From experience, having children is more of a game-changer in your life than anything else. For this post, I’m just going to focus on the tax questions.
1. Should I rush out and change my withholding?
You or your spouse (not both) might be able to claim one more allowance. I would only change withholding if you know that you are withholding too much or too little – from a pro’s calculation, or from your tax refund. Often people have kids at a point in their lives that they have increases in income which may offset the tax benefits of children.
2. What does a dependent count as on your tax return?
In 2015, the exemption is $4k, so, your tax savings is $4k multiplied by your marginal (top) tax rate for federal and state. For most, that means a savings of about $1,000. HOWEVER – if your combined income is more than $300,000, the personal exemptions start to phase out.
3. Does my filing status change?
If you are married, no. If you are single, you now file Head of Household – which is much better. More on this in another post.
4. What about the child tax credit?
The child tax credit is separate from the exemption, and is worth $1k per child. It’s a credit, so you get this, dollar for dollar. However, the phaseout starts at $110k of adjusted gross income, and phases out quickly.
5. Can I write off expenses for my Nanny/preschool/sitter etc.?
Some, if both spouses are working, and need the care to work, go to school, or look for work. Your employer may have a $5000 pre-tax savings program for dependent care. Max this out first. You can claim a portion of the dependent care credit as well. More on this in the next post.
Lets return to our example of Tobias and Lindsay. After the birth of their daughter Mae, their $4k additional exemption will save them $1120 in taxes in the $28% bracket. Based on this, they could add one allowance. They will be ineligible for the child tax credit due to the income phaseout.
Children will increase the number of personal exemptions, make you eligible for the child tax credit, and potentially the dependent care credit. The personal exemptions and child tax credits do phase out though. Don’t change your withholding by much unless you are sure of the consequences.
I often get asked about the tax consequences of getting married. I hope this post answers a few of them. People often rush off to adjust their withholding allowances from Single-0 or 1 to Married 2 right after they get married. Don’t. This is often too much of a change, leading to clients owing tax. Instead, have your paychecks evaluated to determine how much your withholding should change, if at all. Or, you can stand pat and see if you need to adjust after a year or two.
Why do the withholding tables not work like they should? They were designed in another era, when it was less common for two spouses to work. If a wife quits her job right after getting married, then the tables make more sense.
Consider the case of a fictional couple, Tobias and Lindsay. Before getting married, Tobias was earning $100,000 as a therapist, and Lindsay was collecting a $100,000 a year from a family company. They did not own the home they lived in, so their tax situation was fairly simple. They would have each owed 18,500 in tax, before withholding, Or $37k combined. If they were married, they would owe 37,866 – for them, there’s an $866 marriage penalty! Something funny happens with the tax rates after you make 75k individually – below that, the married tables are exactly double the single tables, but after that, the tax rates move up faster for married individuals. Why? You can come to your own conclusions.
What’s worse is that Tobias and Lindsay both rushed out to change their withholding from Single -1 to Married – 2. At Single – 1, their withholding was 19,585 – they each were headed to a 1k refund. At married – 2, their withholding is all the way down to 13,303 each, 26,606 combined. Suddenly they owe over $10k in tax! If they left their withholding alone, they would have enough to cover the tax.
Moral of the story, don’t rush out to change your withholding. On newer W-4 forms, the single box will also say Married 2 incomes, and this makes sense.