Birth of a Child and Adoption Tax Guide
Saturday, February 16, 2008; 12:00 AM
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. 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, 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 the numbers, 7 million fewer dependents were claimed than the year before.
Dependency exemption. Claiming your son or daughter as a dependent will shelter $3,400 of your income from tax in 2007, saving you a quick $850 if you're in the 25% bracket. (The exemption will be worth $3,500 on 2008 returns.) You get the full year's exemption no matter when during the year the child was born. Top-earning taxpayers -- those reporting 2007 adjusted gross incomes more than $234,600 on joint returns, $156,400 on individual returns or $195,500 for heads of households -- gradually lose the tax-saving power of exemptions. Those thresholds will increase to $239,950, $159,950 and $199,950 for 2008. Regardless of your income, if you are hit by the alternative minimum tax, exemptions lose all of their tax-saving value.
$1,000 child credit. 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.
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." For a new parent in the 25% bracket, that will cut withholding -- and boost take-home pay -- by about $70 a month. You can also take the child credit into account on your W-4, pushing withholding down even more.
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 $14,550 in 2007. Having a child, though, pushes the cut off to about $35,000; and if you have two or more children, you can earn almost $40,000 and still have a crack at this credit. The income limits when the right to claim the EITC disappears will increase for 2008.
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 over $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 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 $11,390 in 2007 and if you adopt a "special needs" child, you can claim the full credit even if you spend less than $11,390. This credit phases out as adjusted gross income rises from $170,820 to $210,820. For 2008, the credit will be phased out for incomes between $174,730 and $214,730.