One of the most exciting (and nerve-wracking) times of your life is having a child. The uncertainty, anxiety and stress associated with planning for that special date can be overwhelming, and then they start to grow up! Like all the wonderful and challenging moments that come with parenting, there are a variety of tax implications of expanding your family. We have assembled a couple of articles that touch on income tax return filing changes, including deductions, exclusions, and credits. This first article focuses on the parents’ filing status change, income exclusions, some deductions, household employee requirements, and tax return filing for children.
Soon-to-be parents must consider which color to paint the nursery, the perfect stroller to purchase, how much stuff do they really need, and how this change will impact their finances. Luckily, with a bit of planning, parents can spend more time doting over their bundle of joy (or dealing with tween/teen angst) and less about how much to contribute to the ever important 529 plan (don’t worry, we will get to that later).
The first – and most important – thing to do is to get a Social Security number either at the hospital or by filing a Form SS-5 with the Social Security Administration. Most hospitals have this set up as part of their process prior to mom being released, but know that if they do not, you need to take care of this on your own. If you are adopting a child who has never had a Social Security number assigned, you will need to make arrangements as well.
Filing Status Updates
Once you have brought home your new family member, you may need to review your filing status and consider adjusting your withholding to account for the deductions and credits you are now entitled to receive. If you are married, having a child will not affect your filing status. If you are single and pay for more than half of the cost of keeping up your home and you are the custodial parent, you can now file as Head of Household. This will increase your standard deduction and change your tax brackets to more favorable parameters. If you would like to know more about 2018 tax brackets, visit this resource.
In past years, each person in your household was allowed a personal exemption amount. That dollar amount ($4,050 in 2017) was subtracted from your adjusted gross income and was not subject to tax. Current tax law suspends the personal exemption amount for tax years 2018 through 2025. This means that for a family of four, over $16,000 that was previously exempt from tax will now be subject to tax. Many changes in the Tax Cut and Jobs Act (TCJA) passed in December of 2017 will likely impact your tax return in a variety of ways, including the personal exemption suspension, changes to tax brackets, and the increased child tax credit. We will share more on the child tax credit in another post.
Adoption Assistance Income Exclusion
Taxpayers adopting an eligible or special needs child may be able to exclude employer-provided adoption benefits from income. Both the adoption credit and the adoption assistance exclusion can be claimed on the same tax return, but not for the same expenses. Be sure to read our Part V for information about the credit.
An exclusion from an employee’s gross income is allowed for qualified adoption expenses paid or reimbursed by an employer if such amounts are furnished pursuant to an adoption assistance program. For 2018, the maximum exclusion amount is $13,570, and is phased out ratably for taxpayers with modified adjusted gross income (MAGI) above a certain amount.
Qualified adoption expenses are reasonable and necessary adoption fees, court costs, attorney fees, and other expenses that are: (1) directly related to, and the principal purpose of which is for, the legal adoption of an eligible child by the taxpayer; (2) not incurred in violation of State or Federal law, or in carrying out any surrogate parenting arrangement; (3) not for the adoption of the child of the taxpayer’s spouse; and (4) not reimbursed (e.g., by an employer).
Special rules regarding when expenses are used for the exclusion benefit or credit, and certain substantiation requirements apply. We will be happy to consult with you to assist in determining whether you qualify to claim either an exclusion or credit or both.
Dependent Care Benefits
Parents paying for childcare should also review whether their employer offers a flexible spending plan which allows a child care reimbursement account. Typically, these are referred to as Dependent Care Benefits, and there is even a box on your W-2 for this amount. This allows you to divert up to a total of $5,000 tax free to an account used to pay child care costs.
Keep in mind, this means that a married couple can only exclude from taxable income $5,000 in total, not each, even if both employers offer a plan. Any amounts not used for dependent care will be added back to wages for tax purposes.
In our metro DC/Northern Virginia area, the wait list for child care centers can be up to two years. In these situations, many parents opt to hire an au pair or nanny to care for their children. With commutes that can commonly stretch to an hour or more, the flexibility of an in-home caregiver can be a game-changer for dual income families.
