Wednesday, October 1, 2008

ASK THE TAX PRO - CHILD CARE BENEFITS

Here is a question I recently received from a client -

Q. Are any tax advantages to me for signing up for dependent care benefits in 2009 for my son, who will be 14 in November 2008?

A. Here is how I read the tax law in this situation -

To qualify for a tax benefit for child and dependent care expenses, the expenses incurred must be for the care of a “qualifying person”. A qualifying person includes your qualifying child who is your dependent and who was under age 13 when the care was provided, or a person who was physically or mentally not able to care for himself or herself, lived with you for more than half the year, and was your dependent.

You may be able to exclude from taxable income amounts your employer paid directly to either you or your care provider for the care of your qualifying person while you work.

When completing Part III of the Form 2441 you are asked to enter on Line 18 the “qualified expenses incurred in year XXXX for the care of the qualified person(s)”. Payments made for a child who is age 13 or older (and not disabled) when the care was provided are not qualified expenses for the care of a qualified person, as the child is not a “qualified person” due to the age.

Therefore the amount that would be entered on Line 18 would be “0” – and “0” of dependent care benefits would be excluded from taxable income. Any dependent care benefits paid through an employer plan would be includible in taxable wages.

The only way that a dependent child age 13 or older would qualify for a tax benefit from dependent care expenses is if the child was physically or mentally not able to care for himself or herself.

I would expect that the employer Dependent Care Benefit plan would be written such that it would not provide benefits for a dependent who would not qualify for the tax credit.

For more information check out IRS Publication 503.

Readers – as with any answer, advice or information I provide here at THE WANDERING TAX PRO, if you think I am wrong, or have made a error, or have a different interpretation of the tax law in question please let me know by posting a comment.

TTFN

3 comments:

Den said...

At the present time, the majority of young moms either have to work to make their living or want do build a career and need someone to take care of their children. As a rule, they hire nannies. However, it is so hard these days to find good nannies. Proper child care is a must but so hard to find. On this great site www.pissedconsumer.com you will find lots of complaints concerning the issue.

jenny said...

along the same question, is there a difference between claiming the expense at the end of the year vs. using the dependent daycare benefit?

Robert D Flach said...

Jenny-

I assume you are talking about contributing to a Dependent Care Flexible Spending Account (FSA) at work when you say “the dependent daycare benefit”.

The Credit for Child and Dependent Care Expenses is 20% (assuming your AGI is more than $43,000) of qualifying expenses up to $3,000 for one child and $6,000 for more than one child.

A contribution to a Dependent Care FSA is treated as “pre-tax” for federal income tax purposes. Therefore the tax benefit is calculated at your tax rate – which may be 25% or 28%. It may also be 15%. You can contribute up to $5,000 in a year, regardless of the number of dependent children.

If you spend $5,100 per year for the care of one dependent child your tax credit is $600 ($3,000 x 20% - again assuming an AGI of over $43,000). If you contribute $5,000 of your salary to a Dependent Care FSA and you are in the 25% tax bracket the tax benefit is $1,250. In the 15% bracket the tax benefit is $750. $3,000 in FSA contributions for a person in the 25% bracket will also save $750 in federal income tax.

If you have two qualifying children the maximum credit is $1,200. A $5,000 FSA in the 25% bracket is still better by $50.

There may also be an additional state tax benefit if the FSA contributions are also considered “pre-tax” for state income tax purposes.

Monies set aside in a Flexible Spending Account are considered “pre-tax” for both federal income tax and FICA (Social Security and Medicare) tax purposes. So there is also a FICA tax savings of up to $383 if your wages do not exceed the Social Security maximum wage base.

So you see it is generally “more better” to participate in an employer-sponsored Dependent Care FSA plan than to claim the credit.

The only caveat is that an FSA plan is “use it or lose it”. If you set aside $5,000 in the plan but only incur $3,000 in qualifying expenses you lose $2,000 in wages!

I hope I have been of help.

TWTP