Happy Birthdays from the IRS

Article Highlights:

• Special Tax Birthdays
• Birth of a Child
  • Qualifying Child
  • Child Tax Credit
  • Child Care Credit
  • Earned Income Credit
• Qualifying Relative
• U.S. Savings Bonds Used for Education Expenses
• ABLE Account
• Retirement Plan Catch-up Contributions
• Retirement Plan Distributions
  • Public Safety Employees
  • Early Distributions
• Social Security Benefits Taxation
• Additional Standard Deduction
• Qualified Charitable Distribution
• Required Minimum Distributions
• Longevity Annuity

When Congress enacts tax laws, many times whether the law applies is based on the age of the taxpayer or a taxpayer’s dependent. Reaching a certain age sometimes provides a tax benefit, while in other cases there’s a tax “penalty” – meaning that a specific type of income becomes taxable, or a credit no longer applies. Most of these age-related tax rules concern dependent children or retirement plan contributions or distributions. If you or a member of your tax family is having one of these special birthdays this year, you may be interested in knowing how your taxes will be affected, so here are some birthdays (or half-birthdays in a couple of cases) that have tax significance, listed by the age as of the birthday:

0 – “Zero” in this context means the birth of a child. In tax lingo, when you have a “qualifying child” you are entitled to claim that child as your tax dependent, which will then make you eligible to claim certain tax credits. A qualifying child is an individual who meets the following tests:

(1) Has the same principal place of abode (residence) as you for more than half of the tax year. Exceptions include the year of birth and temporary absences;

(2) Is your son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any of these individuals;

(3) Is younger than you are;

(4) Did not provide over half of his or her own support for the tax year;

(5) Is under age 19, or under age 24 in the case of a full-time student, or is permanently and totally disabled (at any age); and

(6) Was unmarried (or if married, either did not file a joint return or filed jointly only to claim a refund).

For a newborn child, the “half the year” requirement of (1) doesn’t apply if your home was the child’s home for more than half of the time he or she was alive during the year. So, in most instances, if you welcomed a baby into your family this year, even if the child was born on December 31, 2022, the child will be a qualifying child and your dependent for 2022, and you may be able to claim one or more of the following tax credits:

• Child Tax Credit – The child tax credit is $2,000 per child for 2022. If the credit is not entirely used to offset your tax, the excess portion of the credit, up to the amount that your earned income exceeds a threshold ($2,500 for 2022), but not more than $1,500, is refundable. The credit begins to phase out at modified adjusted gross incomes (MAGI) of $400,000 for married joint filers and $200,000 for other filing statuses. The credit is reduced by $50 for each $1,000 (or fraction of $1,000) of modified AGI over the threshold. See also “17” below.
• Child Care Credit – If you use the services of day care providers to look after your dependent child, you may qualify for a tax credit if the expense is an “employment-related” expense, which is one that you or your spouse, if married, incur to work, or look for work. Married couples must file jointly, and both spouses must work (or one spouse must be a full-time student or disabled) to claim the credit.

The qualifying expenses for the credit are capped at $3,000 per year if you have one qualifying child, while the limit increases to $6,000 per year if you have two or more eligible children. However, the qualifying expenses are limited to your income from working and, if you are married, the expenses are limited to the lower of your or your spouse’s work income.  An exception applies when one spouse has no actual income from working and that spouse is a full-time student or disabled. In that case the nonworking or student spouse is considered to have a monthly income of $250 (if there’s one qualifying child) or $500 (for two or more qualifying children).

The credit is computed as a percentage of qualifying expenses with the credit rate ranging from 35% for those with AGI of $15,000 or less to 20% if AGI exceeds $43,000. The credit will reduce your tax bill dollar for dollar, but if the credit is more than your tax, the excess credit is not refundable. See also “13” below.

Some employers provide dependent care assistance programs to help their employees with the cost of daycare. If you participate in such a plan and use payments from the plan to pay childcare expenses, the payments are excludable from your income, up to the lower of your earned income (or if you are married, the earned income of your spouse if it is lower) or $5,000 ($2,500 for married filing separate). Because reimbursement up to these limits is excludable from your income, it is treated as reimbursement for day care expenses that reduces the $3,000 or $6,000 expense limits when computing the credit. Reimbursement more than these limits is taxable to you and does not reduce qualified expenses for the credit.

• Earned Income Tax Credit (EITC) – If you have income from working either as an employee or a self-employed individual, you may qualify for this refundable credit. The credit is based on three factors: your earned income, AGI, and how many qualifying children you have. If you have investment income such as interest and dividends more than $10,300 (for 2022), you are ineligible for this credit. The credit was established as an incentive for individuals to obtain employment. It increases with the amount of earned income until the maximum credit is achieved and then begins to phase out at higher incomes. The table below illustrates the phase-out ranges for the various combinations of filing status and earned income and the maximum credit available.

Although the EITC is available for lower-income taxpayers without children, the credit increases substantially for those with children.

