child and dependent care credit

I spent the better part of the day working on my personal taxes (I know, I know). We’re on an extension – we’re always on extension.

The thing about doing my own taxes is that it reminds me of all of the stupid tax rules out there – you know, the ones that were either not thought out well or were clearly the result of some pandering by somebody. It is also a constant reminder that women don’t make the rules…

You see, one of the credits that you may be able to claim on your personal income taxes is the Child and Dependent Care Credit. This is, ostensibly, a good thing. But it rarely works out as good as it sounds.

If you pay someone to watch your qualifying child or dependent (generally, a child under age 13) while you work or look for work, you can, in theory claim the Child and Dependent Care Credit. The credit is not a straightforward deduction – it is rather a percentage of the amount of expenses actually paid for care. The amount claimed can be up to 35% of your child care expenses, depending upon your income.

Sounds great, right? Not really. First things first. Full-time day care for a 2 year old child costs, on average, $611 per month – or just under $7,500 per year per child. In metropolitan areas, it tends to run closer to $1,000 per month – or more than $10,000 per year per child. (source: Runzheimer International)

As the mother of three children, this means that if I work full time outside of the home (which I used to do), I can expect to spend about $30,000 on child care. Let’s assume that I make $50,000 – higher than the median income in the US. My entire after tax salary will go towards paying for child care. My tax credit, however, is limited to $6,000 for child care expenses. That’s because, for 2007, the cap is $3,000 for one child or $6,000 for two or more children.

That math puts into perspective the argument of staying at home versus working a little bit more, no? It’s not always a simple calculation.

The amount that you can claim decreases as your wages increase. This is an interesting concept because, at least theoretically, higher wage earners tend to require more hours of child care than lower wage earners. In other words, if I am working at a Center City law firm – 60 hours per week to meet my billables – I will make more money, sure, but I will spend more because my child will require more hours of care. However, on my taxes, I will receive a smaller percentage benefit for child expenses.

How much smaller? For qualifying income of $40,000 or more, the credit is 20% of the amount of expenses actually paid up to the cap. Using $50,000, that means that I could claim up to the smaller of $10,000 (20% of $50,000) or $6,000 (the statutory cap) – in other words, $6,000 even though my expenses were closer to $30,000.

So, it sucks for higher wage earners on a purely tax/economic scale but it should work out well for lower wage earners, right? Nope. This credit gets you coming and going. There is a requirement that the income used to calculate the credit is the lowest income as between you and your spouse, not an aggregate. In most – but not all – cases, this means that you calculate the credit based on the woman’s income.

Let’s look at it from the other end. If you work part time, then, and earn, say $15,000, the maximum credit that you could claim for two or more children would be $5,250 (35% of $15,000 since the rate is higher for lower wage earners) – even though you still likely spent close to your entire wages on child care.

And if you freelance or own your own business? Potentially disastrous. Qualifying income must be from wages or salaries or net earnings from self-employment. That’s right, net. Whereas I get to include my gross income from wages, I must include my net income from my business.

And this is why I’m annoyed this tax year. I lost money on my business. Not a lot but enough to put me into the red. The result? A big fat 0 in the child and dependent care credit column despite the fact that I needed child care so that I could manage my business. It doesn’t exactly reward entrepreneurs, does it?

So, if those taxpayers who make a lot of money don’t benefit – and those who find it difficult to pay for child care don’t benefit – who exactly benefits from the child tax credit? Ironically, based on pure economics, it’s someone who doesn’t need the credit at all: a taxpayer who works for wages (ideally, issued a W-2) and whose spouse makes enough money to pay for child care out of his or her salary. Maximum economic benefit – and it makes no sense.

What kind of policy are we pushing here? The clear policy message that we’re sending – mostly for mothers – is “stay at home” unless you marry well. As far as I’m concerned, staying at home should be an option that parents discuss based on their own beliefs and circumstances – not a tax policy decision but I’d love to hear what you think.

(Image source: Chris Erb)

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