Tax Facts about Claiming Tax Benefits for Childcare Expenses

Article Highlights:

  • Credit For Childcare

  • Credit Percentage

  • Child Qualifications

  • Employment-Related Expense

  • Taxpayer Earnings Limits

  • Full-Time-Student or Disabled Spouse

  • Qualifying Care

  • Other Facts and Issues

  • Tactic for Maximizing Credit

Many parents who work or are actively looking for work must arrange for care of their children after the school day ends, on weekends when they get called in to work, and during school vacations. If you are in this situation, and your children requiring care are under 13 years of age (or any age if handicapped), you may qualify for a tax credit that can reduce your federal income taxes and help offset the cost of care for children. Don’t confuse this credit with the Child Tax Credit; they are two separate credits with different requirements. This article is about the Child and Dependent Care Credit.

Basic Facts about Claiming the Childcare Credit

The Child and Dependent Care Credit is available for expenses you incur that enable you to work or actively look for work. You must claim the qualifying child for whom you pay care expenses as your dependent to qualify to claim the credit, but there is an exception for divorced or separated parents (not discussed in this article).

The credit is the percentage of actual care expenses. It can be as high as 35% for lower income taxpayers but is never less than 20% for higher income taxpayers. The table illustrates credit percentages at various levels of adjusted gross income (AGI).

AGI
Over

But Not
Over

Applicable
Percent

AGI
Over

But Not
Over

Applicable
Percent

0

15,000

35

29,000

31,000

27

15,000

17,000

34

31,000

33,000

26

17,000

19,000

33

33,000

35,000

25

19,000

21,000

32

35,000

37,000

24

21,000

23,000

31

37,000

39,000

23

23,000

25,000

30

39,000

41,000

22

25,000

27,000

29

41,000

43,000

21

27,000

29,000

28

43,000

No Limit

20

For an expense to qualify for the credit, it must be needed for you and your spouse, if you are married, to work or be looking for work, and it must be for the care of your child, stepchild, foster child, brother, sister or stepsibling (or a descendant of any of these) who is under age 13, lives in your home for more than half the year and does not provide more than half of his or her own support for the year. Married couples must file jointly, and both spouses must work or be looking for work (or one spouse must be a full-time student or disabled) to claim the credit.

The qualifying expenses are limited to the income you or your spouse, if married, earn from work, using the figure for whoever earns less. However, under certain conditions, when one spouse has no actual earned income and that spouse is a full-time student or disabled, that spouse is considered to have a monthly income of $250 (if the couple has one qualifying child) or $500 (two or more qualifying children). This means the income limitation is essentially removed for a spouse who is a student or disabled.

The qualifying expenses can’t exceed $3,000 per year if you have one qualifying child, while the limit is $6,000 per year for two or more qualifying persons. This limit does not need to be divided equally. For example, if you have paid and incurred $2,500 of qualified expenses for the care of one child and $3,500 for the care of another child, you can use the total, $6,000, to figure the credit. The credit is computed as a percentage of your qualifying expenses from the table above—in most cases, 20%. If the expenses exceed your work earnings, use the earnings to figure the credit. Dependent care benefits received through your employer will also affect the computation of the credit and could result in no credit being allowed.

Example: Al and Janice both work, each with earned income more than $40,000 per year. Janice has a part-time job, and her work hours coincide with the school hours of their 11-year-old daughter, Susan. However, during the summer vacation period, they place Susan in a day camp program that costs $4,000. Since the expense limitation for one child is $3,000, their child credit would be $600 (20% of $3,000).

The credit reduces a taxpayer’s tax bill dollar for dollar. Thus, in the above example, Al and Janice pay $600 less in taxes by virtue of the credit. However, the credit can only offset tax, and any excess is not refundable. The credit cannot be used to reduce self-employment tax or certain other taxes.

Here are some other facts and issues about the tax credit:

  1. Day Camps – The costs of a day camp generally count as expenses toward the child and dependent care credit. A day camp or similar program may qualify even if the camp specializes in a particular activity, such as soccer or computers. The rule (see #4 below) that a dependent care center must comply with applicable state and local laws also applies to a day camp where more than six persons are cared for in return for a fee.

