Every time a baby is born, friends, family, and close ones rush to buy gifts – clothes, essentials, toys and whatnot. But what is the biggest gift that new parents can get? Tax benefits. Yes, with all the joys and the sleepless nights, new parents also get to save some money! This is particularly beneficial as it has been estimated that the cost of raising a child born in 2022 is around $272,049. Phew!
Let’s lay out some tax benefits and tax hacks for the new parents here.
- Before delving into it, you must get a Social Security Number for the child before the filing season. With this, you can claim them as dependents on your tax returns. Usually, the birth registration form that new parents fill out at the hospital has a checkbox for requesting a Social Security Number. But if the baby was not born in a hospital, or for some reason the number was not allotted then you will have to visit the Social Security Administration branch.You will be required to fill out Form SS-5 and submit documents to verify the child’s identity, age, etc. One of these documents should be the birth certificate.
You can claim your new-born as a dependant even if it was born on the last day of the yeari.e even if your baby was born on 31st December 2021, you can claim the baby as a dependant for the entire year!But if it was born on January 1, 2022, then you have to wait until you file your 2022 taxes in 2023 to claim the baby as a dependant.
If there is some delay in receiving the SSN of the new-born, you can file for an extension using Form 4868. The extension should cover the delay in receiving the SSN.
If you claim the newborn on the returns but do not mention the SSN, then the credit and breaks will be disallowed.
- Your filing status may also change. If you are married and have a baby, then your filing status will generally not be affected. However, if you are single and have a baby, as a single parent you can change your filing status from Single to House of Household. This filing status will make you eligible for a larger standard deduction and a favorable tax bracket. You will get a bigger tax break and be paying lesser tax as Head of Household than as a single filer if you can claim the child as a dependant and provide at least half the support. Only one parent can claim the child as a dependant, not both. This is a great option for those who are planning to single-handedly raise the child.
- Calibrate your tax withholding. The IRS requires you to submit a new W-4 form to your employer within 10 days of the birth of a child. You can do it on paper or electronically. Updating your W-4 ensures you are paying the right amount of taxes and not losing too much out of your pocket through the year. This applies even if you adopt a child.
If you do forget to update your W-4, the consequence is that you will end up with a bigger refund after you file your returns.
- Kick-off a 529 plan. What is that? According to the U.S Securities and Exchange Commission, a 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. They are called 529 plans because they are authorized by Section 529 of the Internal Revenue Code. There are two types of plans- prepaid tuition plans and education savings plans.
Prepaid tuition plans allow the plan-holders to prepay for tuition costs at the qualifying schools at today’s rates. In a sense, it is a way of paying for tomorrow’s education today itself. The payment can be made as a lumpsum or in installments. The amount paid will grow at the same rate as the college’s tuition and hence, acts as a hedge against inflation. The catch here is the beneficiaries are allowed to attend only in-state colleges, and it is provided by only 9 states – Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Texas, Virginia, and Washington. Another disadvantage is that this plan does not cover books and boarding.
Education savings plan lets the saver open an investment account for the beneficiary’s future educational needs that include tuition, books, boarding, etc.The saver can choose from a range of investment options that include ETFs and Mutual Funds. The advantage that this plan has over the prepaid plan is that it can be used at any college in the US, sometimes even a non-US one. It can also be used to pay $10,000 per year per beneficiary for tuition at any public or private elementary or secondary school. Funds in this plan will not be taxed when withdrawn (If they are withdrawn for some other purposes, theywill be subject to state and federal income taxes and a 10% federal tax penalty)
Investing in either of the above two plans offers special tax benefits. They may vary depending on the state and the 529 plan. The benefits may include deductions from state income tax. The funds grow tax-free over a period of time, so the longer the duration, the greater the benefit.
- Earned income tax credit – This credit is a boon for parents with low to mid-income levels as it is a refundable tax credit. This credit can be claimed if the child meets the rules for a qualifying child. The child must have a Social Security Number, must not be claimed as a dependent by more than one taxpayer, and must satisfy the 4 tests of age, relationship, residency, and joint return.
|Maximum AGI for Single, Head of Household and Married filing separately
|Maximum AGI for Married filing jointly
|Maximum Credit Amount
- Adoption Tax Credit–Those adopting a child are eligible for the Adoption Tax credit which is a tax benefit for qualified adoption expenses paid to adopt an eligible child. It is a non-refundable one-time credit i.e. it is limited to the tax liability of the year and any excess credit cannot be claimed as a refund. But the excess credit can be carried forward for the next five years. The qualified Adoption expenses include-
- Adoption fees
- Court fees and attorney fees
- Traveling expenses
- Other expenses that are directly related to the principal purpose of the legal adoption of an eligible child. (An eligible child is an individual under the age of 18 or is physically or mentally incapable of self-care)
The credit is applicable for all adoptions- public, private, domestic, international – except for step-parent adoptions. It is not a deduction but a dollar-for-dollar reduction in the amount of tax liability that you owe. The credit is also subject to an income limit and a dollar limit. The income limit is based on your modified adjusted gross income (MAGI). If it falls within certain limits, then the credit is subject to phase-out. If the MAGI is below $216,660 then you can avail the credit and it will not be phased out. If the MAGI is between $216,660 and $256,660, then it will be phased out. If the MAGI is more than $256,660, the credit will be zero.
Form 8839 needs to be filled out and filed along with your Form 1040. For 2021 adoptions that are being claimed in 2022, the maximum adoption credit is $14,440 per child. The parent can claim only the expenses and not the maximum amount of credit that is available to them. For example, if the expenses for adoption were $10,000, they can claim only $10,000 in adoption credit and not the entire $14,440. If the expenses were $20,000, they can still only claim $14,440 as that is the maximum credit limit.
- The Child Tax Credit has seen one of the biggest changes in the tax year 2021. For the year 2021, the CTC became fully refundable (earlier it was non-refundable). The maximum credit amount increased and the age limit also saw a slight change. The maximum credit amount increased to $3,000 per child for ages 6 to 17, and $3,600 for children aged 5 and under.
Parents of a baby born in 2021 can also claim this credit. Non-biological parents and foster parents can also claim this benefit. The parent’s MAGI must be $75,000 and under to claim the maximum credit of $3,600. If it is above, the credit is subject to a phase-out.
- The Child and Dependent Care Credit is also a fully refundable credit (not to be confused with the Child Tax Credit). This credit is designed to help those parents and caregivers while looking for work. You can claim up to $8,000 for the care of one dependent. Read more about the Child and Dependent Care credit here.
These benefits can help new parents reduce their tax bill and save more for the future of their child and make it more secure and stable. Use the services of a CFO consulting service to determine which credits you are eligible for and can claim.