There’s no doubting it: having kids is expensive. Between paying for diapers, daycare, and tons of other baby supplies, new parents can quickly find themselves overwhelmed financially. Fortunately, several tax advantages are available to parents to alleviate a little of the financial responsibility.
1. Child Tax Credit
The CTC is a tax credit for parents of dependent children designed to help offset the cost of raising kids.
For tax year 2021, the CTC is fully refundable, meaning you can claim this tax credit even if you do not owe any taxes or didn’t earn any income last year. On your 2021 return, you can claim the CTC for any children ages 17 or under (in prior years, you could only claim the credit for children under 17).
For the 2021 tax season, the maximum total credit amount increased from the usual $2,000 per child to $3,000 per child ages 6-17 (and up to $3,600 for children ages 5 and under).
Depending on your tax filing status, the increased credit of $1,000 or $1,600 begins to phase out based on your AGI.
You qualify to claim the maximum value of the Child Tax Credit if your AGI is:
- $75,000 or less for single filers
- $150,000 or less for married couples filing jointly
- $112,500 or less for head-of-household filers
If your AGI is higher than those limits, you could still receive a portion of the increased tax credit. In that event, the increased portion of the credit (either $1,000 or $1,600 per child) is reduced by $50 for every extra $1,000 you earn above the income thresholds. For example, if you file a joint 2021 return, have an AGI of $160,000 and two children 5 and under, your full Child Tax Credit amount will likely be $6,700.
The original $2,000 credit per eligible child doesn’t begin to phase out until your AGI exceeds $200,000 (or $400,000 for joint filers).
2. Child and Dependent Care Credit
While the Child and Dependent Care Credit sounds awfully similar to the Child Tax Credit, they are two separate tax benefits available to parents. The Child and Dependent Care Credit is specifically designed to help reduce the burden of childcare costs incurred while you are working or looking for work.
The credit itself is worth 20-35% of qualified expenses. The amount you can qualify to claim depends on how much you spend on child and dependent care as well as your income level. The maximum amount of qualified expenses you’re allowed to claim is $3,000 per qualifying dependents or $6,000 for two or more qualifying dependents.
3. Adoption Tax Credit
If you adopted a child and it was finalized in 2021, you may be eligible for the federal adoption tax credit. For 2021, this benefit can credit you up to $14,300 per child. It’s vital to note, however, that this tax credit is not refundable, which means you can only claim the credit if you have a federal tax bill.
This is a one-time credit per adopted child. Eligibility for the adoption tax credit depends on a few circumstances. First, in order to claim the credit, you need to have adopted a child (other than a stepchild) in the 2021 tax year. The child must be under the age of 18 or must be either physically or mentally unable to take care of him or herself.
Second, your income must fall within the income limits for the credit. In 2021, families with a modified adjusted gross income less than $214,520 can claim the full credit. Families with incomes between $214,520 and $254,520 can claim a partial credit. Any family whose income is above $254,520 cannot claim the credit.
4. Earned Income Tax Credit
For parents with lower incomes, the Earned Income Tax Credit (EITC) can be a game changer. It is a refundable tax credit that ranges from $538 to $6,660 for tax year 2020 and $543 to $6,728 for tax year 2021. The amount you qualify to receive is dependent upon your filing status, how many children you have, and your income level.
5. Make the most of a 529 plan
It’s never too early or too late to start saving for your child’s education. Fortunately, 529 plans offer tax and financial aid benefits when it comes to putting money away for your child’s college expenses.
There are two types of 529 plans: college savings plans and prepaid tuition plans. College savings plans work like a Roth 401(k) or Roth IRA by investing your after-tax contributions in mutual funds or similar investments. Prepaid tuition plans let you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges.
Like a Roth IRA, contributions to a 529 plan are made post-tax and are not deductible from federal income taxes. Funds in a 529 plan grow federal tax-free and will not be taxed when the money is withdrawn for qualified education expenses. Some states also offer state income tax incentives to parents, such as state income tax deductions and tax credits for contributions to the state’s 529 plan.
6. Consider a dependent care flexible spending account
Depending on the benefits offered through your employer, you may be eligible to participate in a dependent care flexible spending plan.
Dependent care FSA programs work much like a regular healthcare FSA in that you can have pre-tax dollars taken out of your paycheck and put into the account. These funds can be used to pay for qualifying dependent care expenses, such as daycare. In 2020 and 2021, you could contribute up to $5,000 in a dependent care FSA.
7. Adjust your tax withholding
Lastly, when you have a child, you may want to adjust your tax withholdings on Form W-4. By adjusting your withholding, you can ensure you have the appropriate amount of taxes withheld from your paycheck so you, ideally, owe less when you file your tax return.
To adjust your withholding, submit a new Form W-4 to your employer. The TaxAct Withholding Calculator can help you determine the right amount of withholdings for your new tax situation.