Tax consequences of important birthdays
At 16, get a driver’s license. At 18, register to vote. At 25, rent a car. These may be significant milestones, but there are also some important birthdays that carry tax consequences. Here are a few important birthdays to keep in mind so there is no surprise at tax time next April:
13: say goodbye to child care tax benefits
The nonrefundable child care credit reduces parents’ taxes dollar for dollar up to $1,050 for one child ($2,100 for two children). But once a child turns 13, their parents can no longer claim this credit for the child care expenses they incur to work or look for work. Child care expenses for a child 13 or older also no longer qualify for reimbursement under a dependent care flexible spending account (FSA), which allows parents to pay up to $5,000 pre-tax for eligible child care expenses.
17: child tax credit ends
The up to $1,000 credit for each qualifying child parents claim as a dependent ends the year the child turns 17. Generally, the child’s age on December 31 is used to determine eligibility.
19-24: other qualifying child-related benefits end
The dependent exemption ends when a qualifying child turns 19 (24 if they’re a full-time student) unless parents support the child and meet other requirements. Likewise, the earned income credit ends at 19 or 24 for full-time students.
19-24: kiddie tax ends
In 2013, about 372,000 families had to pay the “kiddie tax.” The kiddie tax applies tax to the child’s unearned income above $2,100 at their parent’s tax rate, which is likely to be higher than the child’s rate. Once they turn 19, or 24 if they are full-time students, the kiddie tax ends and the unearned income is taxed at the child’s (probably lower) tax rate. Unearned income may include dividends, interest, capital gain, unemployment benefits, some types of taxable scholarships, survivor pensions and even alimony.
26: sign up for health insurance
The Affordable Care Act requires health insurance providers to offer coverage to their policy holders’ children up to age 26. By 26, taxpayers have to get their own health insurance coverage or face the possibility of paying a penalty for being without insurance.
50: make catch-up contributions to retirement plans
Taxpayers can contribute a certain amount to their retirement plans each year, but once they turn 50, they can contribute an extra $6,000 to their 401(k) for a maximum contribution of $24,000, or an extra $1,000 to their traditional or Roth individual retirement account (IRA) for a maximum contribution of $6,500.
55: make catch-up contributions to a health savings account (HSA)
At 55, taxpayers can also start making catch-up contributions of an additional $1,000 to their HSAs. Taxpayers are normally limited to contributing $3,350 for individuals or $6,750 for family plans for 2016.
59 ½: take from retirement accounts without penalty
Taxpayers face a 10 percent penalty for early withdrawals from their retirement accounts unless an exception applies. But by 59 ½, taxpayers can make withdrawals from these accounts for any purpose without needing to pay the penalty.
65: make non-medical withdrawals from an HSA without a penalty
Taxpayers who use their HSA funds for non-qualified expenses have to pay income tax on the withdrawal and a 20 percent penalty. But the penalty is waived after a taxpayer turns 65, meaning the HSA can function like a tax-deferred savings account. However, distributions are still taxable if not used for qualified medical expenses.
70 ½: take required minimum distributions (RMDs)
Whether they are retired or not, taxpayers must start taking required minimum distributions from their traditional individual retirement account (IRA) the year they turn 70 ½. They must take the first distribution by April 1 of the following year. If they do not, they will be subject to a 50 percent penalty on the required amount they did not withdraw. Employer-sponsored retirement plans, like 401(k)s, also require a minimum distribution, but, if the employee is still working at or beyond age 70 ½ for the company sponsoring the plan, the requirement will not kick in until retirement.
The tax consequences of important birthdays may change the financial landscape for taxpayers trying to make the most of their tax benefits. A trusted tax professional can help them understand their options and suggest alternatives when their situation changes.