Here's How Your Taxes Will Change After You Have a Kid
There's no question that having a kid will change your life financially. Introducing a new child to your household adds a slew of new costs, but the good news is that the American tax code is written to help families with some of these expenses.
The IRS — yes, that benevolent organization — offers a variety of tax credits, deductions, and other incentives that could lead to a smaller tax bill when you have a child. But this also makes your taxes more complicated. So here's a review of what your new baby might mean as you file this year's return.
You get to claim an exemption just for having a kid
When you have a child, you can claim an exemption that will reduce your taxable income by $4,050. And for each child you have, you get to claim another exemption. (So four kids represents $16,200 deducted from your taxable income.)
You can also claim the child tax credit
Yes, you get an additional break on your taxes just by adding a member to your family. You can reduce your tax bill by $1,000 for every dependent in your household. This usually includes any family member 17 or under that lives with you, including adopted children, foster children, and even nieces and nephews if you are their primary caregiver. The benefit is reduced once you hit $110,000 gross income if filing jointly, or $75,000 if filing alone.
You can reduce your taxable income by saving for college
The second you have a child, you can begin saving for college and get some nice tax breaks for doing it. The most popular vehicle is called a 529 college savings plan, and many states allow you to deduct contributions from your taxable income. Gains on the investments in a 529 plan also are not taxed. (See also: The 9 Best State 529 College Savings Plans)
You may save money when you eventually send your child to school. As of 2016, it was possible to get a $2,000 Lifetime Learning Credit each year for qualified education expenses, or a $2,500 American Opportunity Credit. There are some subtle differences between the two credits, which you can learn more about at the IRS website.
You might take advantage of a health savings account
You and your partner might not worry about health care expenses, but they become more of an issue when you have kids. Many employers offer health savings accounts (HSAs), which allow you to divert some money into an account to pay for health care expenses you might accrue. Any money placed in an HSA is deducted from your taxable income. You may find it's worth contributing to an HSA if your child has health challenges, or if you have a health insurance plan with a high deductible. (See also: How an HSA Saves You Money)
You might save less for retirement — and thus pay more tax
Are you planning to dial back your retirement savings in order to meet the financial demands of a new child? If so, it's important to know how that impacts your tax bill. Any contributions you place in a 401(k) or traditional IRA are deducted from your taxable income, so if you are putting less aside, your tax bill may be higher. Ideally, you'll be able to save at the same rate as always, but if not, be sure to anticipate paying more in tax.
You may pay less tax if you stop working
Many families find that their gross income goes down after having a kid because one parent stops working full-time or altogether. Lower income means lower taxes, and you may even move into a lower tax bracket. (Moving from $80,000 to $60,000 in earned income, for example, means you pay 15 percent in tax instead of 25 percent when filing jointly.) This lower tax helps take the sting out of having less income overall, and in some cases, you may even end up with more take-home pay.
If you pay for child care, you might get a tax break
The IRS allows parents to save money on their taxes if they pay someone to care for their children. This is a great thing for working parents. The child and dependent tax credit offers up to $1,050 for one person receiving care, or $2,100 for two or more. Poorer families can get 35 percent back of any qualifying child care costs.
Many parents may save more on their taxes by instead utilizing a dependent care flexible savings account. If your employer offers such an account, you can set aside as much as $5,000 of your paycheck to cover child care costs. Contributions to this account are deducted from your taxable income, thus reducing your tax liability.
If you employ a nanny, your taxes could get complicated
In most cases like the situations above, there are tax breaks to help offset the cost of child care. But if you directly hire a nanny — as opposed to hiring one through an agency — you may be considered an employer in the eyes of the IRS. That means a boatload of paperwork, and you're on the hook for things like Social Security, unemployment, and Medicare taxes. So be sure to take all of this into account when researching child care options.
Expanding your home may have tax advantages
When you have a child, you may realize you need to expand your home with a new family room, bedrooms, or other space. The bad news here is that you can't claim the cost of home improvements on your taxes. But, any home upgrades will be added to the cost basis of your home. Thus, you may be able to reduce or even eliminate capital gains taxes when you sell.
If you do make upgrades, you can deduct the cost of things to make the home more energy-efficient, such as Energy Star rated windows and appliances.
Adopting a child comes with a big tax break
If you adopt a child, you get some significant tax breaks in addition to the ones listed above. The Federal Adoption Tax Credit gives families a maximum of $13,460 to offset qualified adoption expenses. This can include adoption fees, court fees, travel costs, and attorney fees, among other costs. Parents who adopt a child may also receive additional tax credits from their state.
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