For many upper middle class taxpayers, the idea of claiming the child tax credit has always been out of the question because of the previously applicable income restrictions.
The 2017 tax reform legislation, however, expanded the universe of clients who are now eligible to claim the child tax credit so that the credit is no longer limited, as historically has been the case, to lower income taxpayers—a change that may feel like a windfall to higher income clients. This expansion, when considered in light of the simultaneous liberalization of the Section 529 education savings plan rules, can dramatically increase the appeal of transforming the benefits of the child tax credit into a tax-preferred education savings bank for a client’s children.
Expansion of the Child Tax Credit
For tax years beginning after 2017 and ending before 2026, the 2017 tax reform legislation doubled the value of the child tax credit, increasing its total value from $1,000 to $2,000 per child under age 17 (i.e., a married couple with two children under 17 may receive an additional $4,000 per year, assuming they do not cross the income thresholds discussed below).
$1,400 of this per-child credit is now refundable, and only this refundable portion will be adjusted annually for inflation going forward. Because a portion of the child tax credit is refundable, the client may receive it even if he or she does not owe any additional taxes to the IRS (meaning that it can be received as a refund).
Importantly, the child tax credit now begins to phase out only when the client’s adjusted gross income (AGI) reaches $400,000 (for joint returns) or $200,000 (for all other filers). This is a substantial increase from the previously applicable income restrictions—prior to 2018, the child tax credit began to phase out when AGI reached $110,000 for joint returns or $75,000 for single filers. Once the client’s AGI reaches the applicable phaseout threshold, the credit amount is reduced by $50 for each $1,000 by which AGI exceeds the threshold.
The increased income thresholds mean that clients with significant disposable income and relatively comfortable lifestyles will now be eligible to claim the child tax credit, and may not strictly need the extra funds for living expenses. For these clients, making use of those extra funds to save for education expenses through a tax-preferred savings account may provide an attractive solution.
Section 529 Savings Plans
IRC Section 529 college savings plans are funded with after-tax dollars that are permitted to grow on a tax-free basis (much like a Roth IRA), so that distributions from the account are not taxed when received so long as they are used to pay for qualified higher education expenses. Previously, qualified education expenses were generally limited to post-secondary school expenses. However, the 2017 tax reform legislation also expanded the reach of Section 529 plans so that clients may now use up to $10,000 in 529 plan funds per year for elementary or secondary school expenses (although it remains important to check with the plan itself to confirm that they have modified their rules to implement this new federal rule).
The new $10,000 limit for elementary and secondary school expenses applies on a per-child basis, so that even if the child is beneficiary of multiple Section 529 plans, he or she may receive only a total of $10,000 in pre-tax distributions annually for pre-college educational expenses.
Contributions to a Section 529 plan are limited to the annual gift tax exclusion amount—meaning that clients can contribute up to $15,000 per year in 2018. If contributions exceed that amount with respect to any single individual’s account, the contribution will be considered a gift that will generate gift tax liability. A client can, of course, fund multiple 529 plans for different beneficiaries without gift tax consequences, as long as the annual contribution for any particular beneficiary does not exceed the annual exclusion amount.
While there are a myriad of uses for newly available child tax credit funds, clients may be attracted to the idea of using these funds to help fund their children’s education savings—and, for clients with younger children, the expanded universe of education expenses for which 529 plan funds may be used can further add appeal to this funding strategy.
- Check out previous coverage of saving for college in Advisor’s Journal.
- Read an in-depth analysis of federal income tax credits generally, at the Advisor’s Main Library.
- Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.