Children and Tax Credits

Child Tax Credit: $2,200 per child under OBBBA, phase-outs, and refundability

The Child Tax Credit under IRC Section 24 provides a credit of $2,200 per qualifying child for 2026, increased from $2,000 by OBBBA. A qualifying child must be under age 17 at the end of the tax year, must be your son, daughter, stepchild, foster child, sibling, or a descendant of any of these, must have lived with you for more than half the year, must not have provided more than half of their own support, must be claimed as your dependent, and must have a valid Social Security number. The child must also be a US citizen, US national, or US resident alien.

The CTC begins to phase out at $200,000 of modified AGI for single, head of household, and qualifying surviving spouse filers, and at $400,000 for married filing jointly. The phase-out reduces the credit by $50 for every $1,000 of income above the threshold. For a single parent with two children ($4,400 in CTC), the credit is fully phased out at approximately $288,000 of MAGI. For MFJ with two children, the credit survives until approximately $488,000.

The refundable portion of the CTC (the Additional Child Tax Credit, or ACTC) is available if the credit exceeds your tax liability. Under OBBBA, the refundable amount is the greater of (a) 15% of earned income above $2,500 (up to the maximum refundable amount per child) or (b) the refundable amount specified by OBBBA. The refundable CTC means that low-income taxpayers who owe zero income tax can still receive a cash payment from the IRS. Self-employed individuals calculate earned income as net self-employment income (Schedule C net profit), not gross receipts. If your Schedule C shows a loss, you have zero earned income for ACTC purposes, which can eliminate the refundable portion.

The Other Dependents Credit (ODC) under Section 24(h)(4) provides $500 for each dependent who does not qualify for the full CTC — typically children aged 17-18, college students aged 19-23 (if a full-time student and still your dependent), elderly parents, or other qualifying relatives. The ODC is non-refundable and phases out at the same income thresholds as the CTC.

The CTC is $2,200 per qualifying child under 17 for 2026. Phase-out begins at $200,000 (single) / $400,000 (MFJ). The refundable portion requires earned income above $2,500. (IRC §24; IRC §24(h)(4); OBBBA (CTC increase to $2,200))

Child and Dependent Care Credit, Dependent Care FSA, and the self-employed exception

The Child and Dependent Care Credit under IRC Section 21 provides a credit of 20% to 35% of qualifying child care expenses, depending on your AGI. The maximum qualifying expenses are $3,000 for one qualifying individual or $6,000 for two or more. The credit percentage is 35% for AGI at or below $15,000 and decreases by one percentage point for every $2,000 of AGI above $15,000, bottoming out at 20% for AGI above $43,000. For most self-employed individuals, the credit will be 20%, producing a maximum credit of $600 (one child) or $1,200 (two or more children).

Qualifying expenses include daycare, nursery school, preschool, before-school and after-school care, summer day camp, and payments to a babysitter or nanny while you work. Overnight camp does not qualify. The care must be for a child under age 13 (or a dependent of any age who is physically or mentally incapable of self-care) and must be provided so that you can work or look for work. Both spouses must have earned income (or be full-time students or disabled) for the credit to apply. For self-employed parents, your net SE income from Schedule C counts as earned income. If your Schedule C shows a loss, you have zero earned income and the credit is disallowed.

The Dependent Care FSA (Flexible Spending Account) under IRC Section 129 allows you to set aside up to $5,000 per year ($2,500 MFS) in pre-tax dollars for dependent care expenses. The FSA saves you income tax plus self-employment tax on the amount contributed — for a self-employed individual in the 22% bracket, that is a combined savings of 37.3% (22% income tax + 15.3% SE tax) on up to $5,000, or $1,865. Self-employed individuals can establish a Dependent Care FSA through their own plan (if they have employees) or through a spouse's employer plan. The FSA and CDCC cannot be used for the same expenses, but they can be combined: use the FSA for the first $5,000 of expenses and the CDCC for additional qualifying expenses up to the dollar limits (reduced by FSA contributions).