If you plan to hire a nanny independent of an agency, you could become an employer in the eyes of the IRS. To be considered an employer, you must pay a household employee more than $2,100 during the year, or wages of $1,000 or more during any calendar quarter. You are also responsible for paying Social Security and unemployment taxes as well as reporting the wages on a W-2. This article from the Thompson Greenspon Tax Blog can assist you with knowing your obligations should you hire a household employee.
Saving and Paying for College
It is never too early to begin saving for college. This calculator from CollegeBoard.org will help you determine how much a future college education may cost. College may not be the best option for your child, so be sure to look at technical and trade schools as well. There are thousands of skilled labor jobs that are unfilled that have excellent pay and benefits.
The 529 Plan
One option to help save for post-secondary education is a state 529 plan. While there is not a Federal deduction for contributions to 529 plans, many states offer a tax deduction on your state tax return for contributing to their state plans. For example, in Virginia, taxpayers are entitled up to a $4,000 deduction per account (depending on the amount invested during the year) on their state tax return, provided the taxpayers are investing in a Virginia 529 plan.
Contributions to these plans grow tax free if the money is used to pay qualifying education expenses. Qualifying expenses typically include tuition, fees, books, and supplies and equipment required for use in an eligible institution. Check out this article on our blog with new guidance from the IRS regarding 529 plans in light of the TCJA.
An eligible institution is any college, university, trade school, or other post-secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education. In 2018, qualifying education expenses include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.
Coverdell Education Savings Accounts
Another savings option is the Coverdell Education Savings Account (ESA). Again, these funds grow tax free and remain tax free if used towards qualifying education expenses. One downfall of this account is that there is no state tax deduction for contributions.
Tuition and Fees Deduction
This deduction was slated to sunset in 2016 but was extended one year to 2017. No word as of yet whether it will be extended again. The tuition and fees deduction can reduce the amount of your income subject to tax by up to $4,000. Our next article will highlight the credits available for qualified expenses for college.
The basics of the deduction are below.
You may be able to deduct qualified education expenses for higher education paid during the year for yourself, your spouse or your dependent, UNLESS:
- your filing status is married filing separately;
- another person can claim you as a dependent on his or her tax return;
- your MAGI is more than $80,000 ($160,000 if filing a joint return);
- you were a nonresident alien for any part of the year and did not elect to be treated as a resident alien for tax purposes; or
- an education credit is claimed for expenses of the student for whom the qualified education expenses were paid
Two final things to keep in mind are that Congress has created the “kiddie tax” to force investment income earned by a dependent child to be taxed at the rates for trusts and estates. The top rate for trusts and estates kicks in when unearned income exceeds $12,500 in a tax year.
529 plans are not considered investment vehicles owned by the child; however, other accounts such as Uniform Gift to Minors Act (UGMA), Uniform Transfers to Minors Act (UTMA) or other investment accounts held in the child’s name will be considered his or her unearned, investment income and taxed to the child. If you would like to know more about the kiddie tax, we go more in depth here.
While there are many things to worry about with a new child, we hope that the information presented above removes taxes from that list, or has given you the resources to learn more. Please contact us to speak with one of our tax specialists if you have any questions.
Eric is a Tax Senior at Thompson Greenspon specializing in non-profit, trust and estate, and individual taxation.
Eric holds a J.D. from the Syracuse University College of Law, and a BA in Economics and Political Science from Hartwick College.
Erin Kidd is the Tax Individual Practice Supervisor at Thompson Greenspon and has nearly a decade of tax experience specializing in individual taxation. Throughout her career, she has focused on simplifying complex tax issues and educating clients to maximize their tax benefits and plan for future events. Erin is responsible for the review of individual Federal and multi-state tax returns, managing the firm’s Military Spouse Remote Preparer Program, preparation of individual tax returns with international taxation and reporting requirements, and assisting with the resolution of client issues with Federal and State Taxing Authorities.
Erin holds a Bachelor’s and Master’s Degree in Business Administration from Morehead State University, is an Enrolled Agent, a federally licensed tax preparer who has unlimited rights to practice before the IRS, and an Accredited Financial Counselor ®. She has been recognized by the Garrison Commands of West Point, NY and Fort Leavenworth, KS for her contributions to the military community for her work with the installations’ Volunteer Income Tax Assistance Centers.
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