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 article below is accurate for your 2017 taxes, the one that you file this year by the April 2018 deadline, including a few retroactive changes due to the passing of tax reform. Some tax information below will change next year for your 2018 taxes, but won’t impact you this year. Learn more about tax reform here.
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.
Claiming your son or daughter as a dependent will shelter $4,050 of your income from tax in 2017, 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.
$1,000 child tax credit
For 2017, a new baby also delivers a tax credit of up $1,000, 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 $110,000 on joint returns, and above $75,000 on single and head of household returns. For some lower-income taxpayers, the 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.
Fix your withholding at work
Since claiming an extra dependent will cut your tax bill, it also means you can cut back on tax withholding from your paycheck. File a new W-4 form with your employer to claim an additional withholding "allowance."
For a new parent in the 25 percent bracket, that will cut withholding—and boost take-home pay—by about $75 a month.
If you are married, having a child will not affect your filing status. But if you're single, 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 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 $20,600 in 2017. (For single filers the 2017 limit is $15,010.) 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.
|2017 EIC Income Limit||Joint-Filers||Single-Filers|
|3 or more children||$53,930||$48,340|
Child 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 between $600 and $1,050 if you're paying for the care of one child under age 13, or between $1,200 and $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).
Lower income workers with an Adjusted Gross Income of $15,000 or less can 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 $43,000.
Child care reimbursement account
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 a year of your salary 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. But note that while the limit for Flex accounts is $5,000, the credit can be claimed against up to $6,000 of eligible expenses if you have two or more children. So even if you run $5,000 through a Flex account, you could qualify to claim the 20 percent to 35 percent credit on up to $1,000 more.
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 2017, the credit is worth as much as $13,570. If you adopt a "special needs" child, you can claim the full credit amount even if your actual adoption costs are less. For 2017, this credit phases out as Adjusted Gross Income, rises from $203,540 to $243,540.
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 college bills. (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. ESA 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 as 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, he or she 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—he or she 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. But don't try to pull any punches. 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 2017, the first $1,050 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 $1,050 is taxed at the child's own rate (probably 10 percent). Any additional investment income is taxed at the parents' rate—as high as 39.6 percent. Under current rules, the kiddie tax applies until the year a child turns 19 (or 24 if he or she is a dependent full-time student.)
The Nanny Tax is also not good news, but it's fair. If you lawfully 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 $2,000 in 2017—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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