Is there a new baby in the house? That's good news in many ways, because the chip off the old block also will allow you to chip away at some of the income taxes you owe.
A growing family makes you eligible for a variety of tax savings. They include an additional exemption, credits such as the child tax credit and the child- and dependent-care credit. To a lesser degree of effectiveness, you can also reduce taxes by shifting income to a youngster.
Dependency exemptionThe primary child-related tax saving comes in the form of another personal exemption you can claim on your tax return. The personal exemption amount is generally adjusted each year for inflation and is subtracted from your income. The lower your income, the lower your tax bill.
While the added family member usually is a child, you could claim a parent or even an unrelated person as long as he or she meets all of the following five tax dependency rules:
Five tax dependency rules
- Relationship or member-of-household test
The person must be a relative or live in your household all year. There are exceptions for dependents who are born or die during the tax year.
- Gross income test
The dependent may not have more than the annual exemption amount in gross income. However, this doesn't apply to children who are under 19 at the end of the tax year or full-time students under the age of 24.
- Support test
The taxpayer must provide more than half of the person's support. Several relatives who support an individual must create a multiple support agreement, allowing one of them to claim the exemption, and this person must provide more than 10 percent of the individual's support. If the parents are divorced or separated, the custodial parent generally gets the exemption, regardless of who provides the support, unless the custodial parent gives up the exemption via a written agreement.
- Joint return test
Generally, the person can't file a joint tax return with someone else unless it is only to claim a refund of tax withheld.
- Citizen or resident test
The person must be either a U.S. citizen, resident alien or national, or a resident of Canada or Mexico.
So, if the newest addition to your household passes all of these tests, then you've got another exemption. Just be sure to provide the dependent's Social Security number.
Tax creditsIn addition to claiming the personal exemption, there are numerous tax credits that you may be eligible for when your family grows. The great thing about tax credits is that they reduce your tax liability on a dollar-for-dollar basis.
Bankrate's Tax Basics on credits discusses these breaks in more detail, but the ones you'll be most likely to qualify for once little Jimmy or Janie arrives are the child tax credit, the additional-child tax credit, and the child- and dependent-care credit.
Adoptive parents also may be able to claim a credit on their federal income tax return for qualified adoption expenses.
Income shiftingTaxpayers also may be able to save money by shifting income from parents to children who are in a lower tax bracket. Such tax-reduction strategies are accepted by the IRS -- within limits. Parents who try to shelter large amounts of income by putting an adult's investments in a child's name will confront " kiddie tax" restrictions.