Tax Deductions and the Timing of Babies’ Births

There has been a flurry of articles recently regarding the first-borns of 2008. Every article cites the fact that the baby being born on January 1st means the family will not be able to claim the child as a tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. and will also not receive the child tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. for taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. year 2007. For simplicity, there is no pro-rated system for exemptions or filing status under the federal income tax. For a family earning less than $100,000 who is in the 15% marginal tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. , a baby in 2007 would have saved the family about $1,500. While this may seem a lot, it may be disturbing for some to see the extent to which parents concern themselves with this issue in the delivery room. It has been the case for some doctors to induce birth prior to midnight on January 1 just so the family can get a bigger refund check in three months. (Most likely, there is also the issue of fraud where the doctor could merely backdate the birth.) Is this behavior optimal?

Assuming the parents care about their offspring to the same extent that they care about themselves, then one would expect them to act with more caution in disrupting a pregnancy for the mere purposes of a one-time income gain. On the cynical side, however, if they care about their offspring less than themselves, then some parents would be willing to engage in a relatively high degree of risk to the health of the child in order to obtain a bigger tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. check.

For more on this phenomenon, check out a New York Times article on the topic last year. There is also some empirical economic evidence on this as well.

A similar issue is scheduled to take place 23 months from now with the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. . Under current law, it will be nonexistent in 2010, but will come back in full force in 2011. This could possibly lead to some difficult decisions having to be made in December 2010 regarding the value of one’s living a few extra months or years relative to the financial gain to heirs of a zero estate tax bill.

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