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Laura Rowley Money & Happiness

Laura Rowley, Money & Happiness

Kids Can Be a Boon at Tax Time

by Laura Rowley

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Posted on Thursday, February 22, 2007, 12:00AM

Kids are a blessing in so many ways -- especially at tax time. The government offers an array of deductions, credits, and incentives to help parents raise and educate their children.

The Basics

The most basic is the child tax credit for dependents under age 17. It cuts your bill by $1,000 dollars per child for the 2006 tax year. But the credit begins phasing out at higher incomes: $110,000 dollars for couples who file jointly; $75,000 for single heads of households; and $55,000 if you're married but filing separately.

For parents who are adopting, the government offers a dollar-for-dollar tax credit of more than $10,960 to help cover expenses such as court costs, adoption and attorney fees, and travel expenses. But the credit phases out at incomes above $164,410, and there are limitations (i.e., adopting your spouse's child does not qualify).

Parents are eligible for the credit in the tax year after they finalize the adoption. (For more information, see IRS Form 8839.)

Help with Child-Care Payments

You may be surprised to learn that Uncle Sam will help pay for child care for kids under age 13, including a nanny, nursery school, kindergarten, or even summer camp. The Child and Dependent Care tax credit can cover from 20 percent to 35 percent of your costs, up to $3,000 for one child and $6,000 for two or more children, depending on household income, according to Elda Di Re, a partner with Ernst & Young.

Eligible taxpayers include households with:

• Two parents working full-time

• A working single parent

• One parent earning an income while the other is a full-time student or is disabled and unable to care for the children

The credit doesn't completely phase-out at higher incomes. "There's a misconception among people that once you make a certain amount of money you won't get the credit, but that's not true," says Di Re. (For more information, see IRS Publication 503.)

The Feds Get Flexible

Meanwhile, working parents whose employers offer flexible spending accounts for dependent care have a significant tax advantage.

With these plans, a parent commits before the beginning of the year to have their employer withdraw up to $5,000 from their pre-tax pay, and set it aside for child care. Parents then submit receipts for dependent care expenses to their company administrator, who pays the bills from the monies set aside.

Because that income is never taxed, someone in the 40 percent tax bracket would pay just 60 percent of the cost of their child's care. So, if your three- or four-year-old's preschool tuition is $5,000 per year, and you're in the 40 percent tax bracket, your actual tuition cost will be just $3,000.

As an added bonus, you'll have reduced your taxable income by $5,000. One drawback: If you don't use the money in your flexible spending account during the calendar year, you lose it.

Keep in mind that you can't double dip on both programs. "If you're going to choose the Child and Dependent Care Credit or the flexible spending account, the latter is usually a better tax deal," says Di Re. "But if you're doing your tax return and you didn't do a spending account last year, then go ahead and claim the credit."

Teenage Tax Tips

If you have a teenager who earned income in 2006 -- through a summer job, say -- consider opening a Roth IRA in her name, Di Re suggests. "Although you don't get a tax deduction for the Roth contribution, it grows forever tax-free," she explains.

Di Re recommends opening a Roth over establishing a UGMA (Uniform Gift to Minors Act) custodial account. "The Roth is a great way to set up lifetime savings for a child."

Although Roth IRAs are designed to be retirement vehicles, a child could use the money later in life for other expenses, because the contributions (but not the profits) can be withdrawn at any time with no tax or penalty. (In some circumstances -- such as a home down payment -- the profits can be withdrawn penalty-free as well, although tax must be paid if the money is withdrawn before age 59-1/2.)

Tax Savings and College

As for college savings, the biggest tax advantages come from state qualified tuition plans, or 529 plans. As of the third quarter of 2006, more than 9 million children were enrolled in 529 plans, which held more than $97 billion, according to information clearinghouse College Savings Plans Network.

Investors can save money in a child's name, or pre-pay tuition at a specific university. Money in these accounts grows tax-deferred and is free of federal taxes when withdrawn.

Consumers can choose plans outside their home states, and the plans typically offer a variety of investments, including an age-based portfolio that shifts from aggressive to more conservative as a child nears college age.

"One of the benefits is that a 529 is not going to be throwing off income each year as a child is growing up," says CPA Joe Hurley, founder and CEO of Savingforcollege.com. "If you're investing in other vehicles, and the child earns more than $850 in investment returns, you're going to run into the kiddie tax. The cost and hassle of filing a child's tax return is something people don't think about when putting money in a kid's name."

529 Plan Essentials

Because the 529 account is owned in a parent's name, it has minimal effect on financial aid eligibility. (President Bush's current budget proposal would exclude 529s entirely from consideration in financial aid, but Hurley doubts the provision will survive.)

