Family Finances: What Tax Breaks are Available for New Parents?

Meredith’s daughter, Tallulah, was happy to get her hands on her first brokerage statement.

After the initial whirlwind of midnight feedings, endless laundry, and surprise visits from friends and family, you hit your stride as a new parent.  You learn how to change a diaper in the dark.  You never leave home without a spare pacifier, and you become an expert at digging goldfish out of backseat crevices. But there can be a learning curve for your finances too: new deductions, credits, college savings plans – it can be as confusing as deciphering crib instructions.

Here are the basics of how your newborn changes your family’s financial situation:

Dependency Exemption. In addition to the personal and spousal exemptions of $3,800 apiece, a little one born in 2012 will add a dependency exemption of $3,800 (this increases to $3,900 for 2013).  These exemptions reduce your gross income, but watch out – the American Taxpayer Relief Act of 2012 (ATRA) signed into law on January 2^nd this year, phases these exemptions out in 2013 for high-income taxpayers.  You’ll be considered a high-income family if your adjusted gross income exceeds $300,000 for a jointly filed return or $275,000 for a single parent filing as head of household.

Child Tax Credit. Your bundle of joy comes with a $1,000 tax credit that reduces your tax bill dollar for dollar and can even provide you with a refund.  However, it will start to phase-out if your family makes over $110,000 for a jointly filed return or $75,000 for a single parent filing as head of household.

Child Care Credit. If your family incurs childcare expenses to allow both parents (or a single parent) to work or look for work, you’re provided with a credit equal to 20-35% of applicable expenses depending on your family’s gross income.  The maximum credit is $1,050 for one child and $2,100 for two or more qualifying dependents.

Dependent Care Flexible Spending Account. A dependent care flexible spending account will allow you to set aside up to $5,000 of your paycheck per year tax-free!  You can then use that savings account to cover eligible childcare expenses such as daycare, after-school programs, or nannies.

529 College Savings Plan. A 529 plan allows your family to put aside after-tax dollars into a savings account that will grow tax-free and have its withdrawals be tax exempt as long as the money is used for your son or daughter’s qualified education expenses (yes, it will happen sooner than you think!).  This includes tuition, fees, books, room and board, and if your child decides to forgo college in favor of touring with her punk band, the plan can be rolled over to another beneficiary. 

Coverdell Education Savings Accounts. Coverdell plans or ESAs as they’re frequently known are similar to 529 plans in that the balance grows tax-free and withdrawals are tax exempt if used for qualified education expenses; however a big added benefit is that primary and secondary school tuition is included in the definition of “qualified expenses.”  These plans do have some drawbacks:  contributions are limited to $2,000 per year per child, balances must be used or transferred to another beneficiary by the time your child is 30, and your ability to make contributions phases out if your family makes over $190,000 for a jointly filed return or $95,000 for a single parent filing as head of household.

If you want to learn more about the tax breaks that are available to new parents, please contact us. We can help you get your family finances in order and maximize the return on your joyful, little investment.