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 2008
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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.
Tax rebate do-over. If you had a baby or adopted a child in 2008, and your income qualified you for a tax rebate check in the spring of 2008, you may be entitled to an extra $300 economic stimulus credit when you file your 2008 tax return. That's because the initial rebate checks, worth up to $600 for individuals, $1,200 for married couples, and $300 for each qualifying child under 17, were based on information supplied on your 2007 return.
Adding a qualifying child to your family in 2008 gives you a second crack at the rebate check. The stimulus payment –– both the basic component and the additional funds for qualifying children –– begins to phase out for individuals with adjusted gross incomes (AGI) over $75,000 and married couples who file a joint return with AGI over $150,000.
Dependency exemption. Claiming your son or daughter as a dependent will shelter $3,500 of your income from tax in 2008, saving you a quick $875 if you're in the 25% bracket. (The exemption will be worth $3,650 on 2009 returns.) You get the full year's exemption no matter when during the year the child was born or adopted.
Top-earning taxpayers -- those reporting 2008 adjusted gross incomes over $239,950 on joint returns, $159,950 on individual returns or $199,950 for heads of households -- gradually lose up to one-third of the tax-saving power of their exemptions. Those thresholds will increase to $250,200, $166,800 and $208,500 for 2009. 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. Don't assume you can't qualify for the refundable credit just because you didn’t in past years. During 2008, Congress liberalized the rules.
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 $15,880 in 2008. Having a child, though, pushes the cut off to about $37,000; and if you have two or more children, you can earn almost $41,646 and still have a crack at this 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.