 

2022 EIC PHASEOUT RANGE
Number of Children	Joint Return	Others	Maximum Credit
None	$15,290 – $22,610	$9,160 – $16,480	$560
1	$26,260 – $49,622	$20,130 – $43,492	$3,733
2	$26,260 – $55,529	$20,130 – $49,399	$6,164
3 or more	$26,260 – $59,187	$20,130 – $53,057	$6,935

 

13 – In the year that your child turns 13, only the day care expenses you paid for the child for the part of the year when he or she was under age 13 qualify for the Child Care Credit.

17 – You can no longer claim the Child Tax Credit on your return starting for the year that your child is 17 at year’s end. So, for the year of your child’s 17th birthday, no Child Tax Credit is allowed for that child.

18 – The year in which your child has their 18th birthday is the last year that the child is considered a qualifying child, unless the child is a student and under age 24. To qualify as a student for this purpose, during some part of each of any 5 calendar months of the year, your child must be:

• A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school; or
• A student taking a full-time, on-farm training course given by a school described in the prior bullet, or by a state, county, or local government agency.

The 5 calendar months don’t have to be consecutive, and a full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.

If your older child isn’t a student under this definition, you might still qualify to claim the child as a dependent, but not as a qualifying child. The term for this type of dependent is “qualifying relative,” even though some individuals can qualify without being related to you. Three tests must be met before you can claim someone as your dependent if they aren’t a qualifying child:

A. Member of Household or Relationship Test – To meet the member of the household test, an individual would have to live with you all year in your household. But under the “or relationship” part of the test, your child would satisfy this test just by being your child, foster child, or stepchild, even if not living with you. Other relatives, such as your siblings, parents, grandparents, and others, could also meet this test.

B. Gross Income Test – To satisfy this test, your child (or other individual who might be a qualifying relative) can have no more than $4,400 (2022) of gross income for the year.

C. Support Test – You would need to provide more than half of the cost of the individual’s support. So, for example, if you wanted to figure whether you provided more than half of your 19-year-old non-student child’s support, compare the amount you contributed to your child’s support with the entire amount of support he or she received from all sources, including the support the child provided from their own funds.

24 – In the year that your child who is a student (as defined above) reaches age 24, the child is no longer a qualifying child for tax purposes and for you to be able to claim the child as a dependent on your tax return, tests A, B and C described above for a qualifying relative will need to be met. Losing the child as a dependent means that you would no longer be eligible to claim the higher-education credits (American Opportunity Tax Credit and Lifetime Learning Credit) based on the education expenses of that child.

24 – If you purchase U.S. Savings Bonds after reaching age 24, when you redeem the bonds and use the proceeds to pay qualified higher education expenses, such as tuition and fees, or contribute the funds to a Section 529 plan, you may be able to exclude the interest on the bonds from your gross income. However, the amount excludable may be reduced depending on your income when the bonds are redeemed.

25 – An ABLE (Achieving a Better Life Experience) account may be established by an individual if their blindness or disability occurred before age 26. Thus, only those who become blind or disabled no later than age 25 qualify for an ABLE account. Those eligible for an ABLE account are termed ABLE beneficiaries. Often the ABLE account is funded by the beneficiary’s parents or others. The total annual contributions to an ABLE account are limited to the annual gift tax exclusion amount ($16,000 for 2022), plus certain employed ABLE account beneficiaries may make an additional contribution. The contributions are not tax deductible but if the employed beneficiary contributes to the account, that individual may qualify to claim the so-called Saver’s Credit.  

The idea behind ABLE accounts is to provide a way of supporting the account beneficiary in maintaining their health, independence, and quality of life. ABLE accounts shelter assets from means testing required by some government benefit programs. Distributions to the beneficiary are tax free if the funds are used for qualified expenses of the disabled individual.

25 – The youngest age at which a taxpayer with no qualifying children can qualify for the earned income credit is 25. If married and filing a joint return, only one of the spouses needs to be least age 25 at the close of the tax year. For 2021 only, the minimum age was dropped to 19 for most taxpayers.

50 – Once you reach age 50 you can make additional annual “catch-up” contributions to salary reduction plans, including 401(k) plans, provided the plan permits catch-up contributions. The allowable “catch-up” amount is indexed for inflation in $500 increments, and for 2022 is $6,500. If you contribute to an IRA, the catch-up amount for IRA owners is $1,000, and is not inflation-adjusted. Thus, the maximum contribution by a worker aged 50 or older to a 401(k) or similar plan for 2022 is $27,000 or to an IRA is $7,000.

50 – A special rule applies for public safety employees aged 50 or older: If you withdraw funds from a government defined benefit pension plan and you are a qualified public safety employee who separates from the job after age 50, the 10% early withdrawal penalty (see “59½” below) does not apply to the original distribution from the plan. However, if the funds are rolled into an IRA or a defined contribution plan, any subsequent distribution (until you reach age 59½) is subject to the 10% penalty. A public safety employee is defined for this purpose as:

• Any employee of a State or political subdivision of a State who provides police protection, firefighting services, or emergency medical services for any area within the jurisdiction of that State or political subdivision, or
• Any Federal law enforcement officer, Federal customs and border protection officer, Federal firefighter, or any air traffic controller.

