Keeping up home test eliminated. Generally, you no longer need to pay over half the cost of keeping up a home for a qualifying person. However, the qualifying person must live with you for more than half of 2005. See Qualifying Person Test for more information.

Qualifying person. To be your qualifying person, a child generally must be your “qualifying child.” See Qualifying Person Test, later.

Katrina Emergency Tax Relief Act of 2005. This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, the special rule for a spouse who is a full-time student may still apply if he or she was unable to attend classes because of Hurricane Katrina. See Publication 4492.

Taxpayer identification number needed for each qualifying person. You must include on line 2 of Form 2441 or Schedule 2 (Form 1040A) the name and taxpayer identification number (generally the social security number) of each qualifying person. See Taxpayer identification number under Qualifying Person Test, later.

You may have to pay employment taxes. If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer who has to pay employment taxes. Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business. See Employment Taxes for Household Employers, later.

This chapter discusses the credit for child and dependent care expenses and covers the following topics.

You may be able to claim the credit if you pay someone to care for your dependent who is under age 13 or for your spouse or dependent who is not able to care for himself or herself. The credit can be up to 35% of your expenses. To qualify, you must pay these expenses so you can work or look for work.

To be able to claim the credit for child and dependent care expenses, you must file Form 1040 or Form 1040A, not Form 1040EZ, and meet all the following tests.

These tests are presented in Figure 32-A and are also explained in detail in this chapter.

Provider Identification Test

You must identify all persons or organizations that provide care for your child or dependent. Use Part I of Form 2441 or Schedule 2 (Form 1040A) to show the information.

Information needed.   To identify the care provider, you must give the provider's:

1. Name,

2. Address, and

3. Taxpayer identification number.

  If the care provider is an individual, the taxpayer identification number is his or her social security number or individual taxpayer identification number. If the care provider is an organization, then it is the employer identification number (EIN).

  You do not have to show the taxpayer identification number if the care provider is one of certain tax-exempt organizations (such as a church or school). In this case, enter “Tax-Exempt” in the space where the tax form calls for the number.

  If you cannot provide all of the information or if the information you provide is incorrect you must be able to show that you used due diligence (discussed later) in trying to furnish the necessary information.

Getting the information.   You can use Form W-10 to request the required information from the care provider. If you do not use Form W-10, you can get the information from:

1. A copy of the provider's social security card,

2. A copy of the provider's driver's license (in a state where the license includes the social security number),

3. A copy of the provider's completed Form W-4 if he or she is your household employee,

4. A copy of the statement furnished by your employer if the provider is your employer's dependent care plan, or

5. A letter or invoice from the provider if it shows the information.

  

You should keep this information with your tax records. Do not send Form W-10 (or other document containing this information) to the Internal Revenue Service.

Due diligence.   If the care provider information you give is incorrect or incomplete, your credit may not be allowed. However, if you can show that you used due diligence in trying to supply the information, you can still claim the credit.

  You can show due diligence by getting and keeping the provider's completed Form W-10 or one of the other sources of information listed earlier. Care providers can be penalized if they do not provide this information to you or if they provide incorrect information.

Provider refusal.   If the provider refuses to give you their identifying information, you should report whatever information you have (such as the name and address) on the form you use to claim the credit. Enter “See page 2” in the columns calling for the information you do not have. On the bottom of page 2, explain that you requested the information from the care provider, but the provider did not give you the information. This statement will show that you used due diligence in trying to furnish the necessary information.

Your credit is a percentage of your work-related expenses. Your expenses are subject to the earned income limit and the dollar limit. The percentage is based on your adjusted gross income.

Figuring Total Work-Related Expenses

To figure the credit for 2005 work-related expenses, count only those you paid by December 31, 2005.

Expenses prepaid in an earlier year.   If you pay for services before they are provided, you can count the prepaid expenses only in the year the care is received. Claim the expenses for the later year as if they were actually paid in that later year.

Expenses not paid until the following year.   Do not count 2004 expenses that you paid in 2005 as work-related expenses for 2005. You may be able to claim an additional credit for them on your 2005 return, but you must figure it separately. See Payments for previous year's expenses under Amount of Credit in Publication 503.

  

If you had expenses in 2005 that you did not pay until 2006, you cannot count them when figuring your 2005 credit. You may be able to claim a credit for them on your 2006 return.

Expenses reimbursed.   If a state social services agency pays you a nontaxable amount to reimburse you for some of your child and dependent care expenses, you cannot count the expenses that are reimbursed as work-related expenses.

Example.

You paid work-related expenses of $3,000. You are reimbursed $2,000 by a state social services agency. You can use only $1,000 to figure your credit.

Medical expenses.   Some expenses for the care of qualifying persons who are not able to care for themselves may qualify as work-related expenses and also as medical expenses. You can use them either way, but you cannot use the same expenses to claim both a credit and a medical expense deduction.

  If you use these expenses to figure the credit and they are more than the earned income limit or the dollar limit, discussed later, you can add the excess to your medical expenses. However, if you use your total expenses to figure your medical expense deduction, you cannot use any part of them to figure your credit.

  

Amounts excluded from your income under your employer's dependent care benefits plan cannot be used to claim a medical expense deduction.

Dependent Care Benefits

If you receive dependent care benefits, your dollar limit for purposes of the credit may be reduced. See Reduced Dollar Limit, later. But, even if you cannot take the credit, you may be able to take an exclusion or deduction for the dependent care benefits.

