Having a new baby can not only change your sleep patterns, it can also change how you file your taxes.
Last year, almost three out of four Americans, 72%, received a tax refund, with the average amount being close to $3,000, according to a recent survey from TurboTax.
This year, tax filing season started on January 27, 2020 and runs through Wednesday, April 15, 2020 for most taxpayers. The IRS is expecting to receive over 150 million individual tax returns for the 2019 tax year, with the vast majority coming in before the April 15 deadline.
While you shouldn’t aim to get a return, that extra influx of money can be helpful, especially for new parents who are juggling all of the added expenses that come with having or adopting a baby.
Thankfully, the IRS has quite a few breaks for parents that could help put extra money back in your pocket. “Dependents are worth a lot of valuable tax deductions and credits,” Lisa Greene-Lewis, certified public accountant and tax expert at TurboTax, tells CNBC Make It.
Here’s a look at where parents could score some breaks and how to avoid some common, and potentially expensive, pitfalls when filing federal income taxes this year.
1. Make sure your child has social security number
“The most important thing to keep in mind when filing as a new parent is to make sure you have a proper tax ID number,” says Chris Cicalese, a CPA with New Jersey-based Alloy Silverstein Accountants and Advisors.
In layman’s terms: a Social Security number. Typically, new parents fill out a birth registration form at the hospital, which has a box you can check to request a Social Security number. But if your baby wasn’t born in a hospital, or you somehow didn’t get a Social Security number through the birth registration form, you’ll need to make time to visit the nearest Social Security Administration (SSA) branch and request a number in person.
You’ll need to fill out Form SS-5 and have documents to verify your child’s age, identity and citizenship status, such as a birth certificate, hospital birth record or other medical documents. One of these should ideally be your child’s birth certificate. You’ll need to bring a driver’s license or passport of your own as well.
2. Take advantage of the federal child tax credit
One of the biggest pitfalls new parents make is not claiming all the tax benefits that they’re entitled to, says Robert Tobey, a CPA based in New York with Grassi & Co.
Families can deduct up to $2,000 from their federal income taxes for each qualifying child under 17. These are credits, so if your tax bill is $10,000 and you qualify for the maximum credit, your bill goes down to $8,000. Plus, up to $1,400 of the child tax credit is refundable this year. Even if you don’t owe any money to the IRS, you can get that money back as a refund as long as you’ve earned at least $2,500 to qualify.
However, once a single taxpayer’s income reaches $200,000, or a couple’s income (filing married jointly) reaches $400,000, the credit “starts to phase out,” Tobey says. It’s still a good deal for most parents, though. “Tax credits are the best thing the tax law offers because credits reduce your tax liability dollar-for-dollar,” Tobey says.
There’s also a non-refundable $500 credit for other qualifying dependents who may not otherwise meet the requirements for the larger child tax credit. If you have children under 23 who are still living at home or if you are supporting grandchildren, you can claim the credit.
3. Don’t forget to deduct childcare
A “common mistake” that San Francisco-based CPA Larry Pon sees is that parents forget to claim child care expenses. “When you pay for someone to care for your child and utilize a daycare center, these expenses qualify for the dependent care credit,” he says.
Parents who use a daycare or child care service may be eligible for the federal Child and Dependent Care Tax Credit (CDCTC) of up to 35% of these out-of-pocket costs up to $3,000 for one child or up to $6,000 for two or more. Again, this is a tax credit and refundable up to $1,400, so if you don’t owe the IRS any money and you apply this credit, you’ll get up to $1,400 back.
The credit does have some limitations, Tobey says. It only applies to children under 13, or if you have older children with mental or physical disabilities who are unable to care for themselves. The percentage you can deduct ranges from 20% up to 35%, depending on your income level. The more you earn, the less you can deduct.
If you use child care, check with your employer to see if they offer a child care flexible spending account. Similar to a health FSA, these accounts allow you contribute money tax-free toward your child care expenses. For someone in the 28% federal tax bracket, this income reduction means saving $280 in federal taxes for every $1,000 spent on dependent care with an FSA, Tobey says.
