Another popular tax break helps parents whose bundle of joy arrived via an adoption. Adoptive parents can get up to an $11,650 credit on their taxes to cover expenses. Like parenting, though, claiming the credit is not easy. The exact year you can claim your expenses depends on several factors, including when they were paid, when the adoption was finalized and even whether your new son or daughter is a U.S. citizen or resident.
Education expensesCollege costs are skyrocketing, prompting many parents to start saving as soon as the little one arrives. Uncle Sam offers several tax-favored ways to help pay for higher education.
With a Coverdell education savings account, a redesigned version of the old education IRA, parents (or grandparents or even just friends) can put away up to $2,000 per year (total, not apiece) for a youngster's schooling. While adults contribute to the savings plan, a child age 17 or younger is named as the account's beneficiary.
The contributions aren't tax-deductible, but they and their earnings can be withdrawn tax-free as long as they are used to pay eligible schooling costs. And while many of these accounts are opened expressly to pay university costs, Coverdell cash can be used for some pre-college expenses, including tuition, room and board, and books and computers for public, private or parochial primary schools.
Once Johnny or Julie is on campus, Uncle Sam offers a couple of education tax credits to help pay the costs.
The Hope credit can be used for expenses incurred during the first two years of post-secondary education. It can be worth up to $1,800 per student, per year. Graduate and professional-level programs are not eligible.
For additional school years, look to the Lifetime Learning credit, which could cut $2,000 off your tax bill. The credit can be used for undergraduate, graduate and professional degree courses for anyone (including yourself if you want to show your kids that the old parental unit can learn a few things, too!)
Credits usually are more tax beneficial than deductions, but that doesn't mean you should automatically discount the tuition and fees deduction. This tax break lets you subtract up to $4,000 of eligible schooling costs from your income.
The deduction's immediate attraction is that it doesn't require you to fill out Schedule A or meet any percentage-of-income minimum. You'll find the deduction right on your 1040 (line 34) or 1040A (line 19).
Plus, you can count undergraduate and graduate expenses for your kids even if they aren't full-time students.
Shifting rules on income shiftingOne former child-related opportunity to lower your tax bill, however, has been dramatically reduced. Previously, many parents shifted some of their higher-taxed investment income to their young children so that the earnings would be taxed at a lower bracket, for example, falling from a possible 35-percent rate to the youngsters' usually 15-percent bracket.
Known as the kiddie tax, the earnings of children 14 or older were taxed at the child's rate. In 2006, the age limit was increased. A year later, it was hiked again. For tax year 2008 and beyond, a young investor now must be 19 to take advantage of his or her own potentially lower tax rates. Even after the youth turns 19, the kiddie tax still applies to his or her investments if he or she is between ages 19 and 23 and a full-time student.
Under the tougher law, when children 18 or younger have holdings that paid up to $900 in investment income in 2008, that amount is tax-free and the next $900 is taxed at the child's rate. Any earnings above that are subject to the kiddie tax, meaning the IRS collects on them at the parent's rate. For 2009, the child's total tax-free limit increases to $1,900, with the first $950 not taxed and the next $950 taxed at the child's rate.
So if your child's earnings are large enough, they are, in essence, added to your taxable income amount. This extra money could push you into a higher tax bracket and could mean the loss (or at least reduced benefit) of some tax deductions and credits that are phased out as income grows.
You can, however, still count on your kids to help lower your tax bill a bit if you own your own business. In this case, by hiring your kids, your company gets a deduction and your child pays income taxes at the youth's lower rate.
Just remember, the job and wages must be reasonable. If you pay an excessive salary to your 16-year-old for a job he's not equipped to perform, an IRS examiner is likely to take a closer look. That scrutiny could quickly erase any tax savings you thought you had gained.
Find more tax-filing information and tips in Bankrate's Tax Guide.