  2. Overnight Camp or Tutoring – No portion of the cost of an overnight camp or a tutoring program is a qualified expense.

  3. School Expenses – Only school expenses for a child below the level of kindergarten will qualify for the credit. But expenses paid for before- and after-school care of a child in kindergarten, or a higher grade are eligible, up until the child turns 13.

  4. Day Care Facility – The expenses paid to the day care center qualify. If the day care center cares for more than six persons, it must comply with applicable state and local laws.

  5. In-Home Care – If your childcare provider is a “sitter” at your home, the sitter is considered your employee, and you may need to pay payroll taxes and file payroll returns.

  6. Records Required – To claim the credit on your tax return, you will need to provide the care provider’s name, address, and tax ID number. No credit is allowed without that information, except the tax ID number is not needed if the provider is a tax-exempt organization such as a church or school. You may run across care providers who are reluctant to provide their ID numbers because they don’t plan on reporting their income and paying their taxes. Just remember, without the ID number, you cannot claim the credit. Be sure to obtain the required information before you pay the provider.

  7. ID Number Required - You must include the name and taxpayer identification number (generally, the social security number) of each child or other qualifying person for whom you paid care expenses.

  8. State Childcare Credit – Some states also allow a similar credit on the state income tax return. If your state is one of those, additional information, such as the care provider’s phone number, may be required.

  9. Disabled Spouse - This credit is also available if you are working and care for a spouse who is physically or mentally incapable of self-care.

  10. Ineligible Care Provider – You can’t include as eligible care expenses amounts you paid to a person that is your spouse, the parent of your qualifying individual if your qualifying individual is your child and under age 13, your child who is under the age of 19, or a dependent whom you or your spouse may claim on your return.

  11. Volunteer Work - If you do unpaid volunteer work or work for a nominal salary, amounts you pay to a childcare provider while you volunteer are not eligible expenses for the childcare credit.

Tactic for Maximizing the Childcare Credit When Both Spouses are Involved in an Unincorporated Business

When both spouses in a married couple are jointly involved in the operation of an unincorporated business (generally a Schedule C), it is common – but incorrect – for all that business’s income to be reported as just one spouse’s income, even when they both work in the business.

In such cases, the spouse not taking credit for his or her portion of the earned income loses out on the chance to accumulate his or her own eligibility for Social Security benefits. In addition, and as noted above, to claim a child care credit, both spouses on a joint return must have earned income (or imputed income if one of the spouses is a full-time student or is disabled), so unless the spouse not including a portion of the income from the joint business has another source of earned income, the couple will not be allowed a child care credit.

There are ways to remedy this situation, however. One option is to file a partnership return for the activity, in which case each spouse will receive a K-1 form that reports his or her share of the net profit. An approach that avoids the necessity of filing a partnership return, and that is probably less complicated, is a qualified joint-venture election, in which each spouse elects to file a separate Schedule C for his or her respective share of the business. This gives them both self-employed income for the purposes of the self-employment tax and for claiming the childcare credit.

A qualified joint venture refers to any joint venture involving the conduct of a trade or business if:

(1) The only members of the joint venture are husband and wife,
(2) Both spouses materially participate in the trade or business, and
(3) Both spouses elect to apply this rule.

Generally, to meet the material participation requirement, each spouse will have to participate in the activity for 500 hours or more during the tax year.

Note, however, that a business owned and operated by spouses through a limited liability company (LLC) does not qualify for the qualified joint venture election.

If the net income from the business exceeds the annual cap on income subject to the Social Security tax, the combined self-employment tax for the spouses with split Schedule Cs will exceed what a single spouse would have paid if he or she had filed a single Schedule C.

An additional benefit when filing split Schedule Cs is the opportunity for both spouses to participate in IRAs and self-employed retirement plans.

For more information about how the childcare credit may affect your circumstances, please call this office.

 

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