Small Business Taxes & Management

Special Report


Child and Dependent Care Credit

 

Small Business Taxes & ManagementTM--Copyright 2016, A/N Group, Inc.

 

 

Introduction

Tax law provides a credit for child and dependent care expenses. The credit can be as much as $1050 per child, maximum two children for low income taxpayers. The credit percentage drops sharply until it's down to 20% for taxpayers with an AGI of $43,000 or more. Thus, the credit for many taxpayers will be no more than $600 per child with a maximum of two qualifying children resulting in a maximum credit of $1,200.

While certainly not overly generous considering the cost of child care, it's a bonus for most taxpayers who would have to pay for day care regardless of any tax benefits. And summer camp expenses may qualify.

 

Qualifying Person

For most taxpayers the qualifying person will be a child. The credit is only allowed for a dependent child under 13 years of age. But that allows some wiggle room. For example, Susie stays at a neighbor who you pay when she comes home from school every day. Susie's birthday is June 20 when she'll be 13. But by May 17th you've already spent $3,000. You qualify for the maximum credit.

The age 13 requirement doesn't apply if the dependent is physically or mentally unable to take care of themselves. That could include a spouse, another person who was a dependent, or would have been a dependent except he or she received gross income of $4,000 or more or met certain filing requirements. The person must have lived with you for more than half the year. For example, your father, who has dementia, lives with you. Both you and your spouse work so during the day you pay an aide to stay with him.

A person is physically or mentally not able to care for themselves if the cannot dress, clean, or feed themselves. Persons who need constant attention to prevent them from injuring themselves or others are considered not able to care for themselves qualify.

If, as a result of divorce or legal separation, you cannot claim your child as a dependent, he or she is treated as a qualifying person if the child was under age 13 or was not physically or mentally able to care for himself or herself, received over half of his or her support from one or both parents, the child was in the custody of one or both parents for more than half the year, and you were the child's custodial parent. (You're the custodial parent if the child lived with you for the greater number of nights during the year. If there's a tie, the custodial parent is the one with the higher adjusted gross income.)

 

Earned Income and Work-Related Expenses Test

In order to qualify for the credit you must have earned income--that's wages, salaries, tips, net earnings from self-employment and other taxable compensation. A net loss from self-employment reduces your earned income. For example, you and your spouse have regular jobs where she earns $26,000 per year; you receive $30,000 from yours. Assuming no other sources, your joint earned income is $56,000. However, you're starting an auto restoration business which operates as a Schedule C that lost $60,000. Your joint net earned income is negative $4,000. You can't take the credit. Basically, if your earned income is less than $3,000 ($6,000 for two qualifying children) any credit will be limited.

Income such as pensions and annuities, workers' compensation, interest and dividends, unemployment compensation, nontaxable workfare payments, child support, and income of a nonresident alien that is not effectively connected with a U.S. trade or business is not earned income.

You can make an election to include nontaxable combat pay in earned income.

 

Qualifying Expenses

In order to qualify for the credit the expenses must be work-related. The expenses are considered work-related only if:

To be work-related, the expenses must allow you to work or look for work. If you're married, both you and your spouse must work or look for work. One spouse is considered working during any month he or she is a full-time student or is physically or mentally unable to care for him- or herself. The work can be either full time or part time, at a regular job or in your own business or partnership.

In order to qualify, the expenses must allow you to work or look for work. For an individual or couple who works a "normal" job, clearly that's during the day for a pre-school child or after school for a school-age child. The care can be in your home or at a day care center.

But the credit can also apply to less "normal" situations. For example, Sue is a hospital nurse working shifts. Fred is generally a stay-at-home dad working on his first novel. They sometimes hire a baby sitter for the day so he can do research. He has no income from the work, but on Saturdays he's a boat salesman at a local marina. Sue often works Saturdays. Expenses for a baby sitter when both of them work on Saturday qualify for the credit.

If you work part-time, you must figure your expenses for each day. If you pay for the care on a weekly, monthly, etc. that includes both days worked and not worked, you can include the expenses paid for days you did not work. If you work at least 1 hour it is considered a day of work. For example, the day care center has weekly and monthly rates, but you only work 4 days a week. The full weekly rate qualifies.

Shift work can also generate issues. For example, you work during the day. Your spouse works at night and sleeps during the day. You pay for care of your 5-year-old child during the hours when you are working and your spouse is sleeping. Your expenses are considered work-related.

Minor work absences do not have to be accounted for. For example, the babysitter is paid on a daily basis, but you're home sick three days and continue to use the babysitter during that time. No allocation is necessary. More than two weeks is generally no longer considered a temporary absence, however.

The expenses must be for the care of the qualifying person. That doesn't include amounts paid for food, lodging, clothing, education or entertainment. If those expenses are incidental to care, they don't have to be excluded from the cost of care. Expenses for nursery school, or other program below the level of kindergarten are expenses for care; expenses to attend kindergarten or a higher grade are not. Before- or after-school care are qualifying expenses, even for kindergarten and beyond. Summer school and tutoring programs are not for care.