Individuals can contribute up to $12,000 a year without triggering the federal gift tax (as long as there are no other gifts during the year). The plans also allow a lump-sum contribution of $60,000 per donor if no other contributions are made in a five-year period. Most plans have a lifetime maximum contribution of $250,000 to $300,000.

Meanwhile, 31 states and Washington, D.C., sweeten the 529 deal with an upfront tax savings. The deductions vary widely -- from unlimited deductions in four states (New Mexico, Colorado, West Virginia, and South Carolina) to a paltry $250 deduction offered by the state of Maine (and that's with income limits).

As an example, my husband and I kept our 529 plans in New York even after we moved out of state, because he still commutes to Manhattan and we get hit with state and city taxes. New York's 529 plan allows investors to deduct the first $5,000 of their contribution from state taxes each year ($10,000 for married couples filing jointly).

Be Smart about Deductions

But don't pick a plan based on the tax deduction alone, says Hurley. "The upfront tax deduction is a big reason to consider your own state's 529 first -- but it doesn't make it a no-brainer to use your state's 529 plan."

Hurley continues, "The value of the deduction varies based on the age of the child. If your child is older and you're going to use the money soon, it's hard to beat the tax deduction with investment returns. But if your child is young, even a small increase in investment returns over time will outweigh the value of the deduction."

Once a child is in college, there are a variety of education credits to help pay for tuition, including the Hope Scholarship and Lifetime Learning Tax Credit. But you can't use both at the same time, and there are income and other limits. (For eligibility information, see IRS Publication 970.)

Many states also offer educational tax credits. "When you have kids in college, talk to an accountant to make sure you get every available deduction and credit you're eligible for," says Di Re.

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130 Comments

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  • Yahoo! Finance User - Saturday, March 3, 2007, 12:27PM ET  Report Abuse

    • Overall: 3/5

    People, please focus on the purpose of this article...tax breaks for families. Nowhere in the article does it call for anyone's anger or ignorance to be posted here. A few of your are missing the point. Take your issues to your therapist and stop badgering everyone here with them.

  • Yahoo! Finance User - Saturday, March 3, 2007, 12:26PM ET  Report Abuse

    • Overall: 4/5

    I have no children in which I receive a tax relief for. But to those of you whom think this is credit should not be given, I ask do you own a home or live by a school. Guess what your property value is higher. On the home that you own, and I assume that you do own a home if you have no children and all the expense of them. Well your mortgage gives you a tax break. We all have them (tax breaks). Not sure why you all feel the need to beat others to death with children. The credit they use is just one of many tax reliefs.

  • Yahoo! Finance User - Saturday, March 3, 2007, 10:28AM ET  Report Abuse

    • Overall: 3/5

    I found the article interesting and the negative comments on the board ridiculous. My husband and I were married for 10 years before having our first child, and I never felt that paying higher taxes and claiming no dependents was an unfair burden. I spent nearly 20 years paying taxes before having my daughter and if some of that money benefits the poor I say great, it is a no brainer way to share in a little charity. Yes some people may take advantage of the system or are not educated enough to know better, but that is not the majority of people. Also when those of you with no children are old and need strangers to take care of you because you don't have any children of your own, I hope it is not my daughter who will have to absorb your bitterness.

  • Maalru - Saturday, March 3, 2007, 9:34AM ET  Report Abuse

    • Overall: 5/5

    can you explain why it is that restaurants only claim a percent of a servers tips, and why it is beneficial for a server to keep a tip log to show their tax prepairer.

  • Yahoo! Finance User - Saturday, March 3, 2007, 9:34AM ET  Report Abuse

    • Overall: 4/5

    Valerie's comments are negative and she deserves to lose tax credit for being such a stick in the mud! All we can do is move on and that's how we pay for the mistakes of the past. Now there is a brighter hope for upcoming Americans--doesn't that just make you tingly inside, Valerie?

  • ChApA - Saturday, March 3, 2007, 9:24AM ET  Report Abuse

    • Overall: 1/5

    Is a shame! Sounds good, but you are playing for the big guys, not for the people. IRS is Private, Why you don't better wathc this movie? www.americafreedomtofascism.com I think, we the People will be better with out IRS and Federal Reserv Bank, they are just private companies, and don't forget, that taxes are not in the constitution. If we know the true, we will be free! Thank you.

  • beatlebeatleb - Saturday, March 3, 2007, 9:24AM ET  Report Abuse

    • Overall: 3/5

    informative very thank you .

