How much money do you need to raise a child? According to an estimate from the U.S. Department of Agriculture, it will cost a middle-income couple roughly $245,000 to raise a child born in 2013 to the age of 18. This is up 1.8 percent from the prior year. Plus, the estimated average cost is much higher in certain parts of the country. For example, high-income families living in the urban Northeast are projected to spend almost $455,000 to raise a child for 18 years.
Beware of the Kiddie Tax
It's not all a bed of tax roses for families with children. Under the so-called "kiddie tax," the unearned income received by a dependent child under age 19 or a full-time student under age 24 is taxed at the top rate of the child's parents to the extent that it exceeds $2,000 in 2014. The kiddie tax threshold increases to $2,100 in 2015.
Generally, the kiddie tax is computed on Form 8615, Tax for Certain Children Who Have Unearned Income, and attached to a tax return filed for a child. Alternatively, parents may file Form 8814, Parents' Election to Report Child's Interest and Dividends, along with their own return.
These figures cover costs for housing, food, transportation, clothing, health care, education, childcare and miscellaneous expenses like cellphones and sports team fees -- but not college. That can easily add tens or hundreds of thousands of extra dollars to the tab.
The IRS offers some measure of tax relief through various provisions of the Internal Revenue Code. Here's a list of the top 10 federal tax breaks for parents.
You can generally claim a dependency exemption for a child under age 19 or a full-time student under age 24, if you provide more than half of the child's annual support. Each dependency exemption is $3,950 on 2014 returns, going up to $4,000 for 2015. You may lose at least part of the benefit of your exemptions if your adjusted gross income (AGI) is above a certain amount, however.
Child Tax Credit
Parents may be entitled to the child tax credit for each qualifying child under age 17 at the end of the year. The maximum credit for 2014 is $1,000 per child. (It remains the same in 2015.)
You may lose at least part of the benefit of your exemptions if your modified adjusted gross income (MAGI) is above a certain amount. If you receive less than the full amount of the credit, you may be eligible for the additional child tax credit.
Child and Dependent Care Credit
Another tax credit, not to be confused with the child tax credit, may be claimed if you pay someone to care for a child under the age of 13 allowing you (and your spouse, if married) to be gainfully employed. The child and dependent care credit is based on a sliding scale. For parents with an AGI of more than $43,000, it's equal to 20 percent of qualified expenses paid to a qualified caregiver to ensure the child's well-being and protection. The total expenses that you may use to calculate the credit should not be more than $3,000 for one qualifying child or $6,000 for two or more qualifying children.
Earned Income Tax Credit (EITC)
This credit is available to only certain lower-income families. On a 2014 return, the maximum EITC amount available is $3,305 for taxpayers filing jointly with one child ($3,359 for 2015); $5,460 or two children ($5,548 in 2015); and $6,143 for three or more children ($6,242 in 2015). You may be eligible for the EITC without a qualifying child, but the credit is higher for families with children. If you can claim the EITC on your federal income tax return, you may be able to take a similar credit on your state or local income tax return, where available.
If you adopt a child, you may be eligible for a special tax credit for qualifying expenses. On a 2014 return, the maximum adoption credit is equal to $13,190 of the qualified expenses incurred to adopt an eligible child ($13,400 in 2015). However, credit amounts are phased out for upper-income taxpayers based on MAGI.
Higher Education Credits
If you pay higher education costs for yourself or an immediate family member, including a child, you may qualify for either one of two education tax credits (but you can't claim both). The maximum American Opportunity Tax Credit is $2,500 per student while the maximum Lifetime Learning Credit is $2,000 per taxpayer. Both higher education credits are phased out for upper-income taxpayers based on MAGI.
The deduction for qualified tuition and fee expenses, which had expired after 2013, was just retroactively extended for 2014 by new legislation. It's on the laundry list of tax extenders Congress will address in 2015. Depending on your MAGI, the deduction on your 2014 return is either $4,000 or $2,000 before it's completely phased out. Note that you can't deduct tuition expenses if you claim one of the higher education credits.
Student Loan Interest
You may be able to deduct interest you paid on a qualified student loan up to a maximum of $2,500 for 2014. (The maximum deduction remains the same in 2015.) This "above the line" deduction can be claimed whether or not you itemize deductions on your tax return.
Self-Employed Health Insurance Deduction
If you're self-employed and pay for health insurance, you may be able to deduct premiums paid to cover your child, as well as yourself and your spouse, if married. This tax break, which was authorized by the Affordable Care Act, applies to children who are under age 27 at the end of the year, even if the child isn't your dependent.
Potential Lower Tax Rates
Last but not least, parents may benefit from shifting income-generating assets to children. As a result, income that is normally taxed to the parents in their high tax bracket is taxed to the children in their lower tax brackets. Of course, this means you must give up control over the assets. Also, remember that this strategy may be mitigated by the Kiddie Tax (see Beware of the Kiddie Tax, above).
For more information about any of the top 10 child-rearing tax breaks -- including phaseout limitations, detailed rules and exceptions -- contact your tax adviser.