Taxes and Life Transitions: Welcoming a New Family Member
One of life’s happiest transitions is welcoming a new family member. While you are getting adjusted to a new schedule and every other detail that comes with a new baby or child, it’s important to keep in mind that family expansion brings with it changes to your tax picture regardless if expansion is due to the birth of a new baby, adoption, or foster care.
First Things First: Your W-4
The first thing you should do is update your W-4 form. This is the form your employer uses to calculate the amount of federal income tax that is withheld from each paycheck. You now have another exemption to claim, and that lowers your tax liability as you will be adding a dependent. When you file for the tax year in which you added to your family, your exemptions increase. The personal exemption amount for tax year 2016 is $4,050 per exemption (depending on your adjusted gross income).
Depending on your situation and whether you itemize on your tax return, updating your W-4 may not be as easy as simply increasing the number of dependents you claim by one. If you claim other credits or income adjustments, you should take these into account when completing your W-4 form. Check out the IRS Withholding Calculator to help make the process a little easier.
Child Care Expenses
Babies and children come with lots of expenses. The majority of these expenses are not tax deductible; however, the cost of providing care while you work may entitle you to a tax credit. Because of the cost of child care, either parent may re-evaluate the feasibility of resuming employment. This credit can make the decision easier by reducing the economic strain of the cost of child care. Remember that this is a credit, not a deduction, so there is a dollar-for-dollar reduction to your overall tax liability.
Additionally, you can claim this credit regardless of income. While the credit is reduced at higher incomes, the Child and Dependent Care Credit does not entirely disappear at higher income thresholds as do many of the credits offered by the IRS. This is certainly a credit that you’ll want to take advantage of. The maximum credit is $3,000 for one qualifying child or individual or $6,000 for two or more qualifying dependents. You may not claim this credit, however, if your filing status is “married, filing separately.” According to the IRS, “The amount of the credit is a percentage of the amount of work-related expenses you paid to a care provider for the care of a qualifying individual. The percentage depends on your adjusted gross income.”
The percentage ranges from 20 to 35 percent of allowable expenses.
For children, a dependent qualifying child is one who is under age 13 when care is provided. (This credit is also available for older qualifying dependents in the case of physical or mental incapacity for self-care.) Additionally, your payments for child care cannot be made to someone you (or your spouse) can claim as a dependent. You will need to report identifying details for the caregiver or organization on your return. Use Form W-10 to request this information from your caregiver.
If you choose to use an in-home nanny for child care and other domestic support, you should withhold and pay Social Security and Medicare tax on the wages you pay. If you pay cash wages of $2,000 or more, you should withhold and pay those taxes. The taxes are currently 15.3 percent of cash wages. The employee’s share and your share (as the employer) are both 7.65 percent which combined equals the 15.3 percent.
You are not required to withhold federal income tax (but you may agree to do so); however, you may be responsible to pay federal unemployment tax. If so, this tax is covered by you and not withheld from your employee’s wages. You can learn more about “nanny tax” at the IRS site.
Adoption and Foster Care
Adopting is a wonderful way to open your heart and home to a child, but there are expenses involved with the process. The adoption tax credit is now a permanent part of the American Taxpayer Relief Bill. The credit is designed to help offset qualified adoption expenses including adoption and attorney fees, court costs, travel expenses, and other expenses involved in the legal adoption of a child.
For 2016, the adoption credit is $13,460 for those with a modified adjusted gross income (MAGI) of $201,920 or less. For those over that threshold but with a MAGI of less than $241,920, the tax credit is reduced. If your MAGI exceeds $241,920, you are not eligible for the credit.
This is a non-refundable credit, so it is limited to your tax liability for the year. In other words, this credit cannot drive your tax liability below zero, resulting in a refund to you. However, any credit that does exceed your tax liability for the year isn’t completely lost. You may carry the excess forward for up to five years. Learn more about the adoption credit at the IRS site.
If you provide care as a foster parent, there are also tax implications of which you should be aware. Foster children are typically not eligible for the same credits and deductions that your biological or adopted children are; however, there may be some tax breaks for you. First, to be considered, a foster child must be placed with you by a judgement, court order, or authorized placement agency. If this is not the case, you may not claim foster care tax benefits. That said, if you receive payments for providing care to a foster child that are paid by a child placement agency or state or local government, these payments are not considered taxable income. Additionally, you may also be able to deduct unreimbursed foster care expenses as a charitable donation if the placement agency is a recognized 501(c)3 organization. If not, those expenses may qualify as support, and the support you provide changes whether or not you can claim the foster child as a dependent. To learn more about claiming a foster child as a dependent, visit the IRS site.
As you can see, there is far greater tax implication when you add a child to your family than simply increasing your W-4 form by a single dependent, especially if you are adopting or providing foster care. It can be complicated, so feel free to contact us, and we can help you throughout the entire process.