NEW BABY AND TAXES
New baby in the house; congratulations! The birth of a child guarantees major changes in your lives … as parents and as taxpayers. Over the years, Congress has peppered the law with tax breaks to help American families. Considering the high cost of child rearing in the 21st century, you’ll need all the help you can get.
Get a Social Security number for your newborn:
Your key to tax benefits is a Social Security number. You’ll need one for your child to claim him or her 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, 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.
Dependency exemption:
Claiming your son or daughter as a dependent will shelter $3,700 of your income from tax in 2011. You get the full year’s exemption no matter when during the year the child was born or adopted.
Prior to 2010, top-earning taxpayers lost a portion of their exemptions. But in 2010, all tax payments–except those hit by the alternative minimum tax – can claim all the tax-saving value of the personal exemptions for every qualifying member of their household. But if you are subject to the AMT, you cannot claim any exemptions.
$1,000 child credit:
For tax year 2001, a new baby also delivers a $1,000 child tax credit, and this is a gift that keeps on giving every year until your dependent son or daughter turns 17. You get the full $1,000 credit no matter when during the year the child was born.
Unlike a deduction that reduces the amount of income the government gets to tax, a credit reduces your tax bill dollar for dollar. So, the $1,000 child credit will reduce your tax bill by $1,000. The credit is phased out at higher income levels, beginning 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 more than exceeds income tax liability for the year, the IRS will issue a refund check for the difference. Do not assume you can not qualify for the refundable credit just because you didn’t qualify in prior years
Fix your withholding at work:
Because claiming an extra dependent will cut your tax bill, it also means you can cut back on tax withholding from your paychecks. File a new W-4 form with your employer to claim an additional withholding “allowance.” You can also take the child credit into account on your W-4, pushing withholding down even more. For a new parent in the 25 percent bracket, that will cut withholding–and boost take-home pay–by about $75 a month.
Filing status:
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 this credit disappears when income on a joint return exceeds $18,740 in 2011. Having a child, though, pushes the cut off to about $41,132. With two children, you can earn up to $46,044 and still have a crack at this credit and with three or more children, you can earn about $49,078 and still claim this valuable credit.
For a single filer without children, the chance to claim this credit disappears when income on a return exceeds $13,660 in 2011. Having a child, though, pushes the cut off to about $36,052. With two children, you can earn up to $40,964 and still have a crack at this credit and with three or more children, you can earn about $43,998 and still claim this valuable credit. 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 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) and your income.
Lower income workers (with adjusted gross income of $15,000 or less) can claim a credit worth up to 35% of qualifying costs, and the percentage gradually drops to a floor of 20% for taxpayers reporting AGI more than $43,000.
Childcare 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 and your spouse divert up to $5,000 a year of your salary into a special account that you can then tap to pay child-care bills. Money you run through the account avoids both federal income and Social Security 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 quality to claim the 20% to 35% credit on up to $1,000 more.
Although you generally can only sign up for a flex account during “open season,” most companies allow you to make mid-year changes in response to certain “life events,” and one such event is the birth of a child.
Adoption credit:
There’s also a tax credit to help offset the cost of adopting a child. The credit is worth as much $13,360 in 2011. This credit phases out as adjusted gross income in 2011 rises from $185,210 and is completely phased out for taxpayers with modified adjusted gross income of $225,210 or more.
Save for college:
It’s never too early to start saving for those college bills. And it’s no surprise Congress has included some tax goodies to help parents save. One option is a Section 529 state education savings plan. Contributions to these plans are not deductible, but earnings grow tax free and payouts are tax free, too, if the money is used to pay qualifying college bills. (Many states give residents a state tax deduction if they invest in the state’s 529 plan.)
Coverdell Education Savings Accounts (ESA), a free way for families to pay for private school tuition and education-related expenses such as uniforms, transportation costs and computers for elementary and high school students, are being severely restricted. There is no deduction for deposits, but earnings are tax-free is used to pay for education expenses. Through 2011, you can use the money tax-free for elementary and high-school expenses, as well as college costs. Beginning in 2011, any earnings you withdraw will be taxable as ordinary income and subject to a 10% penalty unless used for college expenses. The maximum allowable yearly contribution to a Coverdell account will also be lowered from $2,000 to $500. 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.
Kid IRAs: 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. And, it’s true. But there’s a catch. You can’t just open an IRA tax shelter for your newborn and start shoveling in the cash. A person must have earned income from a job or self-employment 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).
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.
Kiddie tax:
The graduated nature of the income tax rates–with higher tax rates on higher incomes–creates opportunities for savings if you can shift income to someone (a child, perhaps) in a lower tax bracket.
Let’s say Dad has $1 million invested in bonds paying $50,000 of taxable interest each year. As a resident of the 35% tax bracket, that extra income hikes his tax bill by $17,500. But, if he could divvy up the money among five children, each of whom earned $10,000 that would be taxed in the 10% bracket, the family could save $12,500 in tax. Nice try but it won’t work. To prevent it, Congress created the kiddie tax to tax most investment income earned by a dependent child at the parents’ top tax rate. For 2011, the first $950 of a child’s “unearned” income (that’s income that’s not earned from a job or self employment) is tax-free and the next $950 is taxed at the child’s own rate (probably 10%). Any additional income is taxed at the parents’ rate–as high as 35%. The kiddie tax applies until the year a child turns 19 or 24 if he or she is a dependent full-time student.
Nanny tax:
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 $1,700 a year — you’re responsible for paying Social Security and unemployment taxes for your caregiver, and reporting the wages you pay to the government on a W-2 form.
