Your New Little Tax Deduction!

Having your first child is an exciting time in your life and I’d like to congratulate you on the birth of your newborn. Along with the rest of the changes this new responsibility brings there are also many parts of the tax code that will impact you financially.

The first thing you will need to do is apply for a Social Security number if the hospital hasn’t already done so on your behalf. When you file your first tax return that includes your newborn the IRS will want to see her social security number along with yours and your spouses. If you are a single parent you may file under head of household status which provides you a bit of savings over filing as a single. Your child comes with her own exemption which means another $3,650 dollars off your gross income before you calculate the tax you owe.

There are a number of additional tax incentives you should be aware of.

First is the Earned Income Tax Credit (EITC) which reduces your tax burden by $3,050 if you’re filing jointly and your adjusted gross income (AGI) is $40,545 or less. Note: A tax credit reduces your tax dollar for dollar as compared to a deduction which reduces your taxable income. For EITC you lose this credit if your investment income for the year is greater than $3,100. If you qualify based on AGI a bit of planning may be in order to keep your investment income below this threshold.

Next we have the Child Tax Credit. This credit is worth up to $1000 for each qualifying child under the age of 17. The credit phases out for a married couple beginning at $110,000. The exact rules and requirements to take advantage of this credit are complex but tax software like TurboTax will walk you through every deduction and credit you deserve.

If both parents are working and/or attending school full time you should consider the Dependent Care Account (DCA) if either of your employers offers this. The DCA allows you to deduct up to $5,000 annually for reimbursement of the expenses incurred for child care up to the age of 13. Your employer should have a website or pamphlet that explains the expenses the DCA covers. The most common expenses are day care, a nanny/au pair, nursery or after school care programs. This benefit is “use it or lose it”, if you don’t submit receipts to cover all of the money you’ve had withheld your employer will not refund it to you. For this reason careful planning is recommended as you must choose between the Child Tax Credit or DCA, no double dipping here.

Last, you may wish to take advantage of the Flexible Spending Account (FSA). Similar to the DCA in that money is held from your paycheck pretax the FSA can be used for any out of pocket health care costs including the copay for any doctor or dentist visits as well as for prescribed medicines (Note: until this year over the counter medicines were reimbursable but this has been changed for 2011). One subtle distinction between the DCA and the FSA is that you may be reimbursed from the FSA account before deposits have been made. In other words if you chose to have $4,000 withheld over the year you may submit and get reimbursed as soon as you’ve incurred up to $4,000 worth of eligible expenses. For the DCA you are reimbursed only as deposits fill your account.

For the two employer plans, a change in family status permits a change to your participating in these plans. Just because your child is born after you made the 2011 benefits decisions does not mean you missed out for the year. Contact HR and put your request in as soon as you can after the birth. Best wishes to you and your new family!