Every once in a while, I see someone in a tax pickle for which there is no solution. The “pickles” may differ, but there is one common denominator: Most of the time you did it to yourself. Naturally, it is extra painful when you realize that you have only yourself to blame for the mess. Here are some examples of situations that can happen when you least expect them.
The Earned Income Credit
This is a classic. The earned income credit is the great money giveaway. Essentially, if you are poor with children, you will get back extra money – lots extra. Let’s take the following case: Family A has three children and an income of $25,000. They will be handed a gift by the government: $10,445, to be exact. Yes, over $10,000 in free money! There is a catch, however: Your investment income (interest, dividends, and capital gains) must be under $3,400.
Here is the scary part: Let us say you are really monitoring things and are within the $3,400. You own a mutual fund that has not gone up since you bought it. If the mutual fund sells a stock within it at a profit, you will receive a 1099 form for your share of the gain, and that will count as part of your investment income. If it puts you even one dollar over, to $3,401, you will be completely ineligible and will lose over $7,000!
Rule #1: If you are a candidate for the earned income credit, your investment income can never ever top $3,400. It could cost you thousands.
Claiming Your Children
You can claim your children as dependents until age 18 (23, if they are students), provided you supported them. Since you can claim them, you also get to claim the benefits of their college expenses. That will give you valuable tax credits for college expenses. It means that if your children go to college, you can receive a big tax savings for the tuition paid. But you need to claim your child as a dependent.
Here’s the catch: You can only claim the child as a dependent if the child does not file a joint return with someone else, i.e., his wife. This true story happened this year: Mr. F claimed his son, who got married in December of 2016. Unbeknownst to him, the son’s father-in-law asked his accountant to do taxes for the new couple. The accountant filed a return for this new couple, who claimed themselves as their own dependents. They earned so little that they barely had to file in the first place. Well, two tax returns cannot claim the same individual, so someone had to amend their return. Hold on tight for this tax law: Once the child has filed a joint return, he or she cannot amend to make it a separate return. Therefore, Mr. F cannot claim his son and cannot claim the valuable tax credit for college. There is no way to fix this. Mr. F lost over $3,500 and asked his mechutan to pay him back!
Rule #2: Once your children are over 18, claiming them can become complicated. It is dependent on their age, student status, income, residence, support, and possibly marriage status.
Children over 23
Once your children are over 23 they can no longer be claimed as a child, but they could still be claimed as a qualifying relative. There is a strict income test for this one. If they exceed $4,050 in annual income, the parent cannot claim them. Take the following case: A father has a son who turned 24 before the end of the year. The son took a part-time job in 2016 and earned $4,100. This cost the father the dependency and also the ability to claim college costs, a sum of over $3,500.
Rule #3: Once children are over 23, they are under a strict income ceiling to be claimed by the parents. If you want to claim your child – limit the child’s income.
The Obamacare Credit
People receive a health insurance credit based upon their income in the previous year. It is assumed they will make the same the following year. If their income increases, they may have to pay back the whole subsidy. Once your income exceeds four times the poverty limit, you get no credit at all. This is based on your adjusted gross income (AGI). What if your income tops that number by a small amount? Well, you could put money into an IRA and push your adjusted gross income below the threshold. You have until April 15th to do that. Miss the deadline and you blew it. It could be that you needed to put just one dollar into the IRA, which could have saved you over $3,000, possibly much more. Oh well.
Rule #4: Every return benefiting from an Obamacare health insurance tax credit should be analyzed to determine the benefit of depositing money into an IRA for the purpose of pushing the AGI down. Then make sure to make the deposit before April 15.
Very often, filing as married will save more than filing as single. Imagine that a girl is working and making $80,000 a year. She is getting married to a young man who is a student on New Years day, 2017. For 2016, she must file as single, because she was not married on the last day of the year! They could have run down to a government office and gotten legally married on December 31. Would she have saved? Yep – possibly over $8,000! Truly amazing.
Rule #5: Marriage makes a big difference on your taxes. Contemplating marriage? Better run the numbers.
College Costs and Daycare
College expenses offer big tax credits, but there are rules regarding amounts and number of years. If you do not time your payments correctly, you can lose $2,500. Furthermore, even for those who are on 100% scholarship can benefit. Although they cannot claim tuition, because they do not pay any, they can claim supplies. That means they could spend $2,000 on a very nice laptop and other supplies and have the government pay for it completely. The catch is that you must pay for these supplies before the end of the tax year to claim the credit.
Daycare expenses have similar rules for timing, and payments that may be wasted if you are not watching your time schedule.
Rule #6: College and daycare expenses have to be timed correctly.
It is unfortunate when I see those who fail to deal with taxes proactively. As you can see, it is possible for a person to waste serious amounts of money by falling asleep at the wheel. By staying on top of things, you will hopefully be able to have a smaller tax bill.
Eli Pollock, CPA, can be reached at email@example.com.