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Complete Tax Planning Guide for New Parents

Complete Tax Planning Guide for New Parents - TaxACT Blog

Having children changes everything – even your tax planning.

Whether you’re a new parent or you’re in the busy middle years of raising kids, it’s important to understand tax issues so you can plan ahead.

Here are some tax issues, from Adoption to Zoo memberships, which may affect you as a new parent:

Adoption Credit

The adoption credit is quite amazing.

Unlike most credits, which only return a portion of your expenses, the adoption credit refunds your adoption expenses on a dollar-for-dollar basis.

You may get a credit for up to $13,190 in 2014.

If your modified adjusted gross income in 2014 is over $197,880, your credit is reduced. If it’s $237,880 or more, you won’t qualify for this credit.

Babysitting and child care

If you pay someone to take care of your child while you work or look for work, you may qualify for a credit of up to 35% of the first $3,000 you pay them.

For two or more children, the credit may be as much as 35% of up to $6,000 in expenses.

If your income is over $15,000, the percentage used to calculate the credit is reduced. If your income is between $15,000 and $17,000, the credit is 34% of your expenses, if you qualify.

If your adjusted gross income is over $43,000, the percentage is 20% of expenses. You can take this credit until your child reaches age 13.

Child Credit

It doesn’t matter if the baby comes in January or December – if you have a new child during the tax year, you may be able to claim a $1,000 child tax credit.

You can take this credit every year until your dependent son or daughter turns 17.

The credit phases out at higher income levels – expect a lower credit if your adjusted gross income is $75,000 or higher ($110,000 if filing jointly).

If you are in the lower tax brackets (use this calculator to find out which tax bracket you are in), the credit is refundable.

This means you may get a refund even if the credit exceeds your income tax liability for the year.

Dependency Exemption

Every child you can claim as a dependent reduces your taxable income by $3,950 in 2014.

That will save you almost another $1,000 if you’re in the 25% bracket.

Again, it doesn’t matter when your child was born during the year.

Earned Income Credit

It’s possible to claim the Earned Income Tax Credit, or EITC, without children, but it’s more difficult.

If you file a joint return with no children, the credit phases out completely when your income exceeds $20,020 in 2014.

If you have just one child, however, you can earn $43,941 in 2014 on a joint return. The income limits are higher with two children, or with three or more children.

Filing Status

If you’re single, you generally used the Single filing status.

However, if you pay more than half the cost of maintaining a household in which your qualifying child lives, you may be able to use the Head of Household filing status.

You may be able to use the Head of Household filing status even if the child’s other parent claims the dependency exemption. You generally pay less tax by using this status than by filing as Single.

Higher Education Savings Plans

The sooner you start thinking about the cost of higher education, the easier your savings plan will be.

Start looking into Section 529 state education savings plans.

You won’t get a tax deduction when you contribute to them, but the plan grows tax free, and your child can make qualified withdrawals tax free.

You may get a state tax deduction when you contribute – check with your state. You, not your child, stays in control of a 529 plan, and there are no income restrictions.

Coverdell Education Savings Accounts (ESAs) are another way to save for college. An ESA is opened in a child’s name. If you use this plan, you’d better start early. No more than $2,000 can be deposited to an ESA in one year.

IRAs for Kids

Retirement planning for youngsters? It’s not crazy, after all. Tweet this

If you look at how well even modest investments can fare, given enough years, you might wish you had put some of your babysitting and lawn mowing money into retirements accounts, too.

Furthermore, the money doesn’t have to actually come from the child’s earned income. The contributions can come from you or Grandma, just as long as it’s no more than $5,500 per year or the child’s earned income, whichever is less.

Kiddie Tax

If you’re in a high tax bracket (use this calculator to find out which tax bracket you are in), you may have noticed that if your child were to file a return, his tax bracket would be much, much lower.

All you have to do is transfer income-producing assets to Junior, and let him rake in the income and pay tax at his lower rate.

Sounds good, right?

Unfortunately, that’s been tried.

As a result, we have the so-called kiddie tax. After the first $1,000 of a child’s unearned income (interest, dividends, and so on), the child pays tax on the next $1,000 at the child’s own rate.

If he or she has more unearned income, it’s taxed at your rate. A “child” for the kiddie tax remains a child until age 19, or 24 if he or she is a dependent and full-time student.

Reimbursements for Child Care

Instead of taking the Child and Dependent Care Credit, you may be able to use a reimbursement account at work.

If this plan is available to you, you or your employer may be able to contribute up to $5,000 a year into this account and use it for child care expenses.

The money you put into this account escapes both Social Security and income tax, potentially saving you more money than you would gain by claiming the child care credit.

This type of plan is also referred to as a dependent care benefit plan.

Social Security Numbers

People used to wait until they needed a Social Security number before they applied for one. That could be years down the road.

All that has changed.

Now, you should apply for a Social Security number as soon as your child is born, or you cannot claim him or her as a dependent on your tax return. If you try, you could face a fine from the IRS. Tweet this

Withholding Adjustments

Having a child can help you save on income tax.

Why wait until you file your return next year to start getting a bigger paycheck? Adjust your withholding to have less tax withheld?

Use TaxACT to estimate the correct amount of tax you should be having withheld and prepare a new Form W-4 to take to your employer.

Zoo, Museum, and Other Memberships

During the child raising years, you may visit the zoo, the aquarium, and other fun places more often than you ever imagined.

Not only are annual passes usually a great deal – and an easy bypass of those long ticket lines – but part of your membership pass may be tax deductible as a charitable contribution.

The organization can tell you how much, if any, of your pass counts as a deduction.

TaxAct makes preparing and filing your taxes quick, easy and affordable so you get your maximum refund. It’s the best deal in tax. Start free now or sign into your TaxAct Account.
About Sally Herigstad

Sally Herigstad is a certified public accountant and personal finance columnist and author of Help! I Can't Pay My Bills, Surviving a Financial Crisis (St. Martin's Griffin). She writes regularly at CreditCards.com, Bankrate.com, Interest.com, RedPlum, and MSN Money. She is an experienced speaker and a member of Toastmasters International. Follow Sally on Twitter.