Tax Tips from the Tax Lawyer: Turning that Bundle of Joy into Dollars
Many taxpayers are likely scrambling to prepare and complete their individual tax returns. Most taxpayers have remembered to include all of their wages, business income, mortgage interest payments, etc. For parents, and especially new parents, are you sure you have claimed all of your applicable family/child tax benefits?
For those who have questions, I will now take a pregnant pause … from my work schedule to make sure you have considered many of the tax savings associated with having children. 1
Personal Exemptions
Most taxpayers are entitled to claim a personal exemption for themselves, a spousal exemption for a spouse and a dependency exemption for each dependent.2 In 2015, the exemption amount is $4,000. This means, for example, that a taxpayer in the 25 percent tax bracket can reduce their total tax by approximately $1,000 in connection with each properly claimed exemption. Taxpayers must remember to include each individual’s taxpayer identification number (TIN) for each exemption they claim on their income tax return.3
In order to claim a dependency exemption for a child, said child must be a qualifying child under the Internal Revenue Code (IRC).4 In order to be a qualifying child, the child must be a U.S. citizen, national or resident of the U.S., Canada or Mexico for some part of the relevant tax year; may not be claimed as a dependent for anyone else; must be the taxpayer’s child; must be younger than the person claiming the exemption and under 19 years of age, or 24 years of age if a student; must have the same principal abode as the taxpayer for more than half of the year (with some exceptions); and must not provide more than one-half of his or her own support during the tax year.5
An additional benefit for unmarried taxpayers with children is that they may be able to file as head of household and increase their standard deduction amount from $6,300 to $9,250.6
Child Tax Credit
Some parents may receive a $1,000 credit for each qualifying child.7 A credit is more valuable than deductions and exemptions because credits provide a dollar for dollar reduction in your tax liability instead of simply lowering your taxable income amount.
Credit for Adoption Expenses
A credit for adoption expenses of up to $13,400 in 2015 may be available for some taxpayers. Costs associated with adoption fees, court costs, attorneys’ fees related to the adoption and traveling expenses related to getting your child may all be includable expenses for purposes of determining this credit.8
Child and Dependent Care Credit
Single taxpayers and joint filers may be entitled to a child and dependent care credit of up to 35 percent for the first $3,000 of child care for one child or the first $6,000 for two or more children. In order for joint filers to claim the credit, both parents must have earned income from employment or business.
If a taxpayer chooses to hire a caregiver for child care services, the taxpayer must pay a “nanny tax” for amounts paid to the nanny in excess of $1,900 in 2015.
This means that the taxpayer must generally withhold and pay FICA9 taxes for wages paid to the caregiver in excess of $1,900.10 The taxpayer must also pay FUTA11 taxes for wages paid to the caregiver of $1,000 or more during a calendar year quarter.12 The taxpayer must report these wages on Schedule H of their U.S. Individual Tax Return (Form 1040). An employer identification number (EIN) should also be obtained by the taxpayer and included on the caregiver’s Form W-2.
Some taxpayers may receive a benefit from their employers in the form of a child care reimbursement account (flex plans), which allow a taxpayer to divert up to $5,000 a year of their salary into a special tax-advantaged account. The account can be used for child care bills and avoids federal and state income tax and social security and Medicare taxes. This benefit cannot be combined with the child tax credit.
Healthcare Costs
Medical expenses that exceed 10 percent of AGI may be deducted as itemized deductions. The medical expenses that may be deducted with respect to prenatal and post-natal care are: prescription medications, prenatal care, ultrasounds, blood work, other lab work and medical tests, hospital fees, delivery room fees, baby’s incubator fees, well-baby checkups and mom’s post baby checkup.
Also, in early 2011, the IRS announced that breast pumps and supplies that assist lactation are medical care under IRC §213(d) and therefore may be deductible expenses.13Taxpayers may also want to inquire as to whether their current health plan would cover these costs.
But Wait! Don’t Quit Your Day Job!
Although I have given you some great tips for turning your little bundle of joy into dollars, please remember that many of these tax benefits are subject to phase-out, which can occur surprisingly quickly, especially for taxpayers who live in the high cost of living areas like the San Francisco Bay Area because they may have correspondingly higher earnings. Consequently, you may not be able to claim any or all of the discussed tax benefits, or they may be subject to at least partial phase-out.
In addition, as of 2013, the United States Department of Agriculture (USDA) estimated that it takes approximately $245,000 to raise one child to age 18 for middle income couples.14 As I have been consistently reminded by others, parenting obligations rarely cease to exist just because a child turns 18 years old. The USDA’s estimate does not include college tuition or inflation or costs incurred after a child reaches 18 years of age.15
So, what is this expectant tax lawyer’s conclusion—does the benefit of an adorable, drooling, fluid secreting little munchkin and all of its potential tax benefits outweigh all of the costs?
Stay tuned. I plan to write a follow up article in approximately 18 years and let you know.
[1] Please note that all income tax rates/brackets, standard deduction, personal exemption, credit and or other tax related figures are for the 2015 tax year.
[2] Internal Revenue Code (IRC) §151.
[3] Please note that personal exemptions begin to phase-out when adjusted gross income (AGI) reaches $309,900 for married taxpayers filing joint returns and surviving spouses, $154,950 for married taxpayers filing separate returns, $284,050 for heads of households, and $258,250 for other unmarried taxpayers. If you are risk of phase-out, you may want to meet with a tax lawyer or other financial professional to discuss making deductible contributions to tax favored accounts.
[6] See IRC §63, adjusted for inflation in subsequent years.
[7] Generally, a qualifying child must be under age 17 at the end of the tax year in which a credit is claimed; be a taxpayer’s son, daughter, adopted child, stepchild or eligible foster child, brother, sister, stepbrother, stepsister or a descendent of any of these individuals; be a U.S. citizen, U.S. national, or resident of the U.S.; did not provide over half of his or her own support; and must have lived with the taxpayer for more than half of the year (with some exceptions). Please note that this credit begins to phase out for married taxpayers filing jointly with AGI that exceeds $110,000, for single taxpayers whose AGI exceeds $75,000, and for married taxpayers filing separately whose AGI exceeds $55,000.
[8] Phase-out occurs when modified AGI reaches $201,010, and is completely phased out when modified AGI reaches $241,010. Rev. Proc. 2014-61, §3.03, 2014-47 I.R.B. 860.
[9] Federal Insurance Contributions Act.
[11] Federal Unemployment Tax Act.
[13] IRS Announcement 2011-14, February 10, 2011.
[14] Roberts, Kenneth. “Average Cost of Raising a Child Over $245,000.” MarketWatch, May 28, 2015.