The birth or adoption of a child is a joyous occasion for a family. In addition to significant lifestyle changes there are also a significant number of tax implications. In this article we will provide you with some information that may assist you. We are going to cover:
• Tax filing rules
• Tax credits
• Adoption credit
• Other things to consider
Tax Filing Rules
Dependency Exemption
A dependency exemption, a reduction in taxable income, of $3,800 for 2012, is allowed for the taxpayer and each child/dependent. The full amount of the exemption is allowed regardless of when during the year the child was born. The dependency deduction will save a taxpayer in the 25% tax bracket $950 in 2012.
If you are unmarried at the end of the year or filing married filing separately, the custodial parent would be the taxpayer allowed the dependency deduction.
Filing Status
Your marital status for tax filing purposes is set as of the last day of the year. If you are unmarried at the end of the year, the custodial parent would have the ability to file using head of household status provided that they meet the following requirements:
• You were unmarried or considered unmarried on December 31. You are considered unmarried if your spouse did not live in your home during the last six months of the tax year.
• You paid more than half the cost of keeping up a home for the year.
• A child or other qualifying person lived with you in the home for more than half the year for which you or the other parent is entitled to claim the dependency exemption.
The head of household status provides a higher standard deduction and lower tax rates than a single taxpayer.
Medical Expenses
If you itemize your deductions on your tax return you may be eligible to deduct a portion of your medical expenses in determining your taxable income. Deductible medical expenses are those that exceed 7.5% of the taxpayer’s adjusted gross income; 10% if you are in alternative minimum tax. For example, if your adjusted gross income is $100,000, you would not be able to deduct the first $7,500 of your medical expenses. Deductible medical expenses related to the birth include:
• Hospital and physician costs related to the birth and not covered by your medical insurance.
• Physician office visit cost for both the mother and child.
• Birthing classes.
• Breast Pumps and Supplies and other Lactation Expenses
• Fertility Enhancement
o Procedures such as in vitro fertilization (including temporary storage of eggs or sperm).
o Surgery, including an operation to reverse prior surgery that prevented the person operated on from having children.
• Pregnancy Test Kits
• Parking and mileage costs ($.14 a mile) to and from the hospital and doctor offices.
• Lead-Based Paint Removal to prevent a child who has or had lead poisoning from eating the paint.
Expenses that are not allowed include:
• Diaper Service
• Baby Sitting, Childcare, and Nursing Services for a Normal, Healthy Baby
This list of deductible and nondeductible medical expenses relate only to expenses associated with the birth of a child. There are many other deductible medical expenses that will affect the amount included on your tax return.
Tax Credits
Child and Dependent Care Credit
Working parents usually require a child care provider to look after the child when they are at work. The child and dependent care credit is a nonrefundable credit that is based on the expenses you incur for child care for children that are under 13 years of age.
Generally, the credit is 20% of the cost of the care with a maximum expense limit of $3,000 for one child and $6,000 for two or more. However, for lower-income taxpayers, the credit percentage can be as high as 35%. The higher percentage is completely phased out at an adjusted gross income (AGI) of $43,000; therefore, taxpayers whose AGI is greater than $43,000 can claim a maximum credit of $600 for one child ($3,000 x 20%) or $1,200 for two or more children.
The expenses that are taken into account for the credit are limited to a taxpayer’s earned income, such as wages and self employment income, and must be reduced by the amount a taxpayer excludes from gross income under an employer-provided dependent care assistance plan.
For taxpayers who file joint returns, the expense is limited to the earned income of the lower paid spouse, so generally both parents must be working or looking for work. Special rules allow a spouse who is disabled or a full-time student to qualify as having earnings when they otherwise have none, thus permitting the couple to claim some credit.
Child Tax Credit
A child tax credit of $1,000, for 2012 and $500 for years after 2012 is available for each qualifying child. The credit phases out at a rate of $50 for every $1,000 of modified adjusted gross income or fraction thereof exceeding $110,000 for joint filers, $55,000 for married filing separately, or $75,000 for single and head of household filers.
For taxpayers with one child, the credit completely phases out in 2012 when Modified Adjusted Gross Income (MAGI) exceeds $129,000 on a joint return, $74,000 for married filing separately (MFS), and $94,000 for unmarried taxpayers. For taxpayers with two children, the credit completely phases out in 2012 when MAGI exceeds $149,000 on a joint return, $94,000 for MFS and $114,000 for unmarried taxpayers. MAGI thresholds are not indexed for inflation.
