Be Tax Savvy
BLUNDER #3: Passing up eligible tax breaks
Whom would you rather give your money to: yourself or Uncle Sam? If that's a no-brainer, make sure you take advantage of every tax benefit available to you. First, adjust your W-4 at work. Adding an exemption for each new child can put an extra $100 to $250 a month in your pocket, since less tax is taken out. True, if you don't increase exemptions, you'll get that money back as a refund in April. But having the extra cash now could help you stay out of debt while you juggle new expenses like life insurance and daycare.
Next, you need to understand two important federal tax credits: the Child Tax Credit and the Dependent Care Tax Credit. (Remember, tax credits are much more valuable than tax deductions: A $500 tax credit actually reduces your tax bill by $500, while a tax deduction for the same amount just lowers your taxable income).
When you claim a child as a dependent -- which you should do in almost all cases -- you qualify for the Child Tax Credit, worth up to $1,000. (Even if your baby is born December 31st, you're eligible for the whole amount.) Additionally, if you use childcare, you may also qualify for the Dependent Care Tax Credit, which can knock $600 to $2,100 off your tax bill. An important caveat: If your employer offers a Flexible Spending for Dependent Care reimbursement account, which lets you set aside up to $5,000 a year before taxes for childcare, you'll need to make a choice. You can't use a Flexible Spending account and still qualify for the full Child Care Tax Credit. (However, you may still qualify for a lesser tax credit; talk to a tax planner to be sure.)
So, which is the better deal? If your family earns $40,000 or less, it's better to skip the flexible spending account and take the whole tax credit. Higher-income families, however, will likely do better with the flexible spending account.