Under IRS rules, parents can get tax breaks when relatives provide child care

June 23, 1991|By Gene Yasuda | Gene Yasuda,Orlando Sentinel

ORLANDO, FLA. ULB — ORLANDO, Fla. -- With the start of their children's summer vacation, many working parents worry about finding high-quality day care and, nearly as important, how to pay forit.

One money-saving opportunity is often overlooked: the federal income tax break for care of children under age 13. Contrary to popular belief, sending a child to a day-care center isn't the only way to qualify.

In some cases, parents are eligible if they pay relatives to look after the children.

"I do think there is a misconception. . . . I didn't know until we had Elizabeth and looked into the matter," said Kathy Charlton of Winter Park, Fla., who was pleased to discover that she could qualify for a tax break by hiring her sister to care for her 1-year-old daughter.

According to Internal Revenue Service guidelines, parents can pay a relative and receive a tax break as long as the relative is not claimed asa dependent of the taxpayer on federal income tax forms. An exception is made for older brothers or sisters living at home; if the care provider is the taxpayer's child and is under age 19, the taxpayer is still eligible for the break.

"My sister lives with my parents and isn't a dependent of mine, so it worked out perfectly for us," said Ms. Charlton, 28, a high school teacher.

The amount of the tax break is calculated by applying the tax formula to a family's adjusted gross income. Adjusted gross income is all reportable money received minus certain deductions, such as alimony payments and contributions to individual retirement accounts.

A coupling earning $10,000 or less annually receives a tax credit of 30 percent of the amount spent for child care up to $2,400 for one child or up to $4,800 for two or more children. The tax credit diminishes gradually as a couple's income rises until it hits $28,000. A couple earning that amount or more can claim a 20 percent credit.

For example, if a couple's income is $42,767 and they spend $3,640 annually for child care for two children, their tax credit is 20 percent of $3,640, or $728.

"You can spend $10,000 or more, but the most you can apply toward the credit is $4,800," said Connie Nadrowski, a financial planner with Financial Freedom in Longwood, Fla.

"If you spend less than $4,800, that's all you can apply."

Unlike a tax deduction, which is subtracted from taxable income before a taxpayer calculates the amount owed, a tax credit is subtracted from the amount of taxes owed the government, said Beverly Paulk, a certified financial planner with Aegis Financial Advisors Inc. in Maitland, Fla.

For example, if a taxpayer earns $30,000 and has a deduction of $3,000, the person is required to pay taxes on $27,000. In comparison, if a taxpayer owes $3,000 in taxes and receives a credit of $200, he or she needs to pay only $2,800 to the government.

The tax credit is only for daytime care.

The IRS disallows tax credits for overnight camps, saying taxpayers who didn't really need child care were taking unfair advantage of the break.

"You can't even get partial credit," Ms. Nadrowski said. "People were sending their kids to expensive camps and then writing it off, so the IRS ruled against it."

To claim the tax credit, parents must provide the IRS with the name, address and Social Security number

of the care provider or the taxpayer identification number of the child-care institution.

The information is necessary, Ms. Paulk said, "because if the parents are using this as a write-off, then the child-care provider has to be reporting it as income."

She added, "The IRS needs the number to confirm this so it doesn't lose out."

Some families may be able to take advantage of other child-care savings.

Some employers offer a dependent-care assistance plan as part of "cafeteria" benefits packages -- flexible arrangements under which as much as $5,000 a year can be designated for child care.

Ms. Charlton -- who had been getting a tax-break by employing her sister to care for her daughter -- recently learned that her employer, Seminole County Schools, offers a dependent-care assistance plan.

"They take the money out of your paycheck before taxes and set it aside for you," Ms. Charlton said. After discovering that the dependent-care assistance plan would save her more money -- about $400 a year in taxes -- Ms. Charlton enrolled in the school's program and no longer claims the child-care credit.

IRS rules allow working parents to choose the child-care credit or dependence-care assistance plans, but not both.

Parents of children 13 or older can also find tax savings, financial planners say.

Teens with summer jobs, for example, can be claimed as dependents, regardless of how much they earn, as long as they are under age 19 at the end of the tax year, Ms. Nadrowski said. A child's income -- unless it is unearned income, such as an inheritance -- does not have to be included with other household earnings for tax purposes, she said.

For example, if a teen earns $2,000 and his or her parents earn a total of $50,000, the household's taxable income remains $50,000.

If a child earns more than $3,250 a year, he or she is required to file a federal income-tax return.

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