Taxpayer asks: Hi Taxgirl,we had a baby last year, and for part of the year after I returned to work, she was watched in-home by a woman who occasionally watches another little boy. The woman is not licensed as a day care provider, but we did pay her a weekly amount, is this deductible under the child care deductions?
Taxgirl says: Congrats on the baby!
The quick answer to your question is yes… if you qualify. So long as it’s a qualifying child care expense, you can deduct the cost of child care while you work or look for work. The deduction is limited to care for your own children, qualifying as your dependents, under the age of 13.
If you have out of home childcare at a qualifying childcare center, the center must meet federal and state requirements and have a total enrollment of at least six children (I have no idea why six is the magic number). To claim the credit, you report the amount paid, together with the tax ID number of the child care center, on your tax return using a federal form 2441.
If you have home child care, the rules are significantly different. The IRS requires you to treat most home child care workers as household employees (among the exemptions are part-time babysitters under the age of 18). This means that the workers must be eligible to work in the US (so certain foreign students and others might not qualify) and that you may be responsible for payroll taxes (remember the Nanny-gate scandal in the 1990s).
The rules are tricky. Basically, if you pay someone to come to your home and care for your children and you make the rules (i.e. telling them when to come, what to do), you may be a household employer. If so, you will need to obtain an employer identification number (EIN) and pay employment taxes. Employment taxes include Social Security and Medicare taxes (totaling 7.65%) which are withheld from the employee’s pay and matched by the employer, meaning you pay 7.65% as well. Federal unemployment (FUTA) tax (6.2% on the first $7000 of pay) is also paid by the employer. Federal income tax may be withheld on behalf of the employee. You may also be responsible for state unemployment tax and other state and local taxes, depending on your state.
However, if you take your child to your babysitter’s house, it is likely that the babysitter is considered self-employed and therefore, not a household employee. If this is true, you are not liable for payroll taxes. Similarly, if you use an agency that controls the actions and hours of the babysitter (as opposed to your choosing a person from an agency that you then manage), you are not an employer and you do not have to pay employment taxes. But, if an agency merely gives you a list of sitters and you hire one from that list, the sitter may be your employee.
And what do you get for your trouble? A tax credit which can be fairly significant, depending on the amount that you paid and your income level. The tax credit is equal to a percentage of the expenses that you actually paid less any reimbursements from any program or social services agency. The credit starts at 35% of expenses if your adjusted gross income is less than $15,000 and phases out to 20% of expenses if your adjusted gross income is more than $43,000.
If you pay “under the table”, meaning that you don’t pay required federal withholding, you might feel like you’re saving a few dollars but you lose big at tax time since you can’t claim a deduction for child care expenses. Oh, and there’s the small matter of it being illegal.
This is such a complicated issue. If you have any concerns about whether your child care provider is an employee or an independent contractor, I strongly recommend that you contact a tax professional.
Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.