Why Are Babies Called Tax Deductions?

Yesterday my wife and I left the doctor’s office, we had the first experience of our new journey. We heard the heartbeat of what hopefully will be our first child. It was pretty neat to hear that heart beat. Until hearing it, it was hard for me to feel the connection. Once I heard it, I became emotional and excited. Of course, what happens when I get emotional and excited, I think about how it applies to taxes and how i can talk about it.

I am expecting a one’sy (sp?) that says “Daddy’s Little Tax Deduction” at some point. It is a common joke and a common saying, but what does it mean? Let’s look at a simple summary of a couple items that will be new to you if your having a child or plan on it. We will assume a 25% tax bracket with an AGI under 110k and a joint filed return.

• The extra dependency exemption – Each dependent counts for a $3,650 deduction.  So if you have 3 kids, multiplythat by 3 plus you and your spouse.  That is 5 x 3,560 ($18,250) in personal exemptions. If your marginal tax bracket is 25%, your first child saved you about $913 dollars in taxes paid.  If you are filing jointly this exemption will start to phase-out after your Adjusted Gross Income (AGI) reaches $250,200. Head of Household (or single) is $208,500.  Most people will see the full $3,650 which saves this family 900 bucks.
• Child Tax Credit - At least for 2010, there is a $1,000 credit for qualifying children. In 2011 it is scheduled to reduce to $500. For 2010 this credit which is traditional non-refundable (cannot reduce your tax liability below 0) is partially refundable. The child must be under 17 by the end of the year but since were talking about babies that does not matter.  This credit is limited to your modified AGI ($110k for joint, $75k for single). After that the credit reduces, and fast! If you are under the $110k, but in the 25% tax bracket, this credit can be worth up to $4k of a deduction for you!

So with these two items, assuming you just had your first child, not even considering medical expense deductions, you have saved about $1,900 dollars in taxes so far. At 25%, thats $7,600 of income you now don’t pay tax on.

• Child and Depend Care Credit – Form 2441 allows for a dollar for dollar credit (meaning tax rate is irrelevant) on your tax return for dependent care expenses paid for a qualifying child under the age 13. That taxpayer must incur employment-related expenses in providing care for the dependent. The max credit per child is 3k, up to 2 kids can be claimed. Assuming a spouse is working, you just gave birth to your first child, and you spend $5k in qualifying childcare expenses in the first year, your credit is calculated as a percentage of the max amount (3k in this case) allowed depending on your income. The minimum percentage (and realistic one) is 20%. So you spent 5k, can use 3k and get 20%, thats 600 dollars back. Because this is a credit, tax rates don’t matter. In fact, if your at a 25% tax rate, this is equal to a deduction of about $2,372.
• Adoption Credit – Maybe you decided to adopt. Awesome! There are lots of kids out there that need good parents. One of the real bright spots of the healthcare bill in my personal opinion is the treatment of the Adoption Credit. For 2010 the amount is $13,170 and its refundable! That means even if you have no tax due, you may still get a refund.  So if you get the full 13k, and you had a tax liability of 5k, you will get an 8k refund still. That means tax dollars are going towards adopting children who need homes.  Use Form 8839 for this. The income phaseout range for your modified AGI is $182k to 222k.

There are different topics and qualifications for child tax credits, qualifying children, qualified expenses for the credits and so forth. Your situation may or may not fall into the scope of what I have discussed. But for new parents, or anyone wondering, these are common tax deductions associated with your little ones.

Also remember, even if your medical expenses don’t exceed the 7.5% limit on Schedule A, they may count for your state taxes, keep track of them.