Tax Planning

Birth of a Child and Adoption Tax Guide

Tax credit for children, tax relief on daycare costs, the IRS offers some way to alleviate a tax burden on parents trying to raise a family.

June 2010

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 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.

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 $3,650 of your income from tax in 2010, saving you a quick $913 if you're in the 25% bracket. 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. 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. (Try our Withholding Calculator.)

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 $18,470 in 2010. Having a child, though, pushes the cut off to about $40,500. With two children, you can earn more than $45,000 and still have a crack at this credit and with three or more children, you can earn about $48,300 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.

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