The birth of a child is not just a blessed event; it's the beginning of a whole new set of tax breaks for your family. Learn how the newest addition to your family can help trim your tax bill, and how to save for your child's future in the most tax-efficient manner.
• The Child Tax Credit for tax year 2023 is $2,000 per child for qualifying children through age 16. A portion of this credit is refundable as the Addition Child Tax Credit meaning that eligible families can get it in the form of a refund, even if they owe no federal income tax.
• If you're single, having a child may allow you to file as a head of household rather than using the single filing status, giving you a bigger standard deduction and more advantageous tax brackets.
• Having a child increases the amount you can earn and still claim the Earned Income Tax Credit (EITC).
• If you pay for child care to allow you to work and earn taxable income in 2023, you may be eligible for the Child and Dependent Care Credit worth up to $1,050 for the care of one child under age 13, or up to $2,100 for the care of two or more children under 13.
Get a Social Security number
Your key to tax benefits is a Social Security number. You'll need one to claim your child as a dependent on your tax return. Failing to report the number for each dependent can trigger a $50 fine and tie up your refund until things are straightened out.
You can request a Social Security card for your newborn at the hospital at the same time you apply for a birth certificate. If you don't, it can be a real hassle. You'll need to file a Form SS-5 with the Social Security Administration, and provide proof of the child's age, identity and U.S. citizenship.
If registering newborns strikes you as silly, keep in mind that the aim is to prevent taxpayers from claiming dependents they don't deserve (think parakeets and puppies). Apparently, it's working. In the first year the government required Social Security numbers, 7 million fewer dependents were claimed than the year before.
Beginning with the 2018 tax year, dependency exemption deductions are no longer claimed on your tax return. For tax years prior to 2018 claiming your son or daughter as a dependent will shelter $4,050 (for 2017) of your income from tax, saving you a quick $1,012.50 if you're in the 25 percent bracket. You get the full-year's exemption no matter when during the year the child was born or adopted.
Child Tax Credit
For 2023, a new baby also delivers a tax credit of up $2,000, even if the child was born late in the year. Unlike a deduction that reduces the amount of income the government gets to tax, a credit reduces your tax bill dollar-for-dollar.
The credit is phased out at higher income levels, and begins to disappear as income rises above $400,000 on joint returns, and above $200,000 on single and head of household returns for 2023. With the Additional Child Tax Credit, up to $1,500 of the 2023 credit is refundable meaning that if it exceeds your income tax liability for the year, the IRS will issue a refund check for the difference. Don’t assume you can’t qualify for the refundable credit just because you didn’t qualify in prior years.
TurboTax Tip: You may have an even more tax-friendly way to pay your child care bills than the child care credit: a child care reimbursement account at work. These accounts, often called Flex Plans, let you divert up to $5,000 of your 2023 salary into a special tax-advantaged account that you can then tap to pay child care bills.
Stimulus impact on the Child Tax Credit for 2021 only
New, Temporary Advance Child Tax Credit Payments
The Child Tax Credit was expanded by the American Rescue Plan Act, that was enacted in March of 2021. Part of this expansion was to advance the 2021 tax credit to families by sending them direct payments during 2021 rather than having them wait until they prepare their 2021 tax return in 2022. Most families do not need to do anything to get their advance payment. Normally, the IRS will calculate the payment amount based on your 2020 tax return. Eligible families will receive advance payments, either by direct deposit or check.
The amount that you receive will be reconciled to the amount that you are eligible for when you prepare your 2021. Most families will receive about one-half of their tax credit through the advance payments and the other half through their tax return. If you receive too little through the advance payments, you can claim an additional amount on your tax return. In the unlikely event that you receive too much, you might have to pay the excess back, depending on your income level.
Child Tax Credit Changes
The American Rescue Plan raised the maximum Child Tax Credit in 2021 to $3,600 for qualifying children under the age of 6 and to $3,000 per child for qualifying children ages 6 through 17.
The Child Tax Credit changes for 2021 have lower income limits than in other years. Families that do not qualify for the credit using these income limits are still eligible for the $2,000 per child credit using the original Child Tax Credit income and phase-out amounts.
In addition, the entire credit is fully refundable for 2021. This means that eligible families can get it, even if they owe no federal income tax.
For updates and more information, please visit our 2021 Child Tax Credit blog post.
Fix your withholding at work
Since claiming an extra dependent can cut your tax bill, it also means you can likely cut back on tax withholding from your paycheck. File a new W-4 form with your employer to claim additional tax credits that you are eligible for.
For a new parent in the 25 percent bracket, that will cut withholding—and boost take-home pay—by about $75 a month or perhaps even more.
If you are married, having a child will not affect your filing status. But if you're not married, having a child may allow you to file as a head of household rather than using the single filing status.
That would give you a bigger standard deduction and more advantageous tax brackets. To qualify as a head of household, you must pay more than half the cost of providing a home for a qualifying person—and your new son or daughter likely qualifies.
Earned income credit
For a couple without children, the chance to claim the Earned Income Tax Credit (EITC) disappears when income on a joint return exceeds $24,210 in 2023. (For single filers the 2023 limit is $17,640.) The table below shows the income limits to qualify for the credit for joint and single filers, based on how many qualifying children you have.