A qualifying child is one that is under the age of 17 at the end of the year, is not self-supporting, who lived with the taxpayer over half the year and is a U.S. Citizen or national. Children who were born during the year are treated as living with the taxpayer for over half the year even if born in the last half of the year.
If a person’s tax liability is reduced to zero with this and other tax credits, a portion of the unused child tax credit is refundable. The amount refundable is the lesser of the unused credit or 15% of the taxpayer’s earned income in excess of $3,000. For example if married taxpayers had earned income of $90,000 and an unused credit of $800, they would receive a refund of $800, determined as follows, $90,000 – $3,000 = $87,000 x 15% = $13,050. The $800 is less than the calculated amount.
Adoption Credit
The adoption credit is a fairly generous credit. The maximum credit is $12,650 for 2012, per child, with no limit on the number of children adopted. The credit is based on the qualified adoption expenses incurred by the taxpayer and is a dollar for dollar credit; if your qualified adoption expenses are $10,000 you will be entitled to a $10,000 credit.
Qualified adoption expenses include; adoption fees, attorney fees, court costs, travel expenses (including meals and lodging) while away from home, and, re-adoption expenses relating to the adoption of a foreign child.
The credit is phased out for taxpayers with adjusted gross income in excess of $189,710 for 2012 and is completely phased out for taxpayers with adjusted gross income in excess of $229,710. The phase-out is the same for each filing status except married filing separate, in which case a credit generally cannot be claimed.
The adoption credit can also be used with an employer provided adoption plan. However, the expenses can only be used for either the employer plan or the adoption credit. Under an employer provided adoption plan, the employer pays, as a nontaxable fringe benefit, a dollar amount defined under the plan towards the employee’s adoption expenses. These payments are nontaxable to the employee. If the total adoption expenses exceed the amount paid under the employer provided adoption plan, the taxpayer can use the excess expenses in determining the adoption credit. For example, taxpayer incurs $15,000 in adoption expenses and the employer pays $5,000 of these expenses. The taxpayer would then be eligible for an adoption credit of $10,000.
There are special rules for foreign adoptions, adoption of a child with special needs, attempted adoptions, and carry forward of prior years adoption credits. You also need to file certain documents with your tax return. Since there are required attachments you will not be able to file your tax return electronically if claiming the adoption credit.
Other Things to Consider
The birth or adoption is not only a wonderful time for new parents but a rather hectic time as well. Following are several other things to consider and put on your to do list.
• Update or get a will. A will is one of the most important estate documents and is essential now for each spouse.
• Review your life insurance and disability insurance coverage.
• Update your beneficiary forms on all life insurance policies and retirement accounts.
• Save for college tuition. A 529 plan allows one to place money into an investment account with all growth “tax free” as long as monies are pulled out for college education expenses. North Carolina allows for up to a $2,500 deduction for a single taxpayer and up to a $5,000 deduction for a joint tax return against your state taxable income when you make contributions to the North Carolina 529 Plan.
• Review your medical insurance policy and work benefits program. You will need to add your child to your medical coverage. Also many companies offer cafeteria plans that allow for a pretax deduction for child care expenses.
• Employment Taxes for Household Employees – If you pay someone to work in your home and care for your child you may be a household employer and subject to paying social security, Medicare, and state and federal unemployment taxes.
As you can see there are many tax and financial issues that need to be addressed. Please contact us if you need any assistance or have any questions.
About Blackman & Sloop CPAs, P.A.:
Blackman & Sloop is a full-service CPA firm headquartered in Chapel Hill, North Carolina and is actively involved in auditing, taxation, management consulting, financial planning, and related services. The firm directs a large part of its services toward providing management with advice on budgeting, forecasts, projections, financing decisions, financial analysis, and tax developments. The firm also performs review and compilation services and prepares not-for-profit, corporate, individual, estate, retirement plan, and trust tax returns as well as technology consulting services regarding installation and training on QuickBooks. Blackman & Sloop provides services in Raleigh, Durham, Chapel Hill, RTP, Hillsborough, Pittsboro, Charlotte, and the rest of North Carolina. To find out more please visit http://www.blackmansloop.com
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