How Parents Can Save on Income Taxes
And save money for their kids in the process.
August 18, 2018 4 min read
From getting upsold on self-driving strollers to planning for your toddler’s inevitable trip to Stanford, parenting can get expensive. But having children also comes with countless joys, including books at bedtime, unconditional love—and tax benefits.
Here are some of the simplest tax benefits of having a child, which will help you save money and enjoy those bedtime stories that much more.
Child tax credit
One way parents can lower their tax bill is through the child tax credit. This credit lowers the amount of income that is subject to federal income tax.1 For example, if you make $100,000 a year but can claim a $5,000 tax credit, you only owe tax on $95,000, lowering your overall bill and saving you money. By taking a tax credit for children, most families will save hundreds of dollars every year.
If you need help figuring out what tax credits you can get for a child or who should claim a child on taxes, the IRS offers a handy interactive tool for determining whether your child qualifies.
Child care tax credit
Of all the sticker shock that comes with parenting, perhaps no expense throws a wrench into a new parent’s budget like the cost of child care. That’s why it’s important to know how child care affects taxes. The IRS offers most parents thousands of dollars in deductions for qualified child care expenses, which include everything from nannies to private preschools.2 That can save you a decent chunk of change on your tax bill each year.
A 529 savings account
One of the most rewarding aspects of parenting is providing the best possible education for your child. That makes saving for college one of a parent’s most important and challenging tasks.
The easiest way to save for college is by opening a savings account. But another option to consider is a 529 plan, also known as a “qualified tuition plan.”3 There are 2 types of 529s: prepaid tuition plans and college savings plans. Both offer a simple way to save for college. And both come with substantial tax benefits.
Prepaid tuition plans allow parents to buy credits at today’s tuition rates for future enrollment at participating schools. They can offer big savings, but with less flexibility. They typically can only be used at in-state colleges and universities.
College savings plans are more flexible. Offered by most states, they provide parents with a state-sponsored investment fund where money can be deposited and grow until needed. When that time comes, the money can be withdrawn and used to pay tuition at most colleges and universities nationwide.
A 529 offers tax savings on both ends.4 Many states offer income-tax deductions to parents who contribute to a 529, and all investments grow tax-free. When you withdraw funds to pay for tuition, books, room and board, you won’t pay taxes on those investment returns like you would if you were selling stock shares. It’s a win-win for you and your new college student.
Tuition tax breaks
Once your child makes it to college, the IRS offers even more breaks for parents paying those tuition bills. The most commonly used tax break is the American Opportunities Tax Credit, which offers thousands of dollars in tax credits per student. If you still claim your child as a dependent, and depending on your income level, the credit could help lower your income-tax bill in what can be some of the most expensive years of parenting.5
Saving on taxes: college and beyond
So you’ve played all these cards perfectly, and your child is now at Stanford—on a full ride. Don’t worry: There are plenty of ways to put these savings to work for your child while continuing to save on taxes.
The 529 account can be used for graduate school or another family member’s schooling. And if the savings really pile up, you can start a college savings account for your grandchildren, or simply gift money to your kids or grandkids each year. Starting in 2018, up to $15,000 can be gifted to children or grandchildren every year with no gift-tax penalty, creating a tax-free nest egg for your family’s next generation of savers.6
Yes, parenting is joyful, fun and expensive. But just like there are ways to stave off the sleepiness (sleep when the baby sleeps!), there are ways to save, too. You just have to know where to look.