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Baby Tax Breaks

No 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 [3], 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 [4], 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 [5] is a $1,000 refundable tax credit [6] 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 [7] 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 [8])