Tax Implications of Having a Child

How a Baby Can Affect Your Taxes

It is critical to get a Social Security Number for your child if you want to receive tax benefits. You will need to claim your child as a dependent on your tax return, and to do this, you will need a Social Security Number for your child. If you fail to report the Social Security Number for each dependent, you may be subject to a $50 fine and your refund may be delayed until things are straightened out.

You can request a Social Security Card at the same time you apply for a birth certificate. Otherwise, you will need to file a Form SS-5 with the Social Security Administration and provide proof of the child's age, identity, and U.S. citizenship.

Claiming your son or daughter as a dependent will protect $3,500 of your income from tax in 2009, saving you $950 if you are in the 25% bracket. You are eligible for the full year's exemption regardless of when, during the year, your child was born. Regardless of your income, if you are hit by the alternative minimum tax, exemptions lose all of their tax-saving value.

Since you will be claiming an extra dependent and your tax bill will be reduced, you can reduce tax withholding from your paychecks. You need to file a new W-4 form with your employer to change your withholding status. You can also take the child credit into account on your W-4, to reduce withholding even more.

If you are single, having a child may allow you to file as a head of household rather than using the single filing status. This will give you a bigger standard deduction and more advantageous tax brackets. To qualify as a head of household, you must pay more than half the cost of providing a home for a qualifying dependent .

Another way you can save on taxes when you have a child is to have a childcare reimbursement account at your work. These accounts, sometimes called flex plans, let you move up to $5,000 a year of your income into a special account that can be used to pay child care bills. Money that you put into the account lets you avoid both federal income and Social Security taxes, so it could easily save you more than the value of the credit. But remember, you can't use both the reimbursement account and the tax credit. Although you generally can only sign up for a flex account during open enrollment period , most companies allow you to make mid-year changes in response to major life events , such the birth or adoption of a child.

If you have added to your family by adopting a child, there’s a tax credit to help reimburse the cost of adoption. The credit is worth as much $11,650 in 2008. Also, if you adopt a special needs child, you are able to take advantage of the full credit even if the adoption cost was less than $11,650.

Time goes fast and before you know it, your child will be ready for college. It’s a good idea to start saving early on for those college bills. Congress offers some tax incentives to help parents save. One option is a Section 529 state education savings plan. Contributions to these plans are not deductible, but earnings grow tax free and payouts are tax free if the money is used to pay qualifying college bills. Many states offer residents a state tax deduction if they invest in the state's 529 plan. You could also put money into a Coverdell education savings account (ESA) for your child. You can fund up to $2,000 a year for any beneficiary. Again, there is no deduction for deposits, but earnings are tax free if they are used to pay for education expenses. ESA money can also be used for elementary and high school expenses in addition to college costs.

IRAs for children advantageously utilize compound interest, making small investments, especially when a child is young, positioned for immense growth. However, in order to open an IRA, a person must have earned income from a job or self-employment which is not the case with most children. You can’t use money from gifts or investments either. As soon as your child starts earning some money—babysitting or delivering papers, for example, or even by helping out in the family business—he or she can open an IRA. The power of long-term compounding makes this a great idea.

If you hire someone to come into your home to help care for your new child, you might be considered an employer in the eyes of the IRS and face a whole new set of tax rules. If you hire your nanny or caregiver through an agency, the agency may be the employer and have to take care of all the paperwork. But if you're the employer and you pay more than $1,500 a year, you are responsible for paying Social Security and unemployment taxes for your caregiver, and reporting the wages you pay to the government on a W-2 form.

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