Saturday, January 31, 2009

Quantifying the Tax Benefit of Kids

I did my taxes yesterday. Let me tell you something...I think that the tax code is way too complicated. I'm a proponent of the Fair Tax, but I'm fully aware that it will never be implemented in my lifetime; we're too stuck in our ways to change any time soon.

How I learned about taxes last night was by experimenting with answers in TurboTax and seeing how it changed my tax liability. Prior to last night, I had tried reading the IRS documents, but that proved to be pretty painful and ineffective. Here's what I learned:

Taxable Income = Income - Deductions

Taxes Owed = (Tax Rate * Taxable Income) - Tax Credits

Standard Deduction: $10,900 (married filing jointly...though mortgage interest and tithing would put a lot of people over this amount)
Personal Exemptions: $14,000 ($3,500 per person * 4 people in household)

Tax Credits:
Child Tax Credit: $2,000 ($1,000 per child * 2 children)

Doing some quick math, we can quantify the cash benefit of each child:

Cash Benefit per Child = Marginal Tax Rate * $3,500 + $1,000

Assuming a marginal tax rate of 15%, the cash benefit per kid is $1,525 (0.15*$3,500 + $1,000). So, the gov't gave me $3,050 for having 2 kids. Thanks Uncle Sam.

Another way of viewing this $1,525 cash gift purely as deduction from taxable income (rather than the $3,500 deduction + $1,000 credit). $1,525/0.15 = $10,167. For each child you have, you're essentially reducing your taxable income by about $10k (based on today's allowances and tax rates).

Is my math right?

Basically, we got a pretty sizable rebate that I wasn't expecting at all because I didn't understand the US tax system very well. Now I have a lot better understanding of the numbers. Come Monday I'm going to change my W-4 allowances so that I don't end up getting a refund next year (because I'd rather have the money up front and be making interest on it rather than giving the gov't an interest free loan).

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