Your Kids Can Save You Thousands at Tax Time

Kids can cost a fortune, whether you're talking diapers or designer jeans. But when tax time rolls around, your progeny can save you hundreds or even thousands of dollars, as long as you know where to look for savings.

The federal tax code offers numerous deductions and credits for parents of dependent children. You may qualify for some or all of the following tax breaks:

The exemption: Parents of dependent children under age 19 (or dependent full-time students under age 24) can claim a $3,400 exemption per child. For a couple in the 25% tax bracket, that exemption could amount to a savings of $850.

The Child Tax Credit: Detailed in IRS Publication 972, the Child Tax Credit offers families that meet certain income requirements a $1,000 credit for each child under 17. Married couples who file taxes jointly are eligible for the full credit if they have income of less than $110,000, as are single filers who earn less than $75,000 and married couples filing separately with income less than $55,000. The credit is phased out above those income limits.

Bear in mind that a tax credit is far better than a tax deduction: A $1,000 credit reduces your taxes by a full $1,000, while a $1,000 deduction reduces the amount of income on which you pay tax by $1,000 (resulting in tax savings of between $250 and $350 for most taxpayers).

The Child and Dependent Care Credit: Working parents also can claim a credit for childcare expenses for dependent children under age 13. The credit can cover 20% to 35% of the cost of day care, summer camp, a nanny or nursery school, depending on income.

You can also claim this credit for a spouse or other dependent who is unable to care for himself or herself. Whether you claim the credit for a spouse or child, be sure to include the care provider's Social Security number or tax identification number on your tax return. If you file Form 1040, you claim the credit for child and dependent care expenses using Form 2441. Form 1040A filers claim it on Schedule 2.

Dependent Care Flexible Spending Accounts: Many companies allow employees to set aside up to $5,000 per child per year in pretax money for child care expenses. Parents use the accounts to pay for qualified care -- such as before-and after-school programs, a nanny or even summer camp -- and must use the funds by the end of the year (many employers offer a grace period through March 15 of the following year).

If you contribute to a dependent care FSA, you can't claim the $1,000 child care credit. However, if you know you'll spend at least a few thousand dollars on child care in a given year, the FSA is probably a better deal than the credit anyway.

For example, a couple in the 28% tax bracket who spends $5,000 on child care expenses can claim 20% of expenses under the Child and Dependent Care Credit, a savings of $1,000. If the same family deposits $5,000 in an FSA, they will save $1,400 by sheltering that $5,000 from taxes.

The Adoption Tax Credit: Adoptive parents can claim a tax credit of up to $11,650 for adoption-related expenses, such as travel, adoption fees and legal fees, less any employer reimbursement. You can claim this credit for expenses incurred before and during the year the adoption becomes final, and you may claim expenses paid in the year after the adoption in the following tax year.

The credit begins to phase out for families with adjusted gross income of $174,730 and disappears entirely at $214,730. Adoptive parents of special needs children may claim the full $11,650, even if they actually spend less. The rules governing the adoption credit are listed on Form 8839.

Next: Education-related tax breaks.