Welcoming a new child into your life is a great joy, but it also means big financial changes. These young family members can affect your tax situation. To start things right, here are some tips to keep in mind.
Tax returns and withholdings
Having a baby – or adopting a child – could affect your filing status. For example, a single adult with a baby may be able to change his or her filing status to head of household. In some cases, changing your filing status could mean a better tax rate. If you had been using the married filing separate filing status, a change to head of household status may allow you to claim additional credits and deductions.
A major life event, such as getting married or having a child, could affect your tax liability. Parents may qualify for one or more tax credits or deductions. Adjust your withholding to compensate for these life changes. Not doing so could result in more funds being withheld than necessary.
What credits are available?
The Recovery Rebate Credit is a special one-time benefit that most people received in 2020 in the form of an Economic Stimulus Payment. But people who did not receive the maximum amount of the Economic Stimulus Payment, and whose circumstances have changed, may be eligible now.
The child and dependent care tax credit allows married couples filing jointly to claim up to $3,000 in childcare expenses per qualifying individual (up to $6,000 total). The qualifying individual must be under the age of 13 and claimed on the tax return as a dependent. Married couples claiming the credit must both be working and file jointly. How much you can claim depends on your income. It is important to note a parent must have custody of the child for more than half of the year to qualify for this credit.
Recovery Rebate Credit
An adoption tax credit or income exclusion could be an option for you if you adopted a child or tried to adopt a child. The non-refundable tax credit is available for certain qualified adoption expenses. Qualified adoption expenses do not include expenses that someone pays to adopt the child of their spouse. How much a person can claim is dependent on income and is capped at $14,300. In addition, parents may be able to exclude from their gross income up to $14,300 of qualified adoption expenses paid by an employer under an adoption assistance program. Both a credit and an exclusion for expenses may be claimed, but not for the same expense.
The earned income tax credit is a refundable credit for people who earn low to moderate incomes. Even if you did not qualify for this credit before, you may now qualify as limits are set higher for those with children.
A child tax credit is worth up to $2,000 per qualifying child, with a refundable portion up to $1,400. To qualify for the child tax credit, a child must be under the age of 17 and claimed as a dependent. A $500 credit for dependents who are ineligible for a child tax credit is also available.
You may want to take advantage of an employer’s dependent care flexible spending account. These accounts help you pay for childcare by allowing you to divert up to $5,000 of your salary on a pre-tax basis and use it to be reimbursed for these childcare expenses.
If you choose to hire a nanny to care for your child, you may be subject to household employment taxes. Your CPA can help you navigate these taxes to ensure you are compliant.
Other smart financial planning moves
Financial planning tip – Start saving early for education by opening a 529 plan account for your child. A 529 plan is an excellent choice for college savings since contributions grow tax-deferred and the distributions are income-tax-free if they are used for qualified education expenses.
Guardians and wills – A will provides instruction on how, when and on what terms your assets will be distributed to your family and other beneficiaries at your death. Updating or creating a will becomes particularly important when having children as it is the legal document where a guardian is appointed for minor children.
Review beneficiary designation forms – Retirement accounts and life insurance policies pass according to the beneficiary designations rather than a will. Review beneficiary forms for retirement accounts and life insurance policies to ensure the proper individuals are listed, especially after children are born.
Life and disability insurance – Consider obtaining life and disability insurance to protect you or your spouse’s income stream in the event of a death or disability. This is important for young families whose financial security is dependent on their ability to earn income.
What else should I know?
If your child is born in the United States getting a Social Security number obtaining a Social Security number is a straightforward process that can be done before you even leave the hospital. This process is more complicated if you are adopting a child from another country. You will have to wait until the adoption is final and the child is in the United States before you can apply for a Social Security number.
If you have questions about your new bundle of joy contact SME CPAs at 706-722-5337.
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