How a New Child Impacts Your Taxes

January 13, 2021

Welcoming a child into your life is sure to bring a lot of smiles, laughter, and ... tax advantages. While your tax situation is the furthest thing from your mind when you hold your child for the first time, ignoring it for too long would be a mistake. We’re sure you’d rather be doting on your growing family, but you really need to learn how a new child impacts your taxes. 

Social Security Number

To claim your new bundle of joy as a dependent on your taxes, you need to apply for a social security number (SSN). You may be able to do this in the hospital when you file for a birth certificate. But, if you don’t, you’ll need to contact the Social Security Administration for assistance.

Further Reading: The SSA’s Social Security Numbers for Children

Form W-4

After your child is born, you should update Form W-4 with your employer. Form W-4 determines your tax withholding from each paycheck, which should decrease when you add your new dependent. The tax savings leave more money in your pocket to pay for what will seem like a never-ending supply of diapers and wipes. Ask your HR or payroll department for assistance.

Related Reading: Individual Taxpayers: How to Prepare for Tax Season

Employer Benefits

You’ll probably want to add your new child to your health insurance plan (their SSN is required here, too). But, you may also want to check if your employer offers a Child Care Reimbursement Account, otherwise known as a Dependent Care Flexible Spending Account (FSA). The account allows you to set aside up to $5,000 of tax-free money to cover child care expenses. While the tax advantage is undeniable, be aware that you must use every penny in the account each year. Otherwise, you forfeit the remaining funds.

Filing Status and Tax Bracket

If you’re married and file jointly, having a baby won’t impact your filing status or tax bracket. However, if you’re single, it could. If you cover more than fifty percent of your child’s living expenses in a year, you could file as head of household and get put into a more favorable tax bracket as a result.

Deductions and Credits

If your tax filing status changes from single to head of household, your standard deduction will increase from $12,400 to $18,650. As a new parent, you may also be entitled to a few different tax credits and deductions, such as:

  • Child Tax Credit

  • Child Care Credit

  • Adoption Credit

  • Earned Income Credit

  • Medical Expense Deduction

Let’s review each of them.

Child Tax Credit

You can get up to $2,000 in tax credit for each qualifying child. However, the credit amount is subject to income limits. If your modified adjusted gross income (MAGI) is above $200,000 as a single filer or above $400,000 when filing with your spouse, your credit will be reduced or eliminated.

Child Care Credit

This credit mitigates the cost of paying for someone to care for your child while you’re at work. The amount you’re eligible to get is based on your income, the price of the care, and how many children received the care. When calculating your credit, you can include up to $3,000 worth of expenses for one child and up to $6,000 for two or more children.

Please note: The Internal Revenue Service (IRS) doesn’t like it if you try to double-dip with the Child Care Credit and the Dependent Care FSA. That means you can’t use the funds to cover the same expense.

Adoption Credit

Your new child doesn’t need to be biologically related to you to receive a tax break. If you adopted a kid, you could receive up to $14,300 to offset adoption expenses. This tax credit is subject to income limits, and you’re ineligible for it if you adopt your spouse’s child. Learn more here.

Earned Income Credit

The earned income credit was introduced to give lower-income earners a break. But, when you add children to the mix, the income limit to qualify increases significantly. For example, if you file jointly with your spouse, your income limit is $21,710. But, when you have one child, it jumps to $47,646.

Medical Expense Deduction

Having a baby in a hospital will cost you a shiny nickel. So, if you itemize your deductions, you may be eligible to deduct your medical expenses. Your expenses must exceed 7.5% of your adjusted gross income (AGI) to qualify.

Fun Facts: A tax deduction decreases your taxable income. A tax credit actually reduces your tax liability.

Saving for College

College is incredibly expensive. So, to get your child off to a good start without landing in the poorhouse, it’s best to start saving early. One popular way to do this is to open a 529 Plan for them.

With a 529 Plan, your savings grow tax-free. When you make a withdrawal, you won’t have to pay taxes as long as the money is used for a qualifying educational expense. Plus, in a handful of states, your contributions are tax-deductible.

Pro Tip: Check out the Coverdell Education Savings Account to help fund pre-college schooling costs.

The Nanny Tax

While having a child usually helps your tax situation, you should be aware of the Nanny Tax. If you employ a caregiver, or nanny, for your kid directly (instead of going through an agency), you must pay Social Security, Medicare, and unemployment tax on behalf of the caregiver. You must also prepare and submit Form W-2 to both the nanny and the IRS.

Pro Tip: If your child will have investment income, you might want to read up on the Kiddie Tax.

How Rapidly Can Help

When you go through a significant life change, like having a child, your taxes get even more complicated. Don’t worry, though. If the idea of DIY’ing your taxes this year has you shaking in your boots, we’ve got you. Try our free, fast, and fun tool to locate a tax professional that’s uniquely suited to help you navigate your tax situation.

Final Thoughts

When your family grows, you’ll have to deal with a lot of changes. That’s OK -- everything you’ll go through is worth it. Hopefully, this blog post gives you a clear idea of how the birth of a child impacts your taxes. However, taxes are complicated, and this isn’t professional advice. So, if you’re feeling unsure, we encourage you to book an appointment with a qualified accountant or tax pro.

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