Tax Planning and the Child Tax Credit

If you have children qualifying for the Child Tax Credit and make in the neighborhood of $110,000 to $200,000 per year, this pertains to you. If not, feel free to ignore or share with someone who does.

What is the Child Tax Credit?

The Child Tax Credit is a $1,000 tax credit worth up to $1,000 for each child under the age of 17 (child has to be 16 years or younger at the end of the year). The credit amount is gradually phased out based on the following Modified Adjusted Gross Income (MAGI) levels:

  • $55,000 for married couples filing separately
  • $75,000 for single, head of household, and widow filers
  • $110,000 for married couples filing jointly

Once you reach the phase-out income the tax credit is reduced by $50 for each $1,000 of income above the threshold amount.

The upper phase-out increases with the number of qualifying children you have and looks like this:

Number of Kids Phase Out Starts Completely Phased Out
1 $110,000 $130,000
2 $110,000 $150,000
3 $110,000 $170,000
4 $110,000 $190,000
5 $110,000 $210,000
6 $110,000 $230,000
7 $110,000 $250,000

Why does this matter for tax planning?
If you are in the 25% marginal bracket for every extra dollar you phase yourself out of the tax credit, it costs you an extra 5% in taxes above your marginal rate (30% total).
Let’s say you are a young married resident, doctor, or professional with two kids currently in the Child Tax Credit phase out range (25% marginal bracket), but you know in the future you will likely be in the 28% marginal bracket or higher. Ignoring the Child Tax Credit, you may be inclined to contribute to a ROTH 401(k) or even complete ROTH conversions while you are in a lower tax bracket. However, you may be better off to wait on the ROTH conversions or take the immediate tax deduction of the Traditional 401(k) until you are completely phased out of the Child Tax Credit.
Here is an example of how one young family could save $12,000 in taxes by utilizing Traditional 401(k) and HSA contributions to lower their MAGI from $150,000 to $110,000.

Married – 2 Children

Without Deductions With Deductions Difference
Modified Adjusted Gross Income $150,000 $110,000 $40,000
Taxable Income $121,800 $81,800 $40,000
Tax Due $22,067.50 $12,067.50 $10,000
Child Tax Credit $0.00 ($2,000.00) $2,000
Adjusted Tax Due $22,067.50 $10,067.50 $12,000
Marginal Tax Rate 25.00% 25.00% 0%
Average Tax Rate Pre Credit 14.71% 10.97% 3.74%
Average Tax Rate Post Credit 14.71% 9.15% 5.56%
Tax Rate on last $40,000 30.00%

If utilizing ROTH 401(k) contributions or ROTH conversions is appropriate for this family, they can do so at a lower tax rate once they have been completely phased out of the credit and are in the 28% marginal bracket.
Keep an eye on the Alternative Minimum Tax (AMT) as the more dependents and tax credits you have the higher your risk is for being subject to AMT.