Example 1--Sue is in the fourth grade. In order to work a babysitter comes to your home until you get home after work. The care is a qualifying expense.

Example 2--You send Sue to nursery school. In addition to care the school has reading lessons and other educational activities. The school also provides lunch for the children. The cost of the education and lunch is not broken out. The full tuition qualifies.

Example 3--You send Sue to summer camp. She comes home every evening. The cost of the camp includes transportation to and from. The full cost qualifies. That's true even if the camp specializes in a particular activity such as computers or soccer. The cost of transportation would not be a qualifying expense if you had to provide the transportation, for example, hiring a taxi.

Example 4--You send Fred to a an overnight camp. None of the expense qualifies.

The cost of a housekeeper may qualify. Part of the expense must be for the care of a qualifying individual and enable you to work. For example, expenses you pay for household services meet the work-related expense test if they are at least partly for the well-being and protection of a qualifying person. Household services include the services of a housekeeper, maid, or cook. That doesn't include the services of a chauffeur or gardener. Meals and lodging that you provide a housekeeper in your home qualify as work-related expenses. Lodging in a spare bedroom in your home doesn't qualify. The extra cost of a larger apartment for the housekeeper would. You do not have exclude incidental expenses, such as when the housekeeper spends 20 minutes during the day picking you up from the train station.

Taxes you pay on wages are a qualifying expense. Withheld taxes are part of the care-giver's wages.

Dependent care outside your home provided by a dependent care center qualifies only if the center complies with all state and local regulations that apply to these centers. A dependent care center is a place that provides care for more than six persons and receives a payment for doing so, even if the center is run as a nonprofit.

Amounts paid to a relative can be qualifying expenses if that individual is not your dependent. If the caregiver is your child, he or she cannot be under age 19 at the end of the year, even if he or she is not your dependent.

If a care provider takes a qualifying person to or from a place where care is provided, that transportation is for the care of the qualifying individual. If you pay the transportation cost for the care provider to come to your home, that expense is not for care. For example, Madison Day Care has a bus that picks up students. The cost is included in the tuition. The total tuition is a qualifying expense. Now assume you pay Quick-Taxi to take your son to the school. The cost doesn't qualify. Or, you pay Jennifer $10 to take a cab to and from your house to take care of your son. That cost doesn't qualify.

 

Other Points

Married, joint. Generally, married couples must file a joint return to take the credit. however, if you are legally separated or living apart from your spouse, you may be able to file a separate return and still take the credit. This can get tricky. There's an explanation in IRS Publication 503.

Provider Identification. You've got to provide the name, address, and taxpayer identification number (social security number for individual; employer identification number for organization) of the care provider. You'll also have to provide the amount paid to each provider. No identification number is needed for a school or church (on Form 2441 enter "Tax Exempt"). Most organizations will automatically provide the info, but if not, ask them to complete a Form W-10. You can do the same for individuals or you can ask them to show a copy of their social security card. If the information is not complete, the credit may be denied, unless you can show due diligence. You can do that by getting and keeping the provider's completed Form W-10. If the provider refuses to provide the information, you can attach a statement to your return. Clearly, not the best approach.

Year expenses paid. You can only claim credit for the expenses in the year paid. If you don't pay the expenses until the following year, you can only claim the credit in that year. For example, you incurred $3,000 of expenses for child care in 2016, but only paid the nursery school $2,000. You can only claim the credit on $2,000. You may be able to claim credit on the remaining $1,000 you pay in 2017, but that will just increase the credit claimed in 2017. Assuming you pay $3,000 in 2017 for 2017, the late paid $1,000 wouldn't provide a benefit.

Reimbursed expenses. You cannot claim a credit on any expenses reimbursed by a state social services agency.

Medical expenses. If an expense can qualify as a medical expense and a dependent care expense, you can use the expense either way, but not both. While it's likely claiming the credit will be more beneficial, you should work the numbers both ways.

Dependent care benefits. These are amounts paid directly by your employer, the fair market value of a daycare facility provided or sponsored by your employer, and pre-tax contributions you made under a flexible spending arrangement. You can only exclude these amounts from income if you paid qualified expenses. If you exclude these benefits from income, you can't use them to claim the credit.

Student. If you're a student, you're assumed to have earned income of at least $250 for that month ($500 for two or more qualifying individuals). This is another place where the rules can get tricky. Internet courses don't qualify. Get IRS Publication 503 for more information.

Volunteer work. Working as a volunteer doesn't qualify as work.

Computation and phaseout. The credit starts at 35% of qualifying expenses (AGI up to $15,000) and drops to 20% for AGI over $43,000. That means the credit for most taxpayers will be $600 for one qualifying child; $1,200 for two. While the computations aren't overly tricky, using software makes it much easier and the software will prevent missing a required item.

Final comment. While some expenses don't qualify, and there are a number of restrictions, it doesn't take much to accumulate $3,000 in qualifying expenses in most areas of the country. Unless it's a town sponsored program, summer day care can easily top that amount.

As with any deduction or credit claimed on your tax return, keep all documentation.

 


Copyright 2016 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536


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--Last Update 07/19/16