  • Yahoo! Finance User - Saturday, March 3, 2007, 9:09AM ET  Report Abuse

    • Overall: 4/5

    wow, I wonder what its like around the holidays with all the people who dont want kids , I can see it now,mom and dad i think you owe me money ,you got tax breaks while i was growing up for me and now ive decided not to so it isnt fair start paying up.

  • MELISSA M - Saturday, March 3, 2007, 8:36AM ET  Report Abuse

    • Overall: 4/5

    thank you, i found this article helpful...i am a single mother, and i work two jobs, my daughter does go to a private school, comments like valeries are such a negative thing, i can afford to have my daughter, and i would have a whole lot more money if i didnt send her to provate school, but in this day when every advantage helps shouldnt we do tthat for our children...my daughter's tuition is almost as much as myy rent, but arnt the first few years of school just as important as the end, in other worrds college? if the children dont get a good solid foundation, how can they possibly build for their futurepeople without children wouldnt be expected to understand this im sure, but once you have a child,it changes your world and you want the best for them, i pay taxes to valerie, and i always have...if you ever have a child, your opinions will change im sure

  • Yahoo! Finance User - Saturday, March 3, 2007, 7:42AM ET  Report Abuse

    • Overall: 3/5

    A good place to start. For those without children these advantages do not hurt you and cheer up, my children will pay for your social security.

  • Valerie B - Saturday, March 3, 2007, 6:42AM ET  Report Abuse

    • Overall: 2/5

    imo, no tax breaks should be given to people for having children.If you cant afford children don't have them because most of us are paying through the nose for you. Also, since what i think doesn't matter and the government wants to give you people these breaks, lets be fair and let those of us that didn't get these kind of breaks years ago but instead had to work an extra job or two to support our households go back and amend our taxes to get the same benefits and tax breaks some of you now get.

  • Victor - Friday, March 2, 2007, 11:22AM ET  Report Abuse

    • Overall: 4/5

    Very good article. Thank you for the tips.

  • Joe T - Tuesday, February 27, 2007, 11:13AM ET  Report Abuse

    • Overall: 2/5

    You need to get your facts straight about the adoption credit. I have adopted twice and the adoption credit is good for the year the adoption is finalized. So in 2006 if you finalized an adoption you take the credit in 2006. If you have carryover then you save it for 2007.

  • Yahoo! Finance User - Monday, February 26, 2007, 3:43AM ET  Report Abuse

    • Overall: 3/5

    As a single educated mother, I find some of the comments that some of you made horrible. How dare you generalize single mothers in the way that you have. Not all of us are young teenagers that didn't practice safe sex. Not all of us didn't get married and have children out of wed-lock, and so what if I did it would be of no business to you. I am taking care of my family NOT YOU AND YOUR TAXES!!!! People need to stop looking so badly at single mothers and start judging themselves before they judge others, because I am sure that each and every one of you were; and are not perfect in life.

  • Dick - Monday, February 26, 2007, 2:08AM ET  Report Abuse

    • Overall: 4/5

    Both my kids are in college and both parents working. Just enough income to not be eligible for any help with grants or susbsidized loans. US parents get to take out PLUS loans and hope that the kids will follow through on promise to take over payments after graduation. In the meantime aboout 400 in monthly loan payments, 175 car payments and health and car insturance at about 350 for them. Cars are 12 years old, We did get a 250 tax credit. WOW!!

  • Brian - Monday, February 26, 2007, 2:06AM ET  Report Abuse

    • Overall: 4/5

    I gotta throw in here. Some kids do great in single family households. While I think its useful to generalize on some issues, this isn't one of them. I think it has everything to do with the parent. This type of tax relief is a no-brainer to me. I have a hard time believing that this tax credit enters the minds of people having children out of wedlock. On the other hand, making it tougher to get divorced has some serious down sides. Lots of miserable spouses stay together "for the kids". The kids learn what fighting looks like instead of family. I'm just saying that having some relief for people making the tough choice to raise kids alone isn't such a bad thing.

  • Yahoo! Finance User - Monday, February 26, 2007, 1:44AM ET  Report Abuse

    • Overall: 3/5

    Oh I'm sorry $1,100. Because that's how much I recieved and it doesn't make a difference. I could've sworn this was about educationg people on how to utilize tax benefits and not about demoralizing America because people in poor communities have babies out of wedlock. Of coure we would all have it a different way, however since we are all human and make mistakes it cannot be perfect. Especially for those who are POOR born into a viscious cycle of hopelessness. A 16 year old girl born in streets of dirty needles, poor education, and single families that have failed time after time after time before them doesn't suddenly think, "Well, if I have a baby i'll qualify for the EIC". All these young people look for in these communities is someone to love and care for them. And 99% of the time they find it in the wrong places and become pregnant because their parents or schoold didn't teach them about abstenance or condoms. Don't go blaming women who already have babies for your empty wallet. And the President's ideas of a moralistic society isn't going to solve the problems of the communites you people ignore. No matter what the campaign, these communites will continue to suffer until either directly identified or money continues to be thrown at them like its all going to go away. And that hasn't been the case which both of us can agree upon.

