The child and dependent care credit - who qualifies and how?
The Internal Revenue Service (IRS) is charged with the responsibility of enforcing the federal tax laws and, thereby, collecting revenues for the United States government. This task has not always been easy, as taxpayers often attempt to conceal and omit taxable income from their federal income tax returns. One of the more common omissions of taxable income is income received for providing child and dependent care services.
For example, relatives or close friends of parents of small children have often provided child care services in exchange for cash payments (which are difficult if not impossible to trace) which are never reported as income on the provider's federal income tax return. In addition, very seldom do the parents paying for such child care services file a Form 1099 with the IRS. Thus, the IRS does not have much opportunity to adequately pursue such unreported taxable income. This omission of income, estimated at $7 billion annually, has over the years cost the federal government a substantial amount of tax revenues. To minimize this form of tax evasion, Congress has recently implemented new measures to deal with this matter.
Requirements for Child
and Dependent Care Credit
Expenses incurred by a taxpayer for child or dependent care that enable the taxpayer to work or seek employment may entitle the taxpayer to a child and dependent care credit. It is not necessary that the taxpayer be employed. It is sufficient for the taxpayer to be seeking employment.
To qualify for the credit the taxpayer must maintain a household for a qualifying dependent. Maintaining a household generally means to provide more than 50% of the maintenance and upkeep of the home. The credit is allowed for taxpayers filing as single, head of household, surviving spouse or married filing jointly. The credit is not allowed for married taxpayers filing separate returns unless the other spouse did not live in the filing spouse's home for the last six months of the tax year.
Qualifying dependents for the credit include dependents of the taxpayer under the age of 13 or dependents or spouse of taxpayer who are physically or mentally disabled. The qualifying dependents who are physically or mentally disabled must regularly spend at least eight hours each day in the taxpayer's household.
Qualifying expenses for the credit include amounts paid by the taxpayer for household services and care for qualifying dependents. Expenses incurred in the taxpayer's home such as payments for a housekeeper are considered qualifying expenses. In addition, expenses incurred outside of the taxpayer's home such as payments to day care facilities or some other care facility are also considered qualifying expenses. Any expenses incurred for an overnight camp do not qualify for the credit. It is important that the expenses are incurred to enable the taxpayer to work or seek employment. Expenses incurred for other reasons (eg. to take a vacation) do not qualify for the credit.
The total qualifying expenses for a tax year may not exceed $2,400 for one qualifying dependent and $4,800 for two or more qualifying dependents. In addition, these maximums are further limited to the taxpayer's earned income for the tax year. For married taxpayers filing a joint return, the maximum amount of total qualifying expenses are limited to the earned income of the spouse with the smaller earned income for the tax year. Furthermore, for married taxpayers where one spouse is unemployed and either a full-time student or physically or mentally disabled, for purposes of determining the limit on the maximum total qualifying expenses, such non-working spouse is deemed to have an earned income of $200 per month for one qualifying dependent or $400 per month for two or more qualifying dependents for each month of such status. This provision enables married taxpayers with only one working spouse to qualify for the credit. The amount of income deemed earned by the non-working spouse has no bearing whatsoever on the taxpayers' taxable income.
The qualifying expenses may be paid to anyone except a dependent of the taxpayer or the taxpayer's spouse or a child of the taxpayer that is under the age of 19. Therefore, payments made to the mother or other relative or friend of the taxpayer qualify for the credit as long as the care providers are not dependents of the taxpayer.
To compute the child and dependent care credit, simply multiply the qualifying expenses (subject to the limitations as discussed above) by the appropriate credit rate. The credit rate is based on the taxpayer's adjusted gross income and ranges from a maximum of 30% to a minimum of 20%. The maximum credit rate applies to taxpayers with adjusted gross income of $10,000 or less and is reduced by 1% for each $2,000 (or a fraction thereof) of additional adjusted gross income in excess of $10,000. Once a taxpayer's adjusted gross income exceeds $28,000, the minimum credit rate of 20% is reached and maintained. The credit rate is as follows:
Table : Adjusted Gross
Income in Credit Excess of Rate $10,000 29% 12,000 28% 14,000 27% 16,000 26% 18,000 25% 20,000 24% 22,000 23% 24,000 22% 26,000 21% 28,000 20%
The maximum credit available is $720 ($2,400 x 30%) for one qualifying dependent and $1,440 ($4,800 x 30%) for two or more qualifying dependents.
Example 1: T, an employed mother of a five-year-old son pays her mother $2,100 per year to care for her child after school. T does not claim her mother as a dependent on her federal income tax return. T's adjusted gross income for the tax year was $23,000.
T's child and dependent care credit for the tax year is $483 ($2,100 x 23%).
Example 2: H and W, a married couple who file a joint return, have two dependent children under the age of 13. Both spouses worked during the tax year. H earned $35,000 and W earned $4,200 for a combined adjusted gross income of $39,200. H and W spent $5,600 during the tax year for care for their children while they worked.