2023 EIC Income Limit Breakdown
|Number of Qualifying Children Claimed||Income Limit for Joint-Filers||Income Limit for Single-Filers|
|Three or more||$63,698||$56,838|
Child and dependent care credit
If you pay for child care to allow you to work—and earn income for the IRS to tax—you can earn a credit worth up to $1,050 if you're paying for the care of one child under age 13, or up to $2,100 if you're paying for the care of two or more children under 13. The size of your credit depends on your income and how much you pay for care (you can count up to $3,000 for the care of one child and up to $6,000 for the care of two or more).
In 2023 the credit begins to phase out with an AGI of $15,000 with the ability to claim a credit of up to 35 percent of qualifying costs; the percentage gradually drops to a floor of 20 percent for taxpayers reporting AGI over $45,000. With an AGI of $438,000 or more the credit is completely phased out.
Child care reimbursement account
You may have an even more tax-friendly way to pay your child care bills than the child and dependent care credit: a child care reimbursement account at work. These accounts, often called Flex Plans, let you divert up to $5,000 of your salary in 2023 into a special tax-advantaged account that you can then tap to pay child care bills.
Money you run through the account avoids both federal and state income taxes as well as Social Security and Medicare taxes, so it could easily save you more than the value of the credit. You can't double dip by using both the reimbursement account and the credit.
Although you generally can only sign up for a Flex account during "open enrollment" in the fall, most companies allow you to make mid-year changes in response to certain "life events," including the birth of a child.
There's also a tax credit to help offset the cost of adopting a child. For 2023, the credit is worth as much as $15,950. If you adopt a "special needs" child, you can claim the full credit amount even if your actual adoption costs are less. For 2023, this credit phases out as Adjusted Gross Income, rises from $239,230 to $279,230.
Save for college
It's never too early to start saving for those college bills. And it's no surprise the Congress has included some tax goodies to help parents save. One option is a Section 529 Education Savings Plan. Contributions to these plans are not deductible on your federal taxes, but earnings grow tax-free and payouts are tax-free, too, if the money is used to pay qualifying education expenses. (Some states give residents a state tax deduction if they invest in their state's own 529 Plan. Visit your state's official website for details.) There are no income restrictions on 529 Plan contributions.
You may also want to fund a Coverdell Education Savings Account (ESA) for your newborn. Up to $2,000 a year can go into an ESA for each child. Again, there is no deduction for deposits, but earnings are tax-free if used to pay qualified education expenses. Both ESA and 529 money can pay for elementary and high school expenses (even a computer used for school and educational software), as well as for college costs. The right to contribute to an ESA phases out in 2023 as modified adjusted gross income rises from $95,000 to $110,000 on single returns, and from $190,000 to $220,000 on joint returns.
You may have heard about Kid IRAs and the fact that relatively small investments when a child is young can grow to eye-popping balances over many decades. It's true, but there's a catch. You can't just open an IRA for your newborn and start shoveling in the cash.
A person must have earned income from a job or self-employment in order to have an IRA. Gifts and investment income don't count. So you probably can't open an IRA for your newborn (unless, perhaps, your child gets paid for being an infant model). But as soon as your youngster starts earning some money—babysitting or delivering papers, for example, or helping out in the family business—they can open an IRA. The phenomenal power of long-term compounding makes it a great idea.
A Roth IRA is an ideal choice for most kids who are in a low tax bracket, where a tax deduction is of little value. With a Roth IRA there’s no up-front tax break, but their savings will benefit from years of tax-free growth, and withdrawals in retirement are tax-free.
So far, this article has had nothing but good news. But the Kiddie Tax unfortunately is not good news. Here is what you need to know:
The graduated nature of our federal income tax rates—with higher tax rates on higher incomes—creates opportunities for savings if you can shift income to someone (such as a child) in a lower tax bracket. For example, let's say Dad has $1 million invested in bonds which pay $50,000 of taxable interest each year. As a resident of the 35 percent tax bracket, that extra income hikes his tax bill by $17,500. But if he could divvy up the money among his five children, each of whom earned $10,000, the money would be taxed in the 10 percent bracket and the family could save $12,500 in taxes, right? Nice try—but it won’t work.
To prevent such schemes, Congress created the Kiddie Tax to tax most investment income earned by a dependent child at the parents' top tax rate. For 2023, the first $1,250 of a child's "unearned" income (that's income that's not earned from a job or self- employment) is tax-free (thanks to the child’s standard deduction) and the next $1,250 is taxed at the child's own rate (probably 10 percent). Any additional investment income at the tax rates used for trusts—as high as 37 percent. Under current rules, the kiddie tax applies until the year a child turns 19 (or 24 if a dependent full-time student.)
The Nanny Tax is also not good news. If you hire someone to come into your home to help care for your new child, you could become an employer in the eyes of the IRS—and face a whole new set of tax rules. If you hire your nanny or caregiver through an agency, the agency may be the employer and have to take care of all the paperwork. But if you're the employer—and you pay more than $2,600 in 2023—you're responsible for paying Social Security, Medicare and unemployment taxes for your caregiver, and reporting the wages to the caregiver and to the IRS on Form W-2.
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