Becoming a new parent is an experience like no other. From the exhausting, exhilarating birth of your new baby to the sleepless nights, the experience for many new parents is all encompassing. The last thing on a parent’s mind is often personal finance. Still, just like other major life events, a new addition to the family has significant financial implications. One of the key areas is the tax code, which provides significant tax breaks for new parents.
The Dependent Exemption
With the dependent exemption, you may claim an exemption of $3,950 (in 2014) for each child you can claim as a dependent. For a person or couple in the 25% tax bracket, the amount of the exemption will be worth almost $1,000 (25% times $3,950) in tax reductions. The deduction is subject to gradual phase-out for high-income levels (over $254,200 for singles, $305,050 for those filing jointly).For a complete list of rules for claiming an exemption for a dependent, see IRS Publication 501.
Child Tax Credit
The child tax credit is a tax credit worth $1,000 (in most instances) per child. This credit is gradually phased out for higher earners (over $75,000 for singles, $110,000 for those filing jointly). To claim the credit, the child must be under 17, have lived with you for half the year, and meet other guidelines. You can determine eligibility for the child tax credit by reviewing IRS Publication 972.
Child and Dependent Care Credit
If you plan on working outside the home, Uncle Sam offers a tax credit for expenses associated with dependent-child care. The child care must allow the parent to work or actively look for work. Parents can claim up to $3,000 in allowable expenses for the care of one child and $6,000 for two or more. The amount of the credit varies between 20 and 35% based on your income. For example, $3,000 in allowable expenses would equal a tax credit of $600 to $1,050, depending on your income level. For more information, please see IRS Publication 503.
College Savings: 529 Plans and Coverdell Educational Savings Accounts (ESAs)
Putting away money for future college expenses of your child can also provide important tax benefits. So-called 529 College Savings Plans (named after the IRS section of the tax code) allow parents to put away money to either “prepay” for college expenses or to put money into an account for future educational needs. Your contributions to 529 plans are not tax deductible; however, there is no limit to the amount that can be saved, and the distributions are tax free as long as the money is used for educational expenses. For more information, please see IRS Publication 970, Benefits for Education.
By contrast, Coverdell Educational Savings Accounts can be used to pay for educational expenses from Kindergarten through college. The contributions are not tax deductible, but the money grows tax free until it is distributed for qualifying educational expenses. Distributions are tax free. The amount that can be contributed is capped at $2,000 per child and is subject to income limits. For more information, please see IRS Publication 970, Benefits for Education.
In addition to taking advantage of these four tax breaks offered to new parents, consider consulting a tax professional to obtain specific guidance on the full range of deductions and credits your family may qualify for.