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VITA: 01/17/09 Lesson 23: Credit for Child and Dependent Care Expenses

VITA: 01/17/09 Lesson 23: Credit for Child and Dependent Care Expenses. Winter 2008 Kristina Shroyer. Lesson 23: Dependent Care Credit. Introduction Looking at Form 1040: So now we've got the taxpayer's Taxable Income (line 43) and Tax on line 44.

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VITA: 01/17/09 Lesson 23: Credit for Child and Dependent Care Expenses

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  1. VITA: 01/17/09Lesson 23: Credit for Child and Dependent Care Expenses Winter 2008 Kristina Shroyer

  2. Lesson 23: Dependent Care Credit • Introduction • Looking at Form 1040: • So now we've got the taxpayer's Taxable Income (line 43) and Tax on line 44. • The next part of this section of the tax return is the Credits. • This is Chapter 23 in your Publication 4491 and is on page 23-1. • A Credit reduces the tax of a taxpayer • There are two types of Credits • Nonrefundable Credits • These are credits that reduce the tax of the taxpayer but cannot reduce that tax below zero. • Basically what this means is the taxpayer cannot get a refund as the result of the credit • The Dependent Care Credit is a nonrefundable credit • Dependent Care Credit is another name for "Credit for Child and Dependent Care Expenses" and is the name I use • Refundable Credits • These credits can reduce the tax of the taxpayer below zero and cause the taxpayer to receive a refund • You'll see some of these credits later today • Forms Used to Calculate the Credit • If the taxpayer files a Form 1040 – Use form 2441 • If the taxpayer files a Form 1040A – Use Schedule 2 • Let's look at a Form 2441 (Publication 4491-W page 202-203)

  3. Lesson 23: Dependent Care Credit • General Information – What is the Dependent Care Credit? • Who can claim the credit? • The credit may be claimed by someone who in order to work or look for work pays someone to take care of their: • Dependent child/children under age 13 • Spouses or dependents who are unable to care for themselves • General information on the credit • It is based on a taxpayer's earned income and AGI • The credit is between 20% and 35% of the taxpayers qualified dependent care expenses • Note that while this percentage is reduced its never reduced below zero so if the taxpayer has no dependent care benefits (discussed in a second) their credit is not reduced to zero • It is a non-refundable credit • So only taxpayer's with taxable income will be able to claim the credit • Taxpayer's who receive dependent care benefits from their employers • Look at box 10 of the W-2 • Generally the amount in box 10 of the W-2 is not included in box 1 • This is where dependent care benefits taxpayers receive from their employers will be reported • Dependent care benefits may also be called flexible spending accounts or reimbursement accounts • How much of these benefits they exclude from income will affect their dependent care credit • They will have to add any non-excludible benefits to income • A situation like this could occur when the taxpayer received the dependent care benefits from their employer but didn't spend them all on qualified child care expenses • Part III of the form 2441 calculates this • Taxpayers may be able to exclude these benefits from their income • Even if a taxpayer has no taxable income, if the taxpayer has dependent care benefits (box 10 form W-2) they need to Complete Part III of Form 2441 if they file Form 1040 (or Schedule 2 of Form 1040A)

  4. Lesson 23: Dependent Care Credit • How to Determine if a Taxpayer is eligible for the Dependent Care Credit • Five Tests (page 23-2 – Publication 4491) • The taxpayer must meet all five of these tests to be eligible • We'll go through each test • Qualifying Person Test • Earned Income Test • Work-related Expense Test • Joint Return Test • Provider Identification Test • How to determine if the taxpayer meets the five tests? • Open Tab G of your Volunteer Resource Guide • Page G-2 has a question tree for determining if a taxpayer meets the five tests • Box 7 on the Green Intake/Interview sheet you have should be checked once you determine the taxpayer has a qualifying person or persons for the credit and paid eligible expenses

