Children are expensive. The government appreciates that which is why they've created a number of extra tax breaks for parents. As a result, having a child will almost always lower the amount you owe in taxes. It's not like marriage where the wrong situation can lead to you owing more through the marriage penalty. To help you plan your finances as a new parent, we've put together our complete guide on how having a child affects your taxes.
Automatic Tax Benefits
There are a few tax benefits which automatically apply to you if you have children.
Extra Personal Exemption
Your child gives you an extra personal exemption. This is a set amount of your income that is not taxed. You already receive a personal exemption for yourself and get another one for your child. In 2015, the dependency exemption for children is $4,000. If you are in the 25% tax bracket, you save $1,000 a year in taxes per child because of this exemption since an extra $4,000 of your income is untaxed ($4,000 x 25% = $1,000).
You are allowed to claim the dependency exemption for children until they turn 19 if they are not a full-time student or until they turn 24 if they are a full-time student. You receive an extra personal exemption for every child you have.
Child Tax Credit
You also receive a Child Tax Credit for every child. The Child Tax Credit is $1,000. This is a full $1,000 in tax savings per year per child if you qualify for the entire credit. You receive this credit for every child that is 16 or younger at the end of the year.
Unfortunately, the Child Tax Credit does have income limits. If you are single, this credit starts phasing out when you earn over $75,000 a year and disappears when you earn over $95,000. If you are married, this credit begins phasing out when you earn over $110,000 and ends if you earn over $130,000.
On the other hand, for lower income households the Child Tax credit is refundable meaning if your total credit is larger than the amount of taxes you owe for the year, the IRS will send you a check for the difference. If you only owe $500 in income taxes, the IRS will send you $500 for the other half of your Child Tax Credit.
Earned Income Tax Credit
The Earned Income Tax credit is another benefit for low to moderate income households. Having children makes it both easier to qualify for this credit and also for a larger tax credit. For example, if you are married, you can only qualify for this credit if your joint income is below $20,430 and the maximum credit you could receive is $506.
On the other hand, if you have one child, you can earn up to $44,846 a year combined and still qualify. In addition, the credit becomes a much larger $3,373 a year. The size of the credit and income limits increase as you have more children until you receive the maximum benefit with three children. Any children beyond three won't increase the Earned Income Tax Credit.
Larger Standard Deduction For Single Taxpayers
If you aren't married, having a child qualifies you a new tax filing status: head of household. To qualify for this filing status, you need to be providing more than half of the financial support for your new child. If you do, you qualify for a larger standard deduction and better tax brackets, both of which should reduce the amount of income tax you owe every year. Unfortunately, there is no adjustment to the tax brackets or standard deduction for married couples since these were already adjusted after they were married.
Situational Tax Benefits
There are a couple of other possible tax benefits which you may be eligible for, depending on your financial situation and other circumstances.
Child And Dependent Care Credit
If both you and your spouse are working full-time or are looking for work full-time and you need to hire someone to take care of your young children, you can qualify for the child and dependent care credit for these expenses. This credit applies for the care of children who are 12 or younger. The credit applies for up to $3,000 a year of expenses if you have one child and up to $6,000 a year of expenses if you have 2 or more children.
You don't get a credit for the full amount of expenses. Instead, it's a percentage of the expenses and that percentage depends on your income. Anywhere from 20% to 35% of your expenses are eligible for the credit depending on your income.
If you adopted your child, you are eligible for a tax credit to help cover the adoption expenses. This includes the adoption fees, court fees, your legal expenses, and any travel expenses that were part of the adoption. You receive a credit of up to $13,400 for all the expense per child. This credit limit applies to the entire adoption, not per year. If you spent $3,400 for adoption expenses in 2015 and then finalized the adoption in 2016, you would only be eligible for another $10,000 credit in 2016.
Preparing for child tax benefits
Before you can apply for any of the tax benefits from having a child, you need to register them as American citizens with the government so they get a Social Security Number. You should be able to apply for this at the hospital at the same time you take out their birth certificate. If you didn't take care of this at the hospital, you can submit Form SS-5 with the Social Security Administration with proof of your child's age, citizenship, and identity.
The reason you need to register your children is to prevent people from claiming fraudulent child tax deductions. Before this rule was put in place, people were claiming their pets, plants, or just making up people to claim tax deductions.
After you've had your child, you should contact your HR department and ask them to adjust the withholding on your paycheck. This is the amount they withhold to cover your estimated taxes. Since having a child will lower the amount you owe, you should revise your W4 form with your employer to make this adjustment. It's not the end of the World if you don't. You'll just get that money back as a refund after you file your tax return. Still, why not get that money now rather than letting the IRS hold onto it?
Having a child is still going to be a lot of work but by keeping this information in mind, you'll at least be ready for the tax consequences. Good luck and congratulations!
Additional Resources At GET.com:
At GET.com we maintain complete editorial integrity on our content & provide transparent & unbiased information. Companies don't pay us to include their products although we receive a compensation when you successfully apply to products from our partners. See how we make money here.At GET.com we maintain complete editorial integrity.