You don’t need to itemize in order to take advantage of the child tax credit or the child and dependent care tax credit. “You can claim the standard deduction and still get the Dependent Care Credits,” says Pon.
4. Consider your filing status
How you classify yourself can affect how much you can deduct from your tax bill. The standard deduction for a single person in 2019 is $12,200, which is the amount of income that’s not subject to federal income tax. Basically, it’s the average break that the government gives right off the bat.
But if you’re a single parent, you can file as head of household, which has a bigger standard deduction of $18,350 for 2019 taxes. If you’re married and filing jointly, having a child won’t change your filing status.
5. Itemize medical expenses
“If you’ve had a baby, gather up your medical bills,” Greene-Lewis says. You can get a tax break on these expenses, but only if you itemize your return.
For those filing 2019 taxes, you can deduct the total out-of-pocket costs of qualified medical expenses for the year that exceed 7.5% of your adjusted gross income. That’s your total gross income minus any student loan payments or contributions to IRAs and HSAs you’ve made throughout the year.
Say you make $50,000 and your student loan payments and IRA contributions add up to $5,000 for the year. That means your adjusted gross income is $45,000. After insurance, the cost of having your baby came to about $6,800.
To figure out your deduction, multiply $45,000 by 0.075 (7.5%). That comes to $3,375, which means any money you’ve spent above that amount can be deducted. In this case, that would be $3,425.
6. Adoptions get credit too
For those who welcomed a new child to the family via adoption, there’s a credit for you as well. For the 2019 tax season, you can get a tax credit for all qualifying adoption expenses up to $14,080 per child, according to the IRS. Those expenses include reasonable adoption fees, court costs and travel expenses.
If you adopt a special needs child from within the U.S., you can claim the entire credit, even if your adoption costs were less than $14,080. Keep in mind that adopting a child of your spouse, however, doesn’t count toward the credit.
You don’t need to itemize in order to take advantage of the adoption credit either, Pon says.
7. Open a 529
Once you have a child, it’s generally a good idea to set up a 529 plan for college savings if you have room in your budget to do so. Pon suggests new parents consider adding $500 per month to the plan.
“You will be amazed at how much that account grows by the time your child goes to college,” he says. He opened one for his daughter and put away $500 a month, plus some extra contributions from grandparents over the years. “My daughter is now a junior in college and she has plenty of money in her 529 plan to cover her remaining expenses with enough left over if she wants to go to graduate school,” Pon says.
Not only does the money you put in a 529 plan grow tax-free, but some states offer tax breaks as well. Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania offer a tax deduction for those contributing to any 529 plan, including out-of-state plans, while about two dozen states offer tax breaks for residents contributing to their state-sponsored 529 plan, according to Blackrock.
8. Carefully consider if and how you hire a nanny
If you have an outside caregiver take care of your kids at home, you may need to pay the so-called “Nanny Tax.” Essentially, if you have a nanny, the IRS may view you as an employer, so you’ll need to file the appropriate paperwork and additional taxes.
“You may be subject to household employee taxes, where you would have to pay some of the employment taxes for them,” Greene-Lewis says. That includes Social Security, Medicare and unemployment.
This can also include adult babysitters, especially if they’re routinely watching your children every weekend for even a nominal amount, like $50. The nanny tax doesn’t apply if the babysitter is under 18 or if they’re a grandparent. You can also avoid this tax if you hire child care providers through an agency, since they will be responsible for paying the associated tax.
9. Update your W-4
Although changing your W-4 now won’t affect your 2019 taxes, it’s still worth taking a look for next year. A W-4 is a common form that you typically fill out when you start a new job. It allows you to select how much to withhold from your paycheck for taxes. You can claim allowances, including for kids, which will bring down the amount that’s withheld out of every paycheck.
“If your W-4 is not accurate, you could be giving the government too much money every paycheck,” Cicalese says. Keep a close eye on the size of your refund after the first year you have a child. “If you receive a significant refund, it may be time to adjust so that you take home more money each paycheck that you can utilize for raising a child.”
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