  5. Lesson 23: Dependent Care Credit • Test 1: Qualifying Person Test (page 23-2) • The taxpayer's dependent care expenses must be for one or more qualifying people • Look at Tab G in the Volunteer Resource Guide • Page G-1 has the information for determining if someone is a qualifying person • A qualifying person is any one of the following: • A person who care was provided for is the taxpayer's dependent AND under age 13 when the care was provided • IMPORTANT: Only the custodial parent can take the Dependent Care Credit • This is true even if the child is being claimed by the noncustodial parent • So the noncustodial parent could be claiming the child as a dependent (and taking the child tax credit as we'll see next) and the custodial parent taking the dependent care credit • This means the noncustodial parent can NOT take the dependent care credit • Dependents who were physically or mentally unable to care for themselves and for whom the taxpayer can claim a dependency exemption • OR if the taxpayer could claim the person as a dependent if it weren't for the $3500 Gross Income test or the Joint Return test (the person had $3500 or more of gross income or filed a joint return) • This person must have lived with the taxpayer for more than half the year • Spouses who were physically or mentally unable to care for themselves

  6. Lesson 23: Dependent Care Credit • Test 2: The Earned Income Test (page 23-3) • The taxpayer (AND spouse if married) must have earned income during the year • What is earned income? • See List on Page 23-3 • Also look at Tab H in the Volunteer Resource Guide • Page H-1, look in particular at what earned income does NOT include • The amount of earned income will determine what percentage is used to calculate the taxpayer's credit • What if the taxpayer's spouse is a full time student or unable to care for themselves? • In this case the taxpayer's spouse is treated as having earned income for any month the spouse is mentally and/or physically unable to care for themselves or a full time student • In this case, the spouse's income is considered to be: • $250 for each month there is a one qualifying person in the home • $500 for each month there are tow or more qualifying people in the home • A full time student is: • one enrolled and attending a school for the number of hours or classes the school considers full time • The spouse must be a full time student for some part of five months during the calendar year • If both spouses are full time students or unable to care for themselves in the same month only one can be considered to have the earned income described above

  7. Lesson 23: Dependent Care Credit • Test 3: The Work Related Expense Test (page 23-4 through 23-6) • Expenses are considered work related if BOTH of the following are true • The expenses allow the taxpayer (and spouse if married) to work or look for work (remember a spouse unable to care for themselves or who is a full time student is considered working) • The expenses are for a qualified person's care, and to provide for that person's well being and protection • Limit on the amount of work related Expenses that can be used to figure the credit • $3,000 for one qualifying person • $6,000 for two or more qualifying people • (We'll see these limits are reduced if the taxpayer received dependent care benefits – box 10 Form W-2) • Examples of Work Related Expenses (let's look at the list on page 23-5) • Add day care and nanny expense to bullet 3 • Note that pre-school is considered a work related expense • Examples of Expenses that are NOT work related (page 23-5) • Education expenses for kindergarten or a higher grade • Overnight camp expenses • Transportation from the home to the care location • Read Second Exercise on page 23-5

  8. Lesson 23: Dependent Care Credit • Test 3: The Work Related Expense Test (continued) • Taxes paid for Household Employees • These are considered a work related expense • Taxpayers should be able to provide a W-2 for the household employee showing the expenses and payroll tax returns if the employee earned $1600 or more for the tax year • If the household employee did not earn more than $1600 per year the taxpayer is not required to pay these taxes • Any taxpayer who did not pay taxes on their household employees and are unsure if they needed to should be referred to a professional tax preparer • Expenses paid to relatives • These may qualify as long as they were not paid to someone the taxpayer claims as a dependent • The taxpayer can NOT deduct expenses paid to relatives in these situations: • If the relative was a dependent who the taxpayer CAN claim an exemption for • If the relative is the taxpayer's child who is under age 19 at the end of the year even if that child is not the taxpayer's dependent

  9. Lesson 23: Dependent Care Credit • Test 4: The Joint Return Test (page 23-6) • General Rule:Married coupleswho wish to take the credit must file a joint return • Exception:Taxpayers can be considered unmarried if they file a separate return AND: • They are legally separated on the last day of the tax year OR • They live apart from their spouse for the last six months of the tax 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 of the year • A taxpayer who's spouse died during the year and has not remarried generally must file a joint return to claim the credit • Question:Can married taxpayers who file as MFS claim the Dependent Care Credit?