  • CletishaM - Monday, February 26, 2007, 1:06AM ET  Report Abuse

    • Overall: 3/5

    I have to say that most of you sound like secondary education wasn't afforded to you. In all honesty I use to think that child credits were ridiculous. My pop would get money for nothing and I didn't understand why. Then I had a child with my husband. The cost of properly bringing up a child with even the bare neccissities could spring for a down payment on a dream home. Young women and MEN irresponsibly bringing children into this world isn't an issue of how much money they can take. Most single families of that nature is an issue of poor education, neglectuful families and low self esteem. It has nothing to do with money assuring you of that, having gone through labor. It is in poor taste that people would even consider the idea that women from poor communites would go through the lengths of having a child for a lousy 1,000 child credit that would go up in smoke in a matter of seconds when compared to the real cost and bills of child care. Do me a favor and get off your high horse. When you have a baby and the govt says, depending on your income, apply the credit to your bill or take this check, give the money to charity because after all you really don't need it.

  • M - Monday, February 26, 2007, 12:19AM ET  Report Abuse

    • Overall: 3/5

    Possible error in article. Section: Help with Child Care Payments. States Kindergarten is eligible. Per IRS Pub 503 link: Kindergarten and above not eligible.

  • Yahoo! Finance User - Monday, February 26, 2007, 12:06AM ET  Report Abuse

    • Overall: 4/5

    People on here who are complaining on the child tax credit telling people to keep their legs closed and so fourth just because of the gov't giving them a little help. I can understand about some of these people who are out there having hundreds of kids and so fourth and who are living off of welfare. These are people who i feel abuse it just so they don't have to work.. The state i live in is completely different. They don't have the AFDC. They have a different program called the W-2 program, where they educate you and help you find a job. I have 2 kids myself and I was on AFDC when my daughter was just a baby for the first 3 months of her childhood. Then I got a job and supported her. I have one baby daddy who is a worthless piece of crap.. Doesn't pay support and all that and goes to jail for it and then gets out and same thing.. back to jail. Then he borrows money from his own kid and never pays her back. What a daddy that is.. I have worked my butt off for my kids. Now I am a stay at home mom.. and i do get some help with taxes.. but look kids aren't cheap the older they get the more they need.... So I think its good that someone helps us out....

  • Christy - Monday, February 26, 2007, 12:03AM ET  Report Abuse

    • Overall: 4/5

    I have two kids, one in my household & one not, I pay support & owe back for the one not in the household, I can't understand how the IRS can take my entire EIC $3200 for my baby & give it to my ex-husband for child support. The only reason I get this is for my one yr.old baby? I could see mabye taking half, but not all. I need this to help out in my household, I love my older son but do not believe this is where the money should come from. Is it for my baby or should it just say child support credit?

  • US Mommy - Monday, February 26, 2007, 12:00AM ET  Report Abuse

    • Overall: 3/5

    I can't even afford to put both of my youngest in childcare. The baby costs $235 per week alone not including expenses like uh formula and diapers that are not provided by the school. Quazi $11,000 /- per year. The tax credit is a joke whoever came up with it forgot that daycare is harder on the blue collar workers and teen parents who break there backs to break $$15,000 a year and get no credit because they don't earn enough. I have a cozy job and daycare costs bite me hard. How about giving Natural Born AMERICANS a once in a life time tax break of 5 years like they do foreigners. Now that would be a real tax break. We could all afford SUVs, convienence stores and Big Ass Houses too and daycare. I'm a paralegal and I want to know why there isn't a government agency, not money hungry firms to help Natural Born Americans with the nightmare hoops, red tape, mouse traps and general bull$$$$ that you have to hassle with to get the one time forgiveness that we do get, and why isn't it free like all the AIDE foreigners get. The people who need it in general can't afford to pay 33.33% of what they owe to some firm if they had that kind of chump change they probably would have paid the tax debt to begin with. I think those firms are no different than those Nigerian e-mails that I see in my spam box daily!!!!!! If there is a free agency to help with tax relief post the name here so we can pass it on to Shelters around here so someone in real need can get some help.

