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CHILD CARE OPTIONS There are actually two alternatives for taking advantage of tax breaks for working parents. For most working couples, however, one is far superior to the other. Most everyone is familiar with the CHILD CARE CREDIT, which provides a credit up to $1200 for most working couples on their federal income tax. Fewer people are aware of the DEPENDENT CARE BENEFIT, which is an exclusion only available through one's employer. The taxpayer may not receive full benefits from both options. A point of clarification here is the difference between a credit and and exclusion. A credit is simply a reduction in your tax bill. The credit is applied only after you have figured out what you owe the government. An exclusion on the other hand, is an amount of money which is never even considered in figuring your taxes. It is tax-free income. For most working couples, the maximum benefit of the CHILD CARE CREDIT amounts to 20% of the sum they spend for qualified day care, up to $6000 (for two children). Again, this credit is only as against the federal income tax return. California taxpayers have no equivalent credit. The DEPENDENT CARE BENEFIT (DCB), on the other hand, offers far greater benefits to middle and high income earners, as well as being applied against both the federal and California income tax returns. The trade-off is a somewhat greater burden in paperwork, since the taxpayer must jump through whatever hoops their employer requires for the reimbursement of qualified child care expenses. This program generally has limited availability; signing up is limited to open enrollment periods like other employee benefits. Other benefits flow from the DCB program as well, as can be seen by the following example. Two working police officers are married and have two children. Their combined income is $120,000. They spend $5000 on day care expenses for the two children. If they do not participate in an employer's DCB program, but rather pay their qualified provider expenses directly, they will be eligible for a 20% credit against a total of $6000 ($3000 for each child). This will result in a total savings of $1200, in the form of a credit applied against their federal tax bill, once the Form 2441 is completed and attached to the federal tax return.. But if one of these taxpayers enrolls in his or her employer's DCB program, the $5000 will be paid with tax-free dollars, once the taxpayers have satisfied the paperwork requirements of the employer. When the taxpayer's W-2 is issued, the taxpayer's wages will not show the $5000 in taxable income in box 1. Instead, the $5000 will appear in box 10, as DEPENDENT CARE BENEFITS. The taxpayers must still use a Form 2441 to show to whom the benefits were paid. The total tax benefits, however, will be substantially greater. First, $5000 of otherwise taxable wages will become non-taxable for both federal and state purposes. After ordinary deductions, these taxpayers will be in the 28% federal tax bracket and the 9.3% California tax bracket. Therefore, savings on income tax will be 37.3% (28% + 9.3%) of the excluded amount, $5000. This equals $1865 in savings, or $765 more than is available from the CHILD CARE CREDIT. But there is more. Normally, like all taxpayers, the parents would benefit from the CHILD TAX CREDIT (this is not the CHILD CARE CREDIT), which for tax year 2005 will be a credit of $1000 per eligible child. Because the taxpayers' income exceeds $110,000, their $2000 credit (for two children) will be "phased out." This is because the current administration considers this couple to be wealthy. Their $2000 credit will be reduced to only $1000. But because the couple has excluded $5000 in DEPENDENT CARE BENEFITS, their Adjusted Gross Income (AGI) has been lowered. This will reduce the "phase-out" from $1000 to $500. In other words, they keep an additional $500, in addition to the $1865 in saved income tax, for a total savings of $2115. This is $915 dollars more than the $1200 available with the CHILD CARE CREDIT. For an individual analysis of how these options may affect your taxes, call me at 800-259-3372 or Email me. |