The CDCC provides 20-35% of up to $3,000 (one child) or $6,000 (two+ children) in qualifying care expenses. The Dependent Care FSA allows $5,000 in pre-tax contributions. Both require earned income. (IRC §21; IRC §129; Treas. Reg. §1.21-1)

Earned Income Tax Credit, 529 plans, and the adoption credit

The Earned Income Tax Credit under IRC Section 32 is the largest federal anti-poverty programme delivered through the tax code. For 2026, the maximum EITC is estimated at approximately $7,830 for a taxpayer with three or more qualifying children, $6,960 with two children, $4,213 with one child, and $632 with no children. The credit phases in as earned income rises, reaches a maximum at a plateau, then phases out as income increases further. The phase-out completion points are approximately $59,899 (MFJ, 3+ children) and $53,865 (single/HoH, 3+ children). The EITC is fully refundable — it can produce a cash payment even if you owe no income tax.

For self-employed individuals, earned income for EITC purposes is net SE income from Schedule C (after deducting business expenses but before the self-employment tax deduction). The IRS scrutinises EITC claims from self-employed filers more heavily than W-2 claims, because the opportunity to inflate or fabricate Schedule C income to increase the EITC is a known compliance risk. The IRS uses data analytics and targeted audits for SE-based EITC claims. Ensure your Schedule C income is accurate and supported by documentation.

529 college savings plans under IRC Section 529 offer tax-free growth and tax-free withdrawals for qualified education expenses (tuition, fees, books, room and board, computers). Contributions are not deductible for federal purposes, but over 30 states offer a state income tax deduction or credit for contributions. Under the SECURE 2.0 Act of 2022, beneficiaries can now roll unused 529 funds into a Roth IRA (up to $35,000 lifetime, subject to annual Roth IRA contribution limits, and the 529 must have been open for at least 15 years). This eliminates the old risk of "overfunding" a 529 and being stuck with a 10% penalty on non-qualified withdrawals.

The adoption credit under IRC Section 23 provides a credit of up to $17,280 per child for 2026 (indexed for inflation) for qualified adoption expenses, including attorney fees, court costs, travel, and agency fees. For special-needs adoptions (as determined by the state), the full credit is available regardless of actual expenses incurred. The credit phases out between $259,190 and $299,190 of MAGI for 2026. The adoption credit is non-refundable but can be carried forward for up to 5 years.

The EITC provides up to $7,830 with 3+ children (2026 est.) and is fully refundable. 529 plans grow tax-free with SECURE 2.0 Roth rollover option. The adoption credit is up to $17,280 per child. (IRC §32; IRC §529; SECURE 2.0 Act §126; IRC §23)

Custody rules: who claims the child, Form 8332, and the tiebreaker tests

When parents are divorced, separated, or never married, the rules for claiming a child as a dependent — and the associated credits — follow a strict hierarchy under IRC Section 152. The custodial parent is the parent with whom the child lived for the greater number of nights during the calendar year. The custodial parent is entitled to claim the child as a dependent and receive the CTC, CDCC, EITC, and head of household filing status. The non-custodial parent receives none of these unless the custodial parent signs Form 8332 (Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent).

Form 8332 releases only the dependency exemption (and by extension the CTC and the ODC). It does not transfer the CDCC, the EITC, or the head of household filing status — those always belong to the custodial parent regardless of Form 8332. This is a crucial distinction that many divorce agreements get wrong. A decree that states "Father claims the children in even years" should be implemented with Form 8332, and the father should understand that he receives only the CTC, not the EITC or CDCC. Form 8332 can be signed for a single year, for multiple specified years, or for all future years. It can also be revoked by filing a revocation with the IRS and providing a copy to the non-custodial parent.

If the child lived with each parent for exactly the same number of nights (or if the child's living arrangement cannot be determined), the tiebreaker rules under Section 152(c)(4) apply in this order: (1) the parent with whom the child lived for the longer period during the year (if determinable); (2) the parent with the higher AGI. The tiebreaker rules also resolve disputes when no agreement exists — if both parents claim the child, the IRS will apply the tiebreaker tests and disallow the claim of the parent who does not prevail.

For self-employed parents, the income variability of SE earnings can create a situation where the tiebreaker AGI test produces different results in different years. The parent with a good business year may have higher AGI, but the custodial parent prevails regardless of AGI if the child lived with them longer. AGI only matters as a tiebreaker when residency is equal.

The custodial parent (parent the child lived with for more nights) claims the child. Form 8332 releases only the CTC to the non-custodial parent. EITC, CDCC, and head of household always belong to the custodial parent. (IRC §152(e); IRC §152(c)(4); Form 8332)