  • Tara - Sunday, February 25, 2007, 11:25PM ET  Report Abuse

    • Overall: 3/5

    Wow. 8 kids. Why in the name of God would you keep having children with deadbeats when you can't afford them? And you sound like you need further education. How can you do that with 8 kids to support? I find it sad that our world and society has come to this. I have 3 kids. It is hard to make it out there, even with the help of my loving husband. I can't imagine what it must be like to have no one to help. But please. For the sake of your kids and my tax money, stop having kids. It's making it hard for the rest of us. The government may tell us eventually that we no longer deserve this tax break, because of people in your situation. I don't mean to sound like a witch. Just frustrated. Like we need any more stress in our lives.

  • C - Sunday, February 25, 2007, 11:16PM ET  Report Abuse

    • Overall: 4/5

    THANK YOU FOR SHARING THIS INFO. AND MAKING IT TO UNDERSTAND.

  • Yahoo! Finance User - Sunday, February 25, 2007, 11:14PM ET  Report Abuse

    • Overall: 3/5

    Hopefully that woman with seven kids and one on the way was just a joke so I won't even address that. As for parents not deserving tax breaks because of the "burden" they have created that is absolutely ridiculous. Why do you think our government started the whole welfare state thing, out of the goodness of their hearts? No. The reason they do it is that they know that nearly every welfare baby born will grow up and in their life time pay so much more in taxes than they cost the government. (and before you even go there, welfare kids generally grow up and don't end up on welfare probably has something to do with how bad it sucks to be on it.)And for all children whose parents don't get welfare, then that is an even larger boon for the government because all of those children will become taxpayers too. It is in the governments best interest to encourage its population to be fruitful and multiply. And for all those out there that think kids are awful, you know that when you get old it'll be somebodys kid that's taking care of you. So when your ancient and alone and have no one left maybe then you'll be happy that someone else made the sacrifice to bring another life into the world.

  • Yahoo! Finance User - Sunday, February 25, 2007, 11:13PM ET  Report Abuse

    • Overall: 3/5

    I think it's good that the government gives you child tax credits, but what about when your raising family members. I'm a 25 yr old single mother of a 4 yr old, who is also trying to raise my two teenage cousins to keep them out of foster care. i was not eligible for any child tax credit for them (according to H&R Block).i thought i would be getting a big return and didn't.

  • Yahoo! Finance User - Sunday, February 25, 2007, 10:48PM ET  Report Abuse

    • Overall: 2/5

    Just gave birth last year to my little boy and am grateful for his presence in mine and my husband's life. However, on the tax credit, a parent receives so little in the way of a deduction for a child. The expenses are astronomical (baby formula, diapers, clothing, toys, education, etc - but well worth it). I applaude any single parent that is able to care for a child or children in this time.

  • Yahoo! Finance User - Sunday, February 25, 2007, 10:46PM ET  Report Abuse

    • Overall: 2/5

    I found this article only somewhat realistic, the various parents that I've talked to have told me that people with more kids actually don't get as high of tax cuts as those with only 2 or 3. Right now I have two young children and one on the way, they're my whole world and I do everything I can for them. It is difficult being lower-mid class and being able to properly provide everything they need without working two jobs, we make it though though, their father pays child support but I've yet to see anything, if he goes to jail again oh well, he doesn't really even bother with them, he hasn't even seen or talked to them since Christmas. I'm in the middle of a terrible divorce with him and the man I'm currently seeing has been a saint and is the love of my life. My ex was and still is a horrible person and I couldn't be happier if he'd just disappear off the face of me and my children's planet. To those of you that see children as a horrible thing why did you even bother reading this article? Just so you'd have something to complain about? Shame on you. My sweetheart and I are working toward making our kids lives the best they can be, we both had it hard growing up and don't want the kids to have to go through that. The tax credits are helpful, but they aren't a huge godsend, and the 8 children commenter isn't really going to get much more than what they have already from tax credits. Especially not for free, everything must be worked for.

  • Yahoo! Finance User - Sunday, February 25, 2007, 10:36PM ET  Report Abuse

    • Overall: 2/5

    Children are great, but don't expect to have the tax man reimburse you for all of the expenses of raising them. The title of the article is simply incorrect, but eye-catching for sure.

  • Adan - Sunday, February 25, 2007, 10:23PM ET  Report Abuse

    • Overall: 2/5

    I agree that this article is not intended to persuade a person to have kids or not to. There are issues far more complex to consider when thinking about bringing life into our world. I also think that the various deductions and credits that our governments gives taxpayers are not at all meant to pay back all the money spent on raising our kids. Restitution for child expenses is not the nature of our government. Tax break or not, the investments I have made in my children and their futures are unmeasurable, and I expect no one but them to pay me back for that in success.

Showing comments 6-35 of 130<< PreviousNext >>
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