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The Short Answer

Family-Friendly Tax Breaks at Risk From Fiscal Cliff

Higher tax rates and government-spending cuts aren't the only potential changes that might affect household finances.

Question: I know the fiscal cliff might mean a higher tax rate for my family and me, but what family-oriented tax breaks also could be affected?

Answer: Federal income tax rate hikes and spending cuts seem to grab most of the fiscal cliff-related headlines, but many other less publicized tax changes also are scheduled to go into effect Jan. 1, including several that will hit families hardest.

Some are provisions that have been in place for a decade, having been enacted under President George W. Bush and later extended under President Barack Obama, while others were enacted more recently under Obama. It's possible that at least some will be extended again, or at least modified so as not to revert fully to their previous levels. But if all or most are allowed to expire, many families--especially those with low to middle incomes--will take a significant tax hit, says Jackie Perlman, a tax research analyst with The Tax Institute at  H&R Block (HRB). "The Bush tax cuts and Obama tax cuts have made for some very family-friendly tax breaks," she says. "And it's not as though these are going away, but they will certainly be less robust."

Perlman says that, income tax rates aside, if the fiscal cliff does happen, reduced tax credits and deductions could be felt early in the year for some taxpayers. "These are all things that will hit your 2013 return that you file in 2014," she says. "That said, we might be looking at changes to your withholding and changes to the way you do your estimated taxes for 2013."

Below are some of these expiring family-friendly tax breaks and how they will change if the full fiscal cliff goes into effect. Bear in mind that a tax credit is a dollar-for-dollar reduction in taxes, making it more valuable than a deduction, which reduces the amount of income subject to tax.

Affecting Parents
Child Tax Credit: Families that had been able to claim a $1,000-per-child credit on their taxes will see this fall to $500 per child if the cliff happens. So a family with three children, for example, will get a $1,500 credit rather than a $3,000 credit. The Child Tax Credit is available to taxpayers with dependent children age 16 or younger and begins phasing out at modified adjusted gross incomes of $110,000 for joint filers and $75,000 for single filers. Also, families who owe less in taxes than the credit is worth will no longer be eligible to have the excess credit refunded to them in most cases.

Child and Dependent Care Credit: This tax credit applies to money paid to cover care for a dependent child age 12 or under or for an adult incapable of caring for himself or herself in order to allow the taxpayer (and the taxpayer' s spouse, if filing jointly) to go to work. It currently covers up to 35% of eligible expenses up to $3,000 for one child or dependent (up to $6,000 for two) but will drop to 30% of the first $2,400 in expenses per child or dependent ($4,800 for two) and phase out at a lower income level.

Adoption Costs: The tax credit for adoption-related expenses, worth up to $12,650 in 2012, will be reduced to a maximum of $6,000 in 2013, and employer-provided adoption assistance will no longer be excluded from income. Also, the credit will be available only for adoption of special-needs children. Income phase-out for the credit will start at $75,000 per family, down from $189,710 this year.

Affecting Married Couples
The Marriage Penalty: The standard deduction for married couples, which currently stands at 200% of the deduction for singles, will revert to 167% of the single deduction. Also, the upper limit of the 15% bracket for married couples will drop from 200% of the upper limit for singles to 167% of that amount.

Earned Income Tax Credit: Higher phase-out levels for married taxpayers will expire for this tax credit, which is aimed at helping low-income families, meaning they will be subject to lower single-taxpayer phase-out levels. In 2012, a couple with two children could make up to $47,162 and still be eligible for the credit versus $41,952 for a single taxpayer with two children, about a $5,200 difference.

Affecting Those Paying Education Expenses
Student Loan Interest Deduction: An annual deduction of up to $2,500 in interest paid on student loans will be limited to the first five years of interest payments. Income eligibility thresholds will drop from $155,000 for joint filers and $75,000 for single filers in 2012 to $75,000 for joint filers and $55,000 for single filers (with those amounts then adjusted for inflation since 2002).

American Opportunity Credit: This expanded version of the Hope Credit, used to offset higher education costs, raised the maximum credit amount to $2,500 and the number of years the credit could be claimed to four. However, if it expires, the maximum credit will drop to $1,800 and the number of years of eligibility will drop to two.

Coverdell Education Savings Accounts: As discussed in this Short Answer article, changes will include yearly contribution limits for this tax-advantaged educational savings vehicle dropping from $2,000 to $500. In addition, Coverdell account funds will no longer be usable to cover educational expenses for kindergarten through 12th grade, effectively making them college-savings-only vehicles.The income limit for families eligible to contribute also will drop, from $220,000 per year to $160,000.

You can read more about tax provisions expiring in 2013 in this report from the Congressional Research Service.

Calculating Your Own Fiscal Cliff Price Tag
Add to the list above the potential impact on families and other taxpayers of an unpatched alternative minimum tax, a steep drop in the estate tax exemption, the new Medicare surtax for high-income taxpayers, and more, and it's clear that the debate over tax rates is really just the start of the discussion. 

All told, the average price tag for all the scheduled fiscal cliff changes, should they go into effect, is $3,446 per U.S. household in 2013, according to an analysis by the nonpartisan Tax Policy Center. A breakdown by income level looks like this:

The Tax Policy Center also offers a fiscal cliff-themed tax calculator that allows you to input your own tax profile and see how you would fare under different scenarios, including the full fiscal cliff going into effect and various alternative proposals. It's a useful tool that can help you put a dollar value on what the debate in Washington means for your family.

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Adam Zoll does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.