What: Welcoming a new child into a family can be very fulfilling and rewarding, but also comes with many expenses that new parents face. There are the hospital bills, baby’s room, clothes and diapers, special food, surrogate or birth mother expenses, travel, and possible loss of income of a stay-at-home parent. However, the Tax Code offers some family-friendly provisions designed to help parents manage this life-changing event.
Why: The Tax Code is structured not only to raise revenue but also to help achieve a number of societal goals, including helping families. Several Tax Code provisions are designed to make finances a little easier for new parents, including some new enhancements from the recently enacted American Rescue Plan Act.
A new child can qualify parents for several tax breaks
- Recovery Rebate Credit. A refundable credit of $1,400 on the 2021 tax return for a new child born or adopted in 2021
- Child Tax Credit. For 2021, a refundable credit of $3,600 for a child under age six, with a potential for advance payments of the credit starting in July 2021
- Child and Dependent Care Credit. For 2021, a refundable credit up to $4,000 for one child, up to $8,000 for two or more qualifying children; employer may also offer a tax-favored childcare reimbursement account up to $10,500
- Earned Income Tax Credit. A refundable credit up to between $1,502 and $6,728 for 2021, depending on the number of children, income level, and tax filing status
- Adoption Credit. A nonrefundable credit up to a maximum of $14,660 for qualifying adoption expenses for 2021; employer may also offer tax-favored adoption assistance program
- Medical expense deduction. A deduction for taxpayers who itemize deductions of the medical expenses associated with birth, where total medical expenses exceed 7.5 percent of adjusted gross income, although this generally does not extend to the medical expenses of a surrogate
- Code Sec. 529 Education Savings Plans. No deduction or credit, except possibly for state income taxes, but significant contributions, tax-free accumulation of earnings, no income limits, and tax-free distributions for qualifying expenses
- Coverdell Education Savings Accounts. Up to $2,000 per year in non-deductible contributions and tax-free distributions for elementary and secondary education
- IRA or Roth IRA. Contributions to an IRA or Roth IRA for the child could commence as soon as a child has earned income, which could be very young for an infant model
- Filing Status. A new child may change the filing status of a single parent from a single filer to a head of household filer
- Withholding. The Form W-4 filed with an employer should be reviewed for possible adjustment to reduce withholding based on the additional tax breaks available
A few other tax issues also may require attention
- Social Security number. Parents should obtain a Social Security number for the child as soon as possible to qualify for all the tax benefits
- Qualifying Child. You need to meet residency and support tests, an issue especially important for divorced or separated parents
- The Kiddie Tax. A provision that can tax unearned income of the child at the parents’ tax rate
- The Nanny Tax. A provision that requires proper tax treatment of anyone hired to care for the new child, including reporting wages and withholding Social Security and Medicare taxes
Who: Tax expert Mark Luscombe, JD, LL.M, CPA, Principal Federal Tax Analyst at Wolters Kluwer Tax & Accounting, can help discuss the tax issues associated with the birth or adoption of a child.
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Contact: To arrange an interview with Mark Luscombe or other federal and state tax experts from Wolters Kluwer Tax & Accounting on this or any other tax-related topics, please contact Bart Lipinski.