Paying taxes is painful… but reading about them shouldn’t be.
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It’s the return of Fix the Tax Code Friday!
Since there’s been some discussion on the blog lately about whether or not parents should receive tax “benefits” in the form of exemptions and credits, I thought I would make it the Fix the Tax Code Friday question:
Should parents be entitled to exemptions and credits to offset the additional costs of raising children? Or should having children be a tax-neutral event?
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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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Taxpayer asks:
My childcare provider says that she doesn’t know her TIN? but she has her state G.E. tax license number. She doesn’t want to give me her social security number, which is understandable, but I do want credit for this expense. What can I, or should I, do?
When I plugged in the number with H&R block it wouldn’t take it…but Turbo Tax did…but I’d rather file with H&R, because it’s cheaper.
Taxgirl says:
I hate that my cynical-meter went up – but it did.
My gut is that your childcare provider does not wish to give you her tax info because she may not be reporting all of the income. Just a hunch.
If you leave the TIN out, your credit could be disallowed unless you can show you used “due diligence” to get it. The best way to prove this is to ask your child care provider to complete a form W-10. You can download the form W-10 as a pdf here (note that it’s not in the list of forms on IRS website, I think that’s an oversight).
As a heads up, a childcare provider who refuses to furnish a TIN can be fined $50 for each instance. Clearly, if there’s a fine, the provider is likely to be angry at you. One of my friends had a provider who flat out told her that she would not allow my friend to claim the expenses on her taxes because she would not claim it on her taxes – that’s really unfair. If someone is willing to play those kind of games with you, why do you believe that he or she is looking out for the best interest of your child? This is why I highly recommend that you use someone who will comply and not make things difficult.
You can read more about child care expenses here.
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.
Have a question? Ask the taxgirl!
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In recent weeks, I’ve received a flurry of emails from parents asking about whether band uniforms, soccer cleats and other expenses related to children are deductible. I thought it might be useful to have a checklist of some child-related deductions that you may be overlooking.
1, Child tax credit. If your modified AGI (adjusted gross income) is $75,000 or less for a single person or head of household ($110,000 for married taxpayers) and you have a qualifying child, you may be eligible for the child tax credit of up to $1000.
2, Child care expenses. If you paid qualifying child care expenses, you may be entitled to a tax credit for those expenses. For more details about what constitutes qualifying child care expenses, see my prior post.
3, Hope credit for college expenses. You may be eligible for a tax credit for your dependents who are college students in their first two years of college, provided that you are responsible for paying those expenses. The credit is up to $1,650 on the first $2,200 of college tuition and fees and is available for students engaged in study at least half-time.
4, Lifetime Learning Credit. You may be eligible for a tax credit of up to $2,000 on the first $10,000 of college tuition and fees for your dependents, provided that you are responsible for paying those expenses. This credit is available for students who take at least one course; the students need not be engaged in study at least half-time.
5, Tuition and Fees Deduction. Expenses for tuition, registration fees, and other required fees for your dependents who attend eligible educational institution (for example, most colleges, universities and vocational schools) may qualify for the Tuition and Fees Deduction. The deduction is limited to $4,000 per year. Your modified AGI must be less than $80,000 for a single taxpayer or head of household and $160,000 for married taxpayers.
6, Adoption Credit. If you have out of pocket expenses relating to adopting a child, you may be eligible for a credit of up to $11,650 per eligible child. Out of pocket expenses include adoption fees, legal fees, court fees and travel expenses; you are not eligible to deduct expenses that are reimbursed to you from any organization.
7, Medical and Dental Expenses. If you paid medical or dental expenses for your dependents, you may be able to take a deduction for the expenses that exceed 7.5% of your AGI.
8, Investment Fees and Expenses. To the extent that you pay investment fees, custodial fees, trust administration fees, and other expenses for managing investments that produce taxable income that is reported on your income tax return, those expenses are deductible. This includes fees related to income reported on your income tax return for investments in the names of your dependents.
9, Charitable Donations. While tuition payments for private and parochial schools are not usually deductible, donations of goods and cash may be. In fact, most schools (private, public and parochial) have 501(c)(3) status – if you’re not sure, just ask. If you make a donation of cash and goods that would otherwise qualify for a deduction, and you do not receive a benefit in return, the value of that donation is tax deductible.
Of course, this is just a short list and the expenses and credits listed may be subject to phase outs, eligibility requirements and other limitations. If you’re not sure whether these expenses or credits apply to you, ask your tax professional!
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