It’s no surprise that having a baby has a profound effect on your life. While most soon-to-be parents understand the many ways a baby will change their lives forever, the tax-specific changes connected with this major life event are not always as clear. Income tax preparation becomes slightly more complicated once you add a child to the mix, but there are a handful of tax benefits that will become available to you. In order to understand the full scope of tax breaks and other implications that come with having a child, there are a few things to consider.
ADJUST WITHHOLDING ON YOUR W-4
One of the first things you should do if you are expecting a baby is adjust your withholdings with your employer. Usually, this is simply a matter of contacting your payroll or HR department and requesting the change. For example, if you are married and both you and your spouse work, and you have one child, you can add up to six exemptions on your W-4.
You don’t have to claim all of the W-4 exemptions to which you are entitled; claiming fewer exemptions may result in a bigger tax refund. However, that’s not necessarily a good thing, as a large tax refund simply means you let the government borrow some of your money interest-free for over a year. It’s best to plan carefully and talk to your tax advisors about applying the best strategy for your situation.
An important step to take care of once your baby arrives is applying for a birth certificate and social security card. In New York State, the Department of Health automatically mails you a free birth certificate about 4 weeks after your child’s birth (once you’ve completed the necessary forms).
You can ensure the documentation application process goes smoothly by taking action ahead of time:
- Save some time by filling out the state Department of Health’s mother/parent worksheet before you leave the hospital with your new baby. This worksheet collects important information for the birth certificate and allows you to then apply for your baby’s social security card.
- The state agency that issues birth certificates will share your child’s information from the mother/parent worksheet with the Social Security Administration, and the SSA will mail the social security card to you.
Why is it important to have a social security card? As long as your child is born before midnight by December 31, you will be able to claim the dependency exemption for the current tax year. Keep in mind that you can’t claim the exemption on either your original or amended return if your child does not have a social security number by the due date of your tax return.
TAX FILING STATUS
The third thing to consider is your tax return filing status. If you are married, having a child will not affect your filing status. If you are single, however, having a child may allow you to file as a head of household rather than using the single filing status. This 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 your new son or daughter.
As for the tax benefits, there are two major sections of the federal tax code that give benefits to households with children:
The Dependent Exemption
When you have a child, the IRS allows you to claim the child on your tax returns, which allows for an extra exemption. Along with your standard deduction, exemptions reduce your taxable income and thus your tax liability. In 2017 the average family can reduce their taxable income by $4,050 for each dependent claimed on their tax return.
The main purpose of tax credit is to reduce the tax you owe the IRS dollar for dollar. There are two classes of tax credits: refundable and nonrefundable. Refundable tax credits reduce your tax, and if the credit exceeds your tax liability, you will receive the remaining amount as a refund. Nonrefundable credits are just that–nonrefundable. The sole purpose of a nonrefundable credit is to reduce your tax, preferably to a zero balance. The IRS offers several tax credits to taxpayers, two of which require you to have a child to qualify:
1. Child Tax Credit – The Child Tax Credit is a refundable credit that reduces the tax you owe. The amount of your credit is based on income and number of children in your home. There are income limits to the Child Tax Credit, and as your income reaches the limit, the amount of the credit phases out.
2. Child and Dependent Care Credit – If your child attends day care or you employ a nanny, you may qualify for additional tax credits. Unlike the Child Tax Credit, the child and dependent care credit is nonrefundable. To qualify for the credit, you must pay a licensed provider to care for your child while you work or search for work. In addition, the child must be under 13 years of age and you may not use the married-filing-separately filing status. As of 2017, the maximum credit you may claim per child is $3,000.
Medical Flex Spending Account (FSA)
You should consider starting a Medical Flex Spending account if you are able to participate through your job for a few reasons. You are allowed to put up to $2,600 of your pre-tax pay into the FSA in 2017, which can then be used to pay your medical bills for doctors, hospital, lab, and prescription fees. There are also substantial tax savings because there is no income tax on money put into an FSA; there are also no payroll taxes withheld from this money. If both you and your spouse have an FSA option, consider each investing in your respective FSA accounts. Take caution that any money left in the account after all your 2017 expenses are paid will be lost, so be sure to plan carefully and ensure that you use all amounts set aside for the FSA.
529 College Saving Plan
It’s never too early to start saving for your child’s college education. A 529 College Savings Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. As 529 Savings Plans are run by the states in many instances, there can be big differences between plans related to state tax incentives and investment choices. A 529 plan works similarly to a Roth IRA in that contributions are not tax-deductible, but all of your withdrawals for qualifying higher-education expenses are 100% tax-free. In the state of New York up to $10,000 can be deducted annually from your New York taxable income for married couples filing jointly who contribute to the New York State 529 College Savings Program.
This blog series is meant to provide an overview of the common implications you might face when you encounter various life events, but there are likely additional considerations dependent on your specific scenario. At FF&F our experienced staff will act as your advisors throughout each step of any event that might affect your tax planning. For more information on this topic, or to discuss tax planning strategies, please contact us at email@example.com or (212) 245-5900.
Lounise George, MBA, is a Tax Manager who has been with FF&F for 10 years. She has over 15 years of accounting experience, and since joining FF&F has worked with a diverse group of clients. Lounise specializes in High Net Worth Individuals & Non-Profit Organizations.