H and W may claim a child and dependent care credit of $840 [$4,200 x 20% (the maximum amount of qualifying expenses is limited to the earned income of the spouse with the smaller earned income)].
The credit, which is a dollar for dollar reduction in the taxpayer's federal income tax liability, is claimed on Form 2441 - Credit for Child and Dependent Care Expenses.
Dependent Care Exclusion
Some employers, under a qualified dependent care assistance program, reimburse their employees for qualifying child and dependent care expenses or provide child and dependent care for the qualifying dependents of their employees. In this situation, the amount of the reimbursement or the value of the care provided is excluded from the gross income of the taxpayer provided the requirements for the child and dependent care credit as previously described are met.
The amount that is excluded from the gross income of the taxpayer is limited to the earned income of the taxpayer. For married taxpayers filing a joint return, the exclusion amount is limited to the earned income of the spouse with the smaller earned income for the tax year. However, in no event may the excluded amount exceed $5,000 ($2,500 for married filing separately). The exclusion amount cannot include any amounts reimbursed or provided by the employer for expenses paid for overnight camping. Any amount for child and dependent care services provided by the employer that exceeds the limit must be included in the taxpayer's gross income in the tax year the service is provided even if payment for the service is made by the employer in a later year.
The taxpayer may not take both an exclusion from income and a child and dependent care credit on the same amount. The qualifying child and dependent care expenses must be reduced dollar for dollar by the amount reimbursed by the employer as illustrated below.
Example: T paid $7,000 for child and dependent care expenses for her six-year-old son and four-year-old daughter. T was reimbursed $2,500 of this amount by her employer under a qualified dependent care assistance program. T's adjusted gross income for the tax year was $29,000.
T's maximum qualifying expenses for the tax year are $2,300 [$4,800 (maximum) - $2,500 reimbursement]. Thus, T's child and dependent care credit is $460 ($2,300 x 20%). The $2,500 reimbursement is excluded from T's gross income.
Changes in Child and
Dependent Care Credit
For tax years beginning January 1, 1989, taxpayers claiming the child and dependent care credit or excluding from their gross income the amount of the reimbursement from their employer for child and dependent care expenses or the value of the child and dependent care provided by their employers must report the name, address and taxpayer identification number (usually the Social Security number or employer identification number) of the child or dependent care provider. If the care provider is a tax-exempt organization, only the name and address of the organization is required. Form W - 10 has been prepared by the IRS to provide the taxpayer with the necessary information and signature from the child or dependent care provider. The form is designed to be an information gathering tool for the taxpayer and is not to be filed with the Internal Revenue Service. In lieu of Form W - 10, a taxpayer may use any other similar document to gather the necessary information.
Taxpayers who fail to provide this information on income tax returns face the risk of having their child and dependent care credit and any exclusion from their gross income for child or dependent care expenses reimbursed or provided by their employer disallowed. This loss can be substantial in view of an allowed maximum child and dependent care credit of $720 for one qualifying dependent and $1,440 for two or more qualifying dependents. In addition, taxpayers who are reimbursed by their employers for child and dependent care expenses or whose employers provide child and dependent care assistance for their employees may be required to report additional gross income up to a maximum of $5,000 ($2,500 for married filing separately).
Other changes made for the child and dependent care credit beginning January 1, 1989, include the reduction of the required age of qualifying dependents from under 15 to under the age of 13 and the requirement of a dollar for dollar reduction of the child and dependent care expenses limit for amounts reimbursed by the employer under a qualified dependent care assistance program and excluded from the taxpayer's gross income.
The new federal tax law requiring taxpayers to provide the name, address and identification number of child and dependent care providers will certainly create substantial confusion and concern for many care providers. This measure is designed to generate additional tax revenues for the federal government for the estimated $7 billion of child and dependent care income that goes unreported each year.
Child and dependent care providers who have not correctly reported their income could be required to pay the tax deficiencies for the unreported income of prior years as well as interest and a $50 fine. The law may make child and dependent care services more expensive and may force some providers out of the business.
The new law should not only be of concern to the child and dependent care providers, but should also be of great concern to the taxpayers who utilize such services. The taxpayer who fails to provide the name, address and identification number of the child and dependent care provider faces the possibility of having the credit or exclusion from gross income for reimbursed amounts or child and dependent care provided by the employer disallowed. This could result in substantial tax consequences to the taxpayer considering the maximum amounts of the credit and income exclusion. Therefore, it is very important that the taxpayer ensure the care provider will be willing to provide the necessary information.
The safest practice for the taxpayer would be to obtain the required information at the beginning of the tax year and before any payments have been made to the provider. The taxpayer should use the Internal Revenue Service Form W - 10 or a similar document to gather the necessary information, making sure the care provider signs and dates the document, and should keep the document for his or her records. Failure to take these steps may result in the loss of a valuable and significant tax credit.
Marvin J. Williams, MBA, JD, CPAN, is assistant professor of accounting at the University of Houston - Downtown.
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|Author:||Williams, Marvin J.|
|Publication:||The National Public Accountant|
|Date:||Dec 1, 1990|
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