  10. Lesson 23: Dependent Care Credit • How to Determine the Amount of the Credit (page 23-8) • The Form 2441 is Used to Calculate the Amount of the Credit • The Credit is basically determined by multiplying the work related expenses by a certain percentage • The percentage is depends on the taxpayer's AGI • The form has 3 Parts (let's look at it) • Part I: General Information about the Care Provider • All taxpayers complete this • Part II: Where the calculation is done for the credit • This is completed by taxpayers who did not receive dependent care benefits from their employer (nothing in box 10 of W-2) • Part III: Where information is reported regarding taxpayers who received Dependent Care Benefits • Remember this is line 10 of their W-2 • We'll talk about this part more next • Taxpayer's who received these complete Part III of the form before Part II (they will have all three parts completed) • TaxWise will calculate the credit for you and fill out the form • All you will have to do is input the information on • the care provider (name, id number address), the qualifying people, the dependent care benefits, and the work related expenses for each qualifying person. • However you should ALWAYS check the completed worksheet and calculations

  11. Lesson 23: Dependent Care Credit • Employer Provided Dependent Care Benefits (page 23-9) • If an amount is in Box 10 of a taxpayer's W-2 • These dependent care expenses include: • Amounts the employer paid directly to the taxpayer or directly to the care provider • Dependent Care Expenses Exclusion from Income • The employee can exclude some or all the dependent care expenses reported in box 10 of this from income • The maximum exclusion is the smallest of: • The total dependent care benefits the taxpayer received (box 10) • The total qualified expenses incurred during the year • The taxpayer's earned income • The spouse's earned income • $5000 (or $2500 if MFS) • This amount (in Box 10) is generally not included in Box 1 Wages of the W-2 • This means when you reported the W-2 wages on line 7 of the tax return this amount was not included • If the employee is not allowed to deduct all of their dependent care expenses, the amounts that are non-excludable will get added to Wages on the Tax return and the word "DCB" will go on dotted line next to line 7 of the return (for Form 1040) • This is all calculated in Part III of Form 2441 • The good news is you don't have to worry about the calculation if you enter the information correctly in Tax Wise (more on this next)

  12. Lesson 23: Dependent Care Credit • Employer Provided Dependent Care Benefits (continued) • If the taxpayer excludes dependent care expenses from income they can still take the dependent care credit but some things change • If the taxpayer excludes dependent care expenses from income • The amount of the excluded benefits • Can NOT be included in the work related expenses of the taxpayer • Reduces the dollar limit on the work related expenses that can be used to figure the exclusion (discussed more in a minute) • The good news is you don't have to worry about the calculation if you enter the information correctly in Tax Wise (more on this next)

  13. Lesson 23: Dependent Care Credit • Limits that Apply to the Dependent Care Credit • Earned Income Limit • The amount of a taxpayer's expenses are limited by/to an earned income limit. • The amount of work-related expenses used to figure the credit can't be MORE than: • The taxpayer's earned income for the year or • If Married Filing Jointly, the smaller of the taxpayer's or spouse's earned income for the year • Dollar Limit • As we already mentioned there is a dollar limit on the amount of work related expenses that can be used to figure the credit • The dollar limit of work related expenses is $3,000 for one qualifying person and $6,000 for two or more qualifying people • If the taxpayer received dependent care benefits the amount of benefits excluded from income must be subtracted from the dollar limit (so the dollar limit is reduced) • See the example on the bottom of page 23-9 • Using TaxWise to compute the Dependent Care Credit • TaxWise does most of the computation for you • IF the taxpayer has dependent care benefits • Make sure and Complete Part III of Form 2441 before completing Part II in TaxWise • Common Errors on this Credit • Make sure all of the required provider information is entered (name, address, identification number) • Make sure Part III of the Form 2441 is filled out if the taxpayer had dependent care benefits (box 10 of the W-2) • Part IV of the Intake/Interview form – make sure box 7 is checked and any special notes are made regarding the credit for the quality reviewer

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