Link and Learn - Credit for Child and Dependent Care Expenses Flashcards
What is a Nonrefundable Credit?
A nonrefundable credit is a dollar-for-dollar reduction of the tax liability that can only reduce the tax liability to zero. The credit discussed in this lesson is a nonrefundable credit. Generally, nonrefundable credits are applied against federal tax in the order they are listed on Form 1040, page 2, in the Tax and Credits section.
What are the credits?
The child and dependent care credit is a nonrefundable credit that allows taxpayers to reduce their tax liability by a percentage of their child and dependent care expenses. The credit may be claimed by taxpayers who, in order to work or look for work, pay someone to care for their qualifying:
Dependent child under the age of 13
Spouse who is unable to care for him- or herself
Dependents who are unable to care for themselves
The credit can range from 20% to 35% of a taxpayer’s qualifying child or dependent care expenses. The percentage is based on the taxpayer’s earned income and adjusted gross income. The amount of the credit cannot be more than the amount of income tax on the return; that is, it can reduce an individual’s tax to $0, but it cannot result in a refund.
Reimbursement Accounts
Some taxpayers receive dependent care benefits from their employers, which may also be called “flexible spending accounts” or “reimbursement accounts.” Taxpayers may be able to exclude these benefits from their income. Employer-provided dependent care benefits appear on the taxpayer’s Form W-2, box 10.
Because the child and dependent care credit is a nonrefundable credit, only taxpayers with taxable income can claim the credit. However, all taxpayers who receive employer-provided dependent care benefits are required to complete Form 2441, Part III, to determine if they can exclude all or part of these benefits from their taxable income.
Determining Eligibility
Determine the taxpayer’s eligibility for the credit based on the information gathered from the intake and interview sheet, along with the Credit for Child & Dependent Care Expenses decision tree in the Volunteer Resource Guide, Nonrefundable Credits tab. Ask taxpayers if they paid for any type of dependent care, including care for a spouse or another dependent.
The decision tree covers the five eligibility tests the taxpayer must meet to qualify for the credit:
Qualifying person test
Earned income test
Work-related expense test
Joint return test
Provider identification test
Keep in mind that the taxpayer must pass all five tests to qualify for the credit.
Qualifying Person Test
To meet the qualifying person test, a taxpayer’s child and dependent care expenses must be for the care of at least one qualifying person. Refer to the Child and Dependent Care Credit Expenses Tip in the Volunteer Resource Guide, Nonrefundable Credits tab, for more information.
A qualifying person is a:
Spouses who were physically or mentally unable to care for themselves and lived with the taxpayer more than half the year.
Someone who was physically or mentally incapable of self-care whom the taxpayer claims as a dependent or for whom the taxpayer could claim a dependency exemption, except that:
The person had income greater than the current year exemption amount
The person filed a joint return
The taxpayer or spouse, if Married Filing Jointly, could be claimed as a dependent on someone else’s current year tax return
Child who was under the age of 13 when the care was provided. If the child is being claimed as a dependent by the noncustodial parent under the special rules for children of divorced and separated parents, only the custodial parent may treat the child as a qualifying person for this credit.
Earned Income Test
The next test is the earned income test. The taxpayer (and spouse if married) must have earned income during the year. Earned income includes: Wages Salaries Tips Other taxable employee compensation Net earnings from self-employment Strike benefits Disability pay reported as wages
Earned Income Test (continued)
A taxpayer’s spouse is treated as having earned income for any month he or she is:
A full-time student, or
Physically or mentally unable to care for himself or herself
In either case, the spouse’s income is considered to be $250 for each month if there is one qualifying person in the home, or $500 each month if there are two or more qualifying people.
If, in the same month, the taxpayer and spouse are either full-time students or unable to care for themselves, only one of them can be treated as having earned income in that month.
Work-Related Expense Test
The third test is the work-related expense test. Expenses are considered work-related only if both of the following are true:
The expenses allow the taxpayer (and spouse if married) to work or look for work, and
The expenses are for a qualifying person’s care, and to provide for that person’s well-being and protection
For married taxpayers, generally both must work or be looking for work. Taxpayers’ spouses are treated as working during any month the spouses were full-time students or were unable to take care of themselves.
Work-Related Expense Test (continued)
Married taxpayers usually must both work, or be looking for work, in order to claim the credit. Taxpayers’ spouses are treated as working during any month they are full-time students or are not capable of caring for themselves.
There is a limit on the amount of work-related expenses taxpayers can include in figuring the child and dependent care credit. The limit is:
$3,000 for expenses paid for one qualifying person, or
$6,000 for two or more qualifying persons
Work-Related Expense Test (continued)
The following expenses count as work-related:
Cost of care outside the home for dependents under 13; for example, preschool or home daycare, before- or after-school care for a child in kindergarten or higher grade
Cost of care for any other qualifying person; for example, dependent care
Household expenses that are at least partly for the well-being and protection of a qualifying person; for example, the services of a housekeeper or cook
Work-Related Expense Test (continued)
Taxpayers who pay someone to take care of their dependent or spouse in their home may be required to pay household employment taxes. See the Employment Taxes for Household Employers section in Publication 17 for more information.
Generally, if the household employee earned less than a certain amount for the tax year, and the taxpayer did not withhold any income tax, the taxpayer is not required to pay employment taxes or provide the employee with Form W-2. Refer taxpayers who did not pay employment taxes for their household employees, and are unsure about these requirements, to Publication 926, Household Employer’s Tax Guide, or to a professional tax preparer.
Work-Related Expense Test (continued)
Payments to relatives may qualify as work-related expenses if the taxpayer does not claim the relative as a dependent. Do not include amounts paid to:
A dependent for whom the taxpayer (or spouse if married) can claim an exemption, or
The taxpayer’s child who is under age 19 at the end of the year, even if the child is not the taxpayer’s dependent
A person who was the taxpayer’s spouse at any time during the year
The other parent of the taxpayer’s qualifying child who is under age 13
Joint Return Test
The next test is the joint return test. Generally, married couples who wish to take the credit for child and dependent care must file a joint return. However, taxpayers can be considered unmarried if they file a separate return and are:
Legally separated on the last day of the tax year, or
Living apart from their spouses for the last six months of the year and paid more than half of the cost of providing a home, which was also the main home of the qualifying person, for more than half the year
Provider Identification Test
Finally, the provider identification test requires that taxpayers provide the name, address, and Taxpayer Identification Number (TIN) of the person or organization who provided the care for the child or dependent.
If the care provider is an individual, the TIN is the social security number or individual taxpayer identification number. If the care provider is an organization, then it is the Employer Identification Number (EIN).
Taxpayers who are unable to provide this information or who have incorrect information may still be able to take the credit if they can show they used due diligence to obtain the correct information. Refer to the sections titled Due Diligence and Provider Refusal in the Child and Dependent Care chapter of Publication 17 for more information. Returns that do not include the provider information cannot be filed electronically.
Figuring the Credit
To determine the amount of the credit, multiply the work-related expenses (after applying the earned income and dollar limits) by a percentage. The percentage depends on the taxpayer’s adjusted gross income.
Use Form 2441, which is divided into three parts:
Part I is for general information about the care provider
Part II is where the credit for child and dependent care expenses is calculated
Part III is where employer-provided dependent care benefits are reported
All taxpayers complete Part I. Taxpayers who did not receive dependent care benefits from their employers also complete Part II. Taxpayers who did receive these benefits complete Part III first, then Part II
