Thursday, December 16, 2010
How much are those New Year's Eve babies worth?
The answer depends on your income--and possibly other factors as well, including the taxpayer's filing status (single, head of household, married filing jointly, married filing separately, qualifying widow), the type of income (earned vs. unearned), whether you lived with the child, and the child's relationship to you.
There is little rhyme nor reason in the graph above, which comes from a paper by Elaine Maag of the Urban Institute Brookings Tax Policy Center. She describes the graph as "a toddler's unevenly written W, with no clear pattern shining through." (Click on the image for a larger and higher res view.)
The graph above assumes the taxpayer is a single parent with two children under age 17, who are her "qualifying children" for the purposes of the dependency exemption, the child tax credit, the additional child tax credit, the earned income tax credit, and the head of household filing status.
As my students have been learning, babies before midnight on New Year's eve can qualify their parents for a whole year's worth of tax benefits. But those tax benefits turn into pumpkins if labor goes past the stroke of midnight.
So, let's say an unmarried taxpayer who supports herself and lives alone is pregnant with twins, has no other dependents, and has an income around $18,000 per year, entirely in the form of earned income, i.e., wages or self-employment income.
If those babies are born before midnight December 31, her federal tax refund might increase by over $8,000 compared to what it would be had they been born after midnight. If she lives in a state like New York, which has an additional (so called "piggyback") earned income tax credit, her combined total federal-state refund could easily be over $10,000.
By contrast, if her income is around $40,000, those two babies are only worth around $4,000 in federal refund. That figure climbs for a while, and then drops off again. What is not shown on the graph above is that, at very high incomes, the babies may be worth very little in tax savings, due to phaseouts and the alternative minimum tax.
Here is how Elaine Maag summarizes the major work-related credits that apply to taxpayers similar to many who use the services of our VITA site at Union College. You can click on the image for higher-res version, or--even better--find a full-size version in her article, Simplicity: Considerations in Designing a Unified Child Tax Credit is available here. The entire article is well worth reading and will be required reading for students in my tax policy class.
It gives a good overview of the system, though--of course, you should rely on your IRS Pub 4012 and Pub 17 for the actual details of the tax returns you will be preparing for real taxpayers.
It should also be noted that there are other important tax benefits associated with children not discussed above, in particular, the higher education tax credits and other tax benefits associated with education.
Bottom line: it is really important to get the details right when figuring out the rules for a qualifying child.