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Family and education tax breaks make raising kids less costly.

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Raising children and helping them pursue their educational goals or pursuing your own can be highly rewarding. But it also can be expensive. Fortunately, a variety of tax breaks can offset some of the costs, helping you keep your family financially secure and their future bright.

Child and adoption credits

Tax credits reduce your tax bill dollar-for-dollar, so make sure you’re taking every credit you’re entitled to. For each child under age 17 at the end of the year, you may be able to claim a $1,000 child credit. If you adopt in 2015, you may qualify for an adoption credit or for an income exclusion under an employer adoption assistance program. Both are up to $13,400 per eligible child. Warning: These credits phase out for higher-income taxpayers. (See Chart 1.)

Child care expenses

A couple of tax breaks can help you offset these costs:

Tax credit. For children under age 13 or other qualifying dependents, you may be eligible for a credit for a percentage of your dependent care expenses. Eligible expenses are limited to $3,000 for one dependent and $6,000 for two or more. Income-based limits reduce the credit percentage but don’t phase it out altogether. (See Chart 1.)

FSA. You can contribute up to $5,000 pretax to an employer-sponsored child and dependent care Flexible Spending Account. The plan pays or reimburses you for these expenses. You can’t use those same expenses to claim a tax credit.

IRAs for teens

IRAs can be perfect for teenagers because they likely will have many years to let their accounts grow tax-deferred or tax-free. The 2015 contribution limit is the lesser of $5,500 or 100% of earned income. A teen’s traditional IRA contributions typically are deductible, but Family and education tax breaks make raising kids less costlyFAMILY & EDUCATION7distributions will be taxed. Roth IRA contributions aren’t deductible, but qualified distributions will be tax-free. Choosing a Roth IRA is typically a no-brainer if a teen doesn’t earn income that exceeds the standard deduction ($6,300 for 2015 for single taxpayers), because he or she will likely gain no benefit from the ability to deduct a traditional IRA contribution. Even above that amount, the teen probably is taxed at a very low rate, so the Roth will typically still be the better answer.

If your children or grandchildren don’t want to invest their hard-earned money, consider giving them up to the amount they’re eligible to contribute. But keep the gift tax in mind. (See page 26.)

If they don’t have earned income and you own a business, consider hiring them. As the business owner, you can deduct their pay, and other tax benefits may apply. Warning: The children must be paid in line with what you’d pay nonfamily employees for the same work.

The “kiddie tax”

The “kiddie tax” applies to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income). For children subject to the tax, any unearned income beyond $2,100 (for 2015) is taxed at their

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parents’ marginal rate, if higher, rather than their own typically low rate. Keep this in mind before transferring income-generating assets to them.

529 plans

If you’re saving for college, consider a Section 529 plan. You can choose a prepaid tuition program to secure current tuition rates or a tax-advantaged savings plan to fund college expenses:

  • Although contributions aren’t deductible for federal purposes, plan assets can grow tax-deferred. (Some states offer tax incentives in the form of deductions or credits.)
  • Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, equipment, supplies and, generally, room and board) are income-tax-free for federal purposes and typically for state purposes as well, thus making the tax deferral a permanent savings.
  • The plans usually offer high contribution limits, and there are no income limits for contributing.
  • There’s generally no beneficiary age limit for contributions or distributions.
  • You can control the account, even after the child is of legal age.
  • You can make tax-free rollovers to another qualifying family member.
  • The plans provide estate planning benefits: A special break for 529 plans allows you to front-load five years’ worth of annual gift tax exclusions and make up to a $70,000 contribution (or $140,000 if you split the gift with your spouse).

The biggest downsides may be that your investment options and when you can change them are limited.

ESAs

Coverdell Education Savings Accounts are similar to 529 savings plans in that contributions aren’t deductible for federal purposes, but plan assets can grow tax-deferred and distributions used to pay qualified education expenses are income-tax-free. One of the biggest ESA advantages is that tax-free distributions aren’t limited to college expenses; they also can fund elementary and secondary school costs. ESAs are worth considering if you want to fund such expenses or would like to have direct control over how and where your contributions are invested.

But the $2,000 contribution limit is low, and it’s phased out based on income. (See Chart 1.) Amounts left in an ESA when the beneficiary turns age 30 generally must be distributed within 30 days, and any earnings may be subject to tax and a 10% penalty.

Education credits and deductions

If you have children in college now, are currently in school yourself or are paying off student loans, you may be eligible for a credit or deduction:

American Opportunity credit. The tax break covers 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of expenses. The maximum credit, per student, is $2,500 per year for the first four years of postsecondary education. The credit is scheduled to be available through 2017.

Lifetime Learning credit. If you’re paying postsecondary education expenses beyond the first four years, you may benefit from the Lifetime Learning credit (up to $2,000 per tax return).

Tuition and fees deduction. If you don’t qualify for one of the credits, you might alternatively be eligible to deduct up to $4,000 of qualified higher education tuition and fees but only if this break is extended for 2015. (Check with your tax advisor for the latest information.)

Student loan interest deduction. If you’re paying off student loans, you may be able to deduct the interest. The limit is $2,500 per tax return.

Warning: Income-based phaseouts apply to these breaks (see Chart 1), and expenses paid with distributions from 529 plans or ESAs can’t be used to claim them. If your income is too high for you to qualify for a credit, your child might be eligible. But if your dependent child claims the credit, you must forgo your dependency exemption for him or her (and the child can’t take the exemption).

WHAT’S NEW!

ABLE accounts offer a tax-advantaged way to fund disability expenses

Who’s affected: People with disabilities and their families.

Key changes: The Achieving a Better Life Experience (ABLE) Act of 2014 offers a new type of tax-advantaged savings program for people who are disabled or blind. The act allows states to establish tax-exempt ABLE programs to help people with disabilities build accounts that can pay qualified disability expenses.

For federal purposes, tax treatment of these accounts will be similar to that of Section 529 college savings plans:

  • Anyone can make contributions to ABLE accounts, but the contributions won’t be deductible.
  • Income earned by the accounts generally won’t be taxed.
  • Distributions, including portions attributable to investment earnings generated by the account, to an eligible individual for qualified expenses won’t be taxable.

Qualified expenses are those related to the individual’s disability, such as health, education, housing, transportation, employment training, assistive technology, personal support, and related services and expenses.

Planning tip: Contact your tax advisor for the latest information on the availability of ABLE accounts in your state.

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