Tax Planning for New Parents
When a couple finds out they are expecting, they usually have more important things on their minds than related tax issues; things like "is it a boy or a girl?", "what are we going to name the little booger?", "are we going to tell people now or later?", that kind of thing.
But inevitably at some point, at least one of the parents' thoughts will turn to the age old question of how they are going to pay for all the things this child will need as it grows up. I am told that when my oldest was born, the first thing I said upon learning it was a girl (we decided to keep that a surprise) was "Oh my, I'll have a wedding to pay for!" Leave it to an accountant!
Fortunately, the tax law has provisions that can help parents financially. Here are a few:
1. Dependent Exemption. Most basic is an extra dependent exemption that you will be able to deduct on your tax return. For 2014, that exemption deduction is $3,950. Depending on your tax rate, that extra deduction could save you anywhere from around $400 to over $1,500 in federal tax.
2. Child Tax Credit. For children under age 17, the law provides for a $1,000 per child tax credit. A credit is better than a deduction, in that it directly reduces your taxes dollar for dollar. For example, if your tax for the year calculates to be $2,500 and you qualify for one child tax credit, the $1,000 credit reduces your tax to $1,500. That's a pretty sweet deal! In some cases, this credit may entitle you to receive a refund check, even if you have no tax liability and have paid in nothing.
3. Earned Income Tax Credit (EITC). While beyond the scope of this article for a full explanation, if you qualify for the EITC, an extra dependent could increase the amount of EITC for which you qualify, if not make you eligible to begin with. The IRS has an EITC Assistant application on its website at IRS.gov that can help you find out more.
4. Childcare. If you happen to be someone who is interested in and can afford to hire a nanny for the care of your child, bear in mind you will be considered to have a household employee. This will require you to withhold taxes, pay the employer's share of FICA taxes and unemployment insurance, file tax forms, W-2's, etc. Much, but not all, of the reporting for this is done on Schedule H of Form 1040, so you may want to look at the instructions for that form for more information. Contracting with a payroll service to handle these chores may be a worthwhile investment.
5. Dependent Care Expenses & Flexible Spending Accounts (FSA). Childcare, whether in home with a nanny or outside the home, can be expensive. If parents work, there is a child and dependent care credit that can help. The amount of the credit varies based on the number of dependents and your income level.
If you have available to you an FSA through your employer, you can make pre-tax contributions to a savings account that can be used to pay eligible expenses. The maximum annual contribution, typically $5,000 for joint filers, can result in a very nice amount of tax savings.
6. College planning. Ok, so the baby may not even be born yet, but it's never too early to start planning for college. One tax-favored way to do this is the use of a section 529 plan. A 529 plan is an educational savings plan administered by a state or educational institution where you can invest funds for future college expenses. The investments in a 529 plan grow tax-deferred and distributions to pay qualified tuition expenses are tax-free for federal and Arkansas purposes. Also, if the plan is one sponsored by the State of Arkansas, it qualifies for a state income tax deduction of up to $5,000 per person (or $10,000 for a married couple), which could save you up to $700 in state income tax.
The joy of a new little life in the house is unparalleled. Making the most of the tax incentives available to parents can take away some of the financial stress so that you can fully enjoy this special season in life.
