CPA in Wilmington NC explains the Child and Dependent Care Credit

I’d rather have a credit during tax preparation than a deduction. Why? A tax credit directly reduces the amount of taxes I’ll pay. A dollar of credit reduces my tax liability, generally speaking, by a dollar. Sometimes even generating a tax refund beyond a zero tax liability. But a dollar of deduction just reduces my taxable income by a dollar, which might only mean reducing my taxes 25 cents or less.

The Child and Dependent Care Credit allows a tax credit on Form 1040 for folks who paid someone to care for their child. Here are some key aspects:

• Children have to be 12 years old or younger to qualify you for the credit.
• Other dependents, besides your child, may qualify you for the credit, too. Generally these “non-child” individuals must be physically or mentally unable to care for themselves. So there are multiple criteria to satisfy, as with most IRS issues.
• The qualifying child or dependent generally must live with you for over half the year. But there are exceptions.
• You must incur the qualifying child care expenses during work or while looking for work. So the child care can’t be just for your convenience or recreation.
• Your Form 1040 tax preparation has to show earned income. This doesn’t just mean from employment and reported on a W-2. Self employment from Schedule C qualifies, too. The IRS defines earned income, for this credit, precisely but differently and more broadly than you might expect. Don’t give up on the credit too soon.
• In 2010, limits on qualifying care fees paid are $3,000 for one child or up to $6,000 for two or more individuals. So a $6,000 max. But this can be deceiving – see below. In addition you can’t claim child care fees that were provided by your employer.
• The child care fees can’t be paid to your spouse or another of your children.
• You can’t be filing with Married Filing Separately status.
• Be aware if you paid someone to provide care at your home; you could be liable for the Nanny Tax. See our other posts on the Nanny Tax. 15.3%. Ouch!
• You must identify the individual or company you paid, including their Social Security or Employer Identification Number. There is Form W-10, Dependent Care Provider’s Identification and Certification. The IRS is great at cross-correlating information.
• File Form 2441, Child and Dependent Care Expenses, with Form 1040 to claim the Child and Dependent Care Credit.
• The actual credit maxes out at 35% of the qualifying child care fees paid, which remember, can’t be more then $6,000. And the percentage phases out as your Adjusted Gross Income increases.

If you’d like a free initial consult with a CPA in Wilmington NC, please call us at (910) 399-2705.

The IRS is obviously encouraging folks who have kids to work, and thus incur Income Tax liability. As taxpayers try imaginative ways to work around IRS intentions, the IRS defines qualifications more precisely. Of course the IRS wants positive PR, and rightfully so in this case. But sometimes folks get the idea that the credit is much higher than it actually is, probably because they focus on the qualifying child care fees paid. As always, adequate documentation is required.

We’re a CPA firm in Wilmington NC, but serve a larger geographical base. So if you like our attitude and friendly expertise in these posts, give us a call at (910) 399-2705 for an initial free consult. With E Mail, faxes, Skype and phone calls, you might be comfortable with less face to face contact our Wilmington clients receive.