Beyond the obvious joys associated with bringing home a new baby, the newest member of your family also comes with a tax benefit. So, while you're managing diapers and feedings, take a few minutes to familiarize yourself with how your growing family can benefit under the new tax laws.
Why your newborn needs a Social Security number
Before you do anything with your taxes, get your baby a Social Security number (SSN). It sounds crazy that you need to register your child for federal retirement benefits, but Robert Allman, an Internal Revenue Service enrolled agent at ABCD Accounting in Miami, explains, "You can't claim a dependent without the dependent having an SSN."
The hospital will allow you to apply for an SSN at the same time you apply for a birth certificate. If you don't apply then, you'll have to apply separately with the Social Security Administration, using the Application for a Social Security Number (Form SS-5).
How to deduct your child from your taxes
Most people think that kids qualify as deductions on their parents' taxes. Actually, you're given a tax credit for each child. The current law allows you to take what is called the Child Tax Credit.
In the 2019 tax year, you get a $2,000 tax credit per child. "If a parent owes no taxes or less than $1,400 to the IRS, the credit will trigger a refund for that amount, assuming the child and parent meet eligibility criteria," says Riley Adams, CPA and owner of Young and the Invested.
The trick here is that the credit phases out in higher income brackets. "The phase-out range starts at $200k for individuals and $400k for married filing joint couples," explains David Henn, CPA, PA, of Rockledge, Florida. "It phases out at $50 for each $1,000 over the $200,000 or $400,000 range, meaning it will be gone at $240,000 or $440,000." So if your joint return shows income at $400,000—or more than $200,000 if you are filing as single or head of household—you won't get the full credit.
If your new family member joined you through adoption, you're entitled to an additional credit. You may be able to deduct up to $14,080 for the 2019 tax year to offset your adoption costs, but the amount depends on your adjusted gross income, and it also phases out at higher levels.
How a new baby can change your tax filing status
A new baby can change your filing status. If you're single, having a baby means you now can file as head of household. This offers the benefit of a larger standard deduction and better tax brackets, so it does matter. If you're married, the baby doesn't affect your tax-filing status.
You'll need to file a revised Employee's Withholding Certificate (Form W-4) at work. "A new dependent will decrease your tax liability for the year, assuming that all other things remain consistent," Allman says. "So when you add a dependent to the family, you should change the number of dependents on your W4. If you don't, you will end up with extra withholding."
Additional tax credits a new baby offers
Adding a child to your family also may allow you to access additional tax credits.
Earned Income Tax Credit: This credit benefits low-income filers. When you add a child to your family, the income limit for this credit increases. For a couple without children, the amount is $21,370. For a single person, the credit is $15,370. When you have a baby, those numbers go up to $46,884 and $41,094, respectively.
Childcare Credit: If you pay for childcare and you or your spouse works, then you're entitled to a credit for a percentage of your childcare costs up to $3,000 for one child or $6,000 if you have two or more kids under age 13. The amount of the credit depends on your income.
"It only applies to daycare or babysitting expenses that are incurred while the parent is working," Altman explains. "The part-time babysitter you pay so you can go out to dinner does not qualify. The payments must go to a qualified childcare provider, and they must be a U.S. citizen. You are asked to provide the Employer Identification Number or the Social Security number of the daycare or individual watching your child while you are at work."
This raises the issue of whether you treat your sitter as your employee and withhold taxes from their pay.
"If the babysitter is not contractually obligated to provide services at the parent's request and doesn't have a stated and specific schedule, then they are considered an independent contractor," George Birrell, CPA at www.gettaxhub.com. "A neighbor providing part-time service as needed is an independent contractor. A live-in nanny would usually qualify as an employee. If the IRS determines that the babysitter should have been an employee, there can be significant repercussions. An employer can be penalized with having to pay 100 percent of associated payroll taxes of any payments made for services if the worker status is determined incorrectly."
Why you should consider a Dependent Care Flexible Spending Account
Dependent Care Flexible Spending Accounts (DCFSA) allow you to pay childcare costs using pretax money. In 2020 you can have up to $5,000 (per individual or total for a married couple) taken out of your pay and placed in a DCFSA account.
"This turns out to be a savings for parents because DCFSAs are sheltered from the 7.65 percent Social Security and Medicare tax and, since it is pretax money, you are saving the income tax on that income as well," Allman explains. "For instance, if you are in the 25 percent bracket, and you put $5,000 into your DCFSA, you just saved $1,250 for the year."
Henn points out that, if you contribute $3,000 to a DCFSA, then you "are not eligible for the dependent care credit for that child." Another caveat is that this type of account is "use it or lose it." This means that if you don't use all of the money, whatever is left at the end of the year is forfeited. So it pays to think about how much childcare you're going actually to use in any given year and plan accordingly.
Expanding your family creates some hoops to jump through when it comes to taxes, but you'll find that you will also be able to leverage savings and benefits within the tax code.