My 9 pound 11 ounce tax deduction

So you became a new, second, third+ parent in 2013?  Congratulations!  We welcomed our first child in April at a healthy 9 pounds and 11 ounces, and sometimes late at night or early in the morning between diaper changes and feedings, I would find myself wondering "just how much is this kid going to save me on my taxes?" It is a common misconception that the tax benefits of having a child outweigh the actual costs of raising said child.  After accounting for diapers, wipes, food, clothes, carseats, bouncers, bumbos and boppys, the costs of raising a child year over year are higher than the tax benefits received by adding a dependent to your tax return.  But, there are tax benefits to take advantage of if you have become a new parent in 2013.

Personal exemptions

The personal exemption is an automatic exemption for everyone on their Form 1040 individual income tax return.  The personal exemption amount is $3,900 (for 2013) per qualifying individual.  A qualifying individual is you, your spouse (if filing a joint return), and each dependent you list on page 1 of your 1040.  For example, if you are married and filing jointly and have 1 dependent child, your personal exemption for 2013 is $11,700 ($3,900 x 3).  Personal exemptions are deducted from adjusted gross income (AGI) to arrive at taxable income on the 1040, meaning that the personal exemption is not a reduction in tax, but is a reduction in the income that determines how much tax you pay.  However, if you have a high income, you might not get full benefit of your personal exemptions due to the personal exemption limitations brought back by Congress beginning in 2013.

Child tax credit

The child tax credit is a potential credit of up to $1,000 per qualifying child.  Notice that this is a credit instead of a deduction, which means that it directly reduces tax instead of reducing income.  To be a qualifying child, the child must:

• be your son, daughter, foster child, brother, sister, stepchild, grandchild, niece, or nephew
• be under the age of 17 at the end of 2013
• not have provided half of their own support during 2013
• have lived with you for at least half of 2013
• be claimed as a dependent on your return
• the child cannot file a joint return for 2013
• be a US citizen, US national, or US resident alien

Married taxpayers with AGI of $110,000 or less and single taxpayers with AGI of $75,000 or less may claim the credit on Form 8812 and attach to their 1040.

Child and dependent care expenses

Taxpayers may be able to claim a credit related to expenses they paid during the year for dependent care.  Qualified expenses are for household services such as a nanny, or outside services such as daycare, that were provided so the taxpayer can work or look for work.  The taxpayer will need to have the name, address, and social security number or employer identification number of the care provider to claim the credit.  The credit can be claimed for dependent care expenses for each child under the age of 13.  The credit is up to 35% of expenses paid for care, and the credit is limited to $3,000 for one child or $6,000 for two or more.  However, there are stipulations.  If the taxpayer's employer paid the care provider directly on the taxpayer's behalf, the care was provided by the employer, or the expenses were paid by the taxpayer from pre-tax contributions to a flexible spending arrangement (FSA), then the credit will be limited.  The credit is claimed on Form 2441.

Children are a blessing, and thanks to the credits and deductions listed above, they can also provide some marginal tax benefits.

Am I a dependent?

Pop quiz: I am married and live with my wife and 2 children, ages 28 and 14, along with my elderly mother-in-law who has no income and my brother who has been unemployed for 2 years, draws $7,500/yr in unemployment yet never offers to pay for anything.  How many dependents can I claim on my Form 1040 individual income tax return?  The answer might surprise you. Determining the correct number of dependents to claim on a 1040 for most families is simple. For example, a married couple with two children under the age of 18 has two dependents (the two children).  But, in family situations like the one laid out above, the number of dependents is not so obvious.  Claiming the correct dependents is important to the taxpayer because it gives them the opportunity to take advantage of tax benefits tied to those dependents, such as personal exemptions, the child tax credit, the child and dependent care credit, education expense deductions and credits, and the earned income credit.  Claiming the correct dependents is also important to the IRS, because they will match the social security numbers listed on the 1040 to their system to make sure the dependency claim is valid.

So who qualifies as a dependent?  Let's start with children first.

Dependent children

To qualify as a dependent, the child must meet the following criteria:

• Must be your son, daughter, stepchild, foster child,  brother (biological, half, or step), sister (biological, half, or step), or a descendant of any of these (grandchild, niece, etc.).  Adopted children are always treated as your own children.
• Their age at the end of the tax year must be 1) under 19, 2) under 24 if a student, and 3) younger than you (and your spouse if filing a joint return). However if the child is permanently or totally disabled, their age does not matter.
•  The child must have lived with you for half of the tax year
• The child must not have provided more than half of their own financial support
• The child is not filing a joint return for the tax year

If the child meets these criteria for the tax year, they are a dependent child.  If the dependent child has to file their own tax return in the same year that they are claimed as a dependent, they cannot claim a personal exemption for themselves.

One note on this topic: mentioned above are brothers and sisters.  In the event that the taxpayer has a much younger sibling, and the taxpayer provides the siblings care (in the event of the death, disability, or absence of the parents), then it is possible for a sibling to be a dependent child.

Dependent relative

In some cases, a relative can qualify as a dependent on someone else's tax return.  To qualify as a dependent, the relative must meet the following criteria:

• The person cannot be a qualifying child or the qualifying child of another taxpayer (a child that meets the criteria in the section listed above)
• The person lived in the home for the entire year and is not a relative, or is a relative (brother, sister, father, mother, niece, nephew, uncle, aunt, or any of these as half, step, grand, or in-law)
• The person's gross income for the year must be less than $3,900 (because that is the amount of the personal exemption).
• The person does not provide more than half of their own support for the tax year.

Just like for children, if a dependent relative files their own tax return in the same year that they are claimed as a dependent, they cannot claim a personal exemption for themselves.

Now back to the example from the beginning.  The correct number of dependents is two.  Here's how:

The 14-year-old child is a dependent, but the 28-year-old is not, because they are over 24 and not a full-time student.

The mother-in-law is a dependent relative because she had no income and she did not provide over half of her own support.

The brother is not a dependent relative because the unemployment he draws makes his gross income above the threshold, even though he did not provide more than half of his own support.

In unique family situations, determining dependency exemptions can be complex.  Taxpayers should consult the IRS website or their tax professional for additional guidance.