Personal Finance 

Baby Tax Breaks

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BabyNo one has a kid for the financial benefits because everyone knows that having kids is expensive. At first it seems manageable, since all you buy are diapers. But eventually the costs begin to escalate as your kid wants to actually do more than sleep, poop, and eat. There are preschools to go to, Little Leagues to join, SAT prep classes to take, and eventually, maybe, colleges to attend. They say that boats are big holes that you throw money into, well kids are vacuums are suck up any money you have lying around.

Fortunately, Uncle Sam is there to lend you a helping hand. It’s not as generous as some European governments, who give healthy stipends to families, but every little bit helps… it’s up to you to make sure you claim every last bit!

Here is a rundown on the tax breaks available to new families (and also to many “old” families):

A New Dependent

The key idea around many of these tax breaks is that you’ve added a dependent to your tax return. So if you recently took in an ailing parent and are their primary caregiver, thus making them eligible to your dependent, you can also take some of the deductions. Remember, many of these breaks are covered under “Child and Eligible Dependent Care.”

First on the list is claiming your new child as a dependent, which will shelter $3,700 in income from your taxes in 2011. If you’re in the 25% tax bracket, that’s $925 in taxes you will now no longer have to pay.

You can also adjust your withholding at work if you don’t do this already. This can boost your take-home pay but doesn’t affect anything else.

Child Tax Credit

Available to taxpayers that earn less than $110,000, the Child Tax Credit is a $1,000 refundable tax credit you claim on your tax return. It’s a credit, not a deduction, so it’s a straight $1,000 reduction on your tax bill. If you earn more than $120,000, the credit is phased out at 5% of your income in excess of $110,000 (thus expiring if your income exceeds $130,000).

Child & Dependent Care Tax Credit

Th nonrefundable Child and Dependent Care credit takes a little bite out of the costs of dependent care (up to $3,000 for one dependent, $6,000 for two or more). The rules state that both spouses have to work full time (or be a full time student for 5 months of the year, or be physically or mentally incapable of self-care) in order to qualify, but otherwise you get a percentage of your care costs (there are strict rules regarding what you can claim) that caps at 20%. The scale is dependent on adjusted gross income with the maximum 35% for those with an AGI under $15,000. The percentage drops 1% for every additional $2,000 in AGI until $43,000. If your AGI is above $43,000, you can claim 20% up to the $3,000/$6,000 limit.

Dependent Care FSA

Finally, much like how you have a medical flexible spending account (FSA), you are also able to take advantage of the dependent care FSA. The rules stipulate that you can put up to $5,000 a year of your salary into an FSA to help pay for child care. Here’s the tricky part – you can’t double dip. So if you set aside $5,000 for a dependent care FSA, you can only claim an additional $1,000 in expenses under the Child and Dependent Care Tax Credit.

Which is better? the FSA or the credit? It depends on your tax bracket. Remember that if you earn more than $43,000 a year, the tax credit gives you 20%. If your marginal tax bracket is above 20%, which is would be if you earned more than $43,000 a year, then you’d rather take the deduction from contributing to an FSA.

There are just the three biggest pieces of the baby tax breaks puzzle. There are other benefits out there, like Coverdell Education Savings accounts, but I only covered the ones with an immediate benefit. An ESA is like the Roth IRA (and they also have contribution limits based on income), you don’t get a deduction but you get the earnings tax free if they are used for education (elementary and high school qualify).

If you recently had a child, hopefully this takes a bit out of the financial bite!

(Photo: bellymotherbaby)

{ 12 comments, please add your thoughts now! }

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12 Responses to “Baby Tax Breaks”

  1. Scott says:

    Congratulations Jim! (I was wondering when your first baby money post would come out.)

  2. MikeZ says:

    I’ve yet to try it but since my girlfriend and I are unmarried with 2 kids (been engaged for something like 15 years now), I think you could theoretically double dip the Dependant care FSA. I’m technically a single father and she’s a single mother (one kid each) who happen to live in the same house. Just another way the government screws you by getting married.

    • Steve says:

      Sorry MikeZ, only the parent who claims the child as a dependent (or the custodial parent) can use the Dependent Care FSA.

      • Scott says:

        I think he’s saying they could each claim one kid each as a dependent (split the two) and then each use $5k in dependent care FSA money. I think it will work, but I’m no tax expert.

        • MikeZ says:

          Yup, 2 kids one for each. This would be double dipping if we were married as this FSA specifies a $5K max per family. However if the parents aren’t married and each claims one child then it appears to work (although I haven’t tried it yet).

          For tax purposes my girlfriend and I already do claim one child each. We make close to the same salary (I make about 20% more so I claim a child and the house (and pay the mortgage), while she claims one child and takes a standard deduction.

  3. NateUVM says:

    Be careful with the double-dip statement.

    You would only be eligible for that addt’l $1000 credit if you had 2 or more qualifying dependents (and qualified for the $6000 credit).

    If you have only one dependent, and already max out your FSA at $5000, you aren’t eligible for that extra $1000 credit. That’s what Jim meants by not being able to double-dip. He was assuming the 2 dependents, but I think it could read differently if you’re not careful.

  4. govenar says:

    Does the US really have a population problem such that we need to pay people to encourage them to have more babies? I think it’d make more sense to discourage people from having babies if they can’t afford them. Maybe there should be a Childless Tax Credit.

    • Scott says:

      Huh? The tax code pretty clearly helps you with your first child quite a bit, just a little with your second, and anything beyond that is an “oops” or a luxury child. So the US is, in fact, encouraging population stagnation at best.

    • HuBu says:

      Just deny WIC and EBT to some families and problem fixed.

      • NateUVM says:

        What problem? Not enough starving children?

        Seriously though, anybody who has more children to just get paid more is either mentally unsound or a criminal. The former should be treated and the latter should be prosecuted.

        The tax code, like any other law, should not be written according to how people abuse it, but rather how it helps our society. It’s not like we should discontinue using money just because it can be counterfeited.

      • SLS says:

        To what problem are you referring here?

        Denying WIC and EBT food benefits only increases poverty; it helps no one.

        As someone who receives EBT food benefits, trust me when I say that there is plenty of hoop-jumping required in the process to “weed out” anyone who does not legitimately need food assistance – whether they have children or are childless.

  5. roommate says:

    Don’t have a kid because it will cost like ten thousand dollars per decade instead invest that same money in your home compounded monthly at 8%(rent + appreciation)

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