credit you get after that is carried forward to the next tax year.
All tax credits are non-refundable unless Congress says otherwise. Currently the only refundable tax credits are:
- Child Tax Credit – if you have kids (or dependents)
- Earned Income Tax Credit – if you don’t make that much money
- American Opportunity Tax Credit – for payments to colleges & universities
- Premium Tax Credit – for health insurance purchase from the federal marketplace
How do I qualify for the Child Tax Credit
To qualify for the Child Tax Credit, you must meet these qualifications:
- Your child (or dependent) must be a US Citizen
- They must’ve lived with you for more than half the year
- The children must be under the age of 17
- Your income must be under a certain threshold – i.e., as you make more money, you start losing the credit.
How much do I save?
Congress is always changing the rules, so the amount changes year-to-year. So, we’re going over the most current years.
Currently, you are allowed a Child Tax Credit of $2,000 per qualifying child, with a refundable portion being up to $1,600. Your threshold starts at $200,000 if you’re single ($400,000, if you’re married). As you start making more than the threshold, your Tax Credit starts getting reduced (also known as the “phaseout”).
Child Tax Credit for 2023 & 2024
Currently, this is how the CTC works for 2023 & 2024:
| 2023 | 2024 | |
|---|---|---|
| Amount you receive per child | $2,000 | $2,000 |
| Age requirement | < 17 years old | < 17 years old |
| Income Threshold if you’re single | $200,000 | $200,000 |
| Income Threshold if you’re married | $400,000 | $400,000 |
| Refundable portion | $1,600 | $1,700 |
Keep in mind, if you make more than the income thresholds, your CTC tax credit will start phasing out.
Possible Changes to the CTC
Last week the House of Representatives recently passed a new $78 million tax bill that would make changes to the CTC for 2023 through 2025.
The main crux of the changes would be to increase the refundable portion of the CTC. Here’s what would change:
- 2023 – Refundable portion goes up from $1,600 to $1,800
- 2024 – Refundable portion goes up from $1,700 to $1,900
- 2025 – Refundable portion goes up from $1,700 to $2,000
The bill is headed to the Senate, and then to the President, to becomes law. If this version of the bill become law, it will retroactively effect 2023.
In other words, if you normally get the CTC, you should wait to file your 2023 tax return.
Conclusion
As I mentioned earlier kids are expensive, but the CTC is one way to save money. However there is another great way to save money through your kids. If you own a company, you can hire your kids. It’s complicated and the IRS has lots of rules, so I wrote an article about it here.