55 – Starting in the year you turn age 55, you may be able to take a distribution from a qualified retirement plan (not an IRA) and avoid an early withdrawal penalty. This exception applies only where you separate from employment (i.e., stop working for the employer that is sponsoring the plan) after reaching age 55, and won’t apply if you retire from your job before turning 55 but wait until after your 55th birthday to take the distribution from the plan. Said another way: You must be age 55 or older, and then separate from employment, for an early distribution to be excepted from the 10% penalty.

59½ – A 10% tax (penalty) applies to premature (also termed early) distributions from traditional IRAs and qualified retirement plans, such as 401(k)s and others. This penalty applies to distributions made before you reach age 59½ (but see “55” above for an exception) and is 10% of the part of the distribution that you would be required to include in your income for the year of the distribution. There are several exceptions to the penalty – some available only for IRAs or only for employer plans, some for both types of retirement vehicles – that aren’t covered in this article. If you plan to make a traditional IRA or retirement plan distribution between your 59th and 60th birthdays, be sure to do it after you reach 59½. If you take the distribution too soon, you could owe the early distribution penalty.

62 – When you reach age 62 you may be eligible to receive Social Security benefits. Once you start claiming your benefits, whether at 62 or a later age, you should be aware that up to 85% of those benefits could be taxed. You may want to have the Social Security Administration withhold income tax from your monthly benefit payment or you may need to make estimated tax payments.

65 – In the year you turn 65 and each year thereafter, and if you do not itemize your deductions on your tax return, you will be entitled to an additional standard deduction amount. This amount is indexed for inflation. For 2022, this extra amount is $1,400 if you are married, whether you use the joint, married separate or qualifying widow(er) filing status, or $1,750 if you file as single or head of household. If married, and your spouse is also age 65 or older, each of you qualifies for the extra amount. There’s no need to prorate the additional amount for the year of your 65th birthday.

65 – An individual with no qualifying children cannot claim the earned income credit starting with the tax year in which they have their 65th birthday. For 2021 only, the maximum age limitation was waived.

70½ – This half-birthday marks the point from which you can make a nontaxable qualified charitable distribution (QCD) from your traditional IRA of up to $100,000 per year. This distribution needs to be made directly by the IRA trustee to an eligible charitable organization for the distribution to be tax free. However, you won’t be able to claim a charitable deduction for the amount that is a QCD.

Distributions to a private foundation or a donor-advised fund aren’t eligible. If filing a joint return and both you and your spouse have an IRA, the $100,000 limitation applies to each of you. Caution:  be careful on the timing since a distribution from an IRA made to a charitable organization in the year you turn 70½, but prior to the date you reach age 70½, is not a qualified charitable distribution and would therefore be taxable.

72 – To prevent an individual from investing in tax-deferred retirement plans, including a traditional IRA, but never withdrawing from the plan, the account owner is REQUIRED to take a MINIMUM (as calculated per IRS regulations) DISTRIBUTION (RMD) beginning in the year the IRA owner reaches the mandatory beginning age, which is currently 72. For the first distribution year, you are allowed to put off the distribution to as late as April 1 of the following year.

Example: Say you turn 72 in 2022 and have a traditional IRA. You have until April 1, 2023, to take the 2022 RMD from your IRA. You will also need to take the 2023 RMD by the end of 2023. So, if you delay the first distribution into the first quarter of 2023, you’ll end up with a double RMD on which to pay tax in 2023.

Distributions from your IRA don’t count toward the RMD you must take from your 401(k) or another employer plan, and vice versa.

72 – Legislation enacted in the last few years permits taxpayers with earned income to continue contributing to their IRAs regardless of their age. Previously, contributions couldn’t be made once the IRA owner became 70½, which for decades was also the age that RMDs had to begin. Even though you may make a traditional IRA contribution at age 72 or older, you will still be required to take an RMD.

So now we have a complication when you can make a traditional IRA contribution and a qualified charitable distribution (QCD) after reaching age 70½. In this scenario if you make a QCD you are required to reduce the amount of the QCD that is nontaxable by any traditional IRA contribution you made and deducted after reaching 70½, even if the IRA contribution and QCD are not in the same year.

85 – If you want to stretch out your retirement funds, you are allowed to use up to the lesser of 25% or $145,000 (2022 limit) of your retirement account to purchase a qualified longevity annuity contract (QLAC) within the account. The amount used to purchase the QLAC is subtracted from the account balance and would thus reduce the RMD from the retirement account each year until a specified time in the future, but no later than age 85, when distributions must begin from the annuity.     

There isn’t space in this article to include all the details related to the numerous tax benefits and rules that apply for the birthdays listed. If you have questions or would like more information about any of them, please contact this office.