Dependent care benefits.   Dependent care benefits include:

1. Amounts your employer pays directly to either you or your care provider for the care of your qualifying person while you work, and

2. The fair market value of care in a day-care facility provided or sponsored by your employer.

Your salary may have been reduced to pay for these benefits. If you received benefits, they should be shown on your W-2 form. See Statement for employee, later.

  Benefits you received as a partner should be shown in box 13 of your Schedule K-1 (Form 1065) with code O. Enter the amount of these benefits on Form 2441, line 12.

Exclusion or deduction.   If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your income. Your employer can tell you whether your benefit plan qualifies.

  If you are self-employed and receive benefits from a qualified dependent care benefit plan, you are treated as both employer and employee. Therefore, you would not get an exclusion from wages but instead a deduction on Schedule C (Form 1040), line 14; Schedule E (Form 1040), line 18; or Schedule F (Form 1040), line 17.

  If your plan qualifies, you must complete Part III of either Form 2441 or Schedule 2 (Form 1040A) to claim the exclusion. You cannot use Form 1040EZ. You must use Form 2441 to claim the deduction.

  The amount you can exclude or deduct is limited to the smallest of:

1. The total amount of dependent care benefits you received during the year,

2. The total amount of qualified expenses you incurred during the year,

3. Your earned income,

4. Your spouse's earned income, or

5. $5,000 ($2,500 if married filing separately).

The definition of earned income for this purpose is not exactly the same as the definition for the credit. See the instructions for Form 2441 or Schedule 2 (Form 1040A).

Statement for employee.   Your employer must give you a Form W-2 (or similar statement) showing in box 10 the total amount of dependent care benefits provided to you during the year under a qualified plan. Your employer will also include any dependent care benefits over $5,000 in your wages shown on your Form W-2 in box 10.

Effect of exclusion.   If you exclude dependent care benefits from your income, the amount of the excluded benefits:

1. Is not included in your work-related expenses, and

2. Reduces the dollar limit, discussed later.

Earned Income Limit

The amount of work-related expenses you use to figure your credit cannot be more than:

1. Your earned income for the year if you are single at the end of the year, or

2. The smaller of your or your spouse's earned income for the year if you are married at the end of the year.

Earned income is defined under Earned Income Test, earlier.

For purposes of item (2), use your spouse's earned income for the entire year, even if you were married for only part of the year.

Separated spouse.   If you are legally separated or married and living apart from your spouse (as described under Joint Return Test, earlier), you are not considered married for purposes of the earned income limit. Use only your income in figuring the earned income limit.

Surviving spouse.   If your spouse died during the year and you file a joint return as a surviving spouse, you are not considered married for purposes of the earned income limit. Use only your income in figuring the earned income limit.

Community property laws.   You should disregard community property laws when you figure earned income for this credit.

Student-spouse or spouse not able to care for self.   Your spouse who is either a full-time student or not able to care for himself or herself is treated as having earned income. His or her earned income for each month is considered to be at least $250 if there is one qualifying person in your home, or at least $500 if there are two or more.

Spouse works.   If your spouse works during that month, use the higher of $250 (or $500) or his or her actual earned income for that month.

Spouse qualifies for part of month.    If your spouse is a full-time student or not able to care for himself or herself for only part of a month, the full $250 (or $500) still applies for that month.

Both spouses qualify.   If, in the same month, both you and your spouse are either full-time students or not able to care for yourselves, only one spouse can be considered to have this earned income of $250 (or $500) for that month.

Dollar Limit

There is a dollar limit on the amount of your work-related expenses you can use to figure the credit. This limit is $3,000 for one qualifying person, or $6,000 for two or more qualifying persons.

If you paid work-related expenses for the care of two or more qualifying persons, the $6,000 limit does not need to be divided equally among them. For example, if your work-related expenses for the care of one qualifying person are $3,200 and your work-related expenses for another qualifying person are $2,800, you can use the total, $6,000, when figuring the credit.

Yearly limit.   The dollar limit is a yearly limit. The amount of the dollar limit remains the same no matter how long, during the year, you have a qualifying person in your household. Use the $3,000 limit if you paid work-related expenses for the care of one qualifying person at any time during the year. Use $6,000 if you paid work-related expenses for the care of more than one qualifying person at any time during the year.

Reduced Dollar Limit

If you received dependent care benefits that you exclude or deduct from your income, you must subtract that amount from the dollar limit that applies to you. Your reduced dollar limit is figured on lines 28 through 32 of Form 2441 or lines 22 through 26 of Schedule 2 (Form 1040A). See Dependent Care Benefits, earlier, for information on excluding or deducting these benefits.

Example.

George is a widower with one child and earns $24,000 a year. He pays work-related expenses of $2,900 for the care of his 4-year-old child and qualifies to claim the credit for child and dependent care expenses. His employer pays an additional $1,000 under a dependent care benefit plan. This $1,000 is excluded from George's income.

Although the dollar limit for his work-related expenses is $3,000 (one qualifying person), George figures his credit on only $2,000 of the $2,900 work-related expenses he paid. This is because his dollar limit is reduced as shown next.

	George's Reduced Dollar Limit
1)	Maximum allowable expenses for one qualifying person	$3,000
2)	Minus: Dependent care benefits George excludes from income	-1,000
3)	Reduced dollar limit on expenses George can use for the credit	$2,000

To claim the credit, you can file Form 1040 or Form 1040A. You cannot claim the credit on Form 1040EZ.

If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer. If you are a household employer, you will need an employer identification number (EIN) and you may have to pay employment taxes. If the individuals who work in your home are self-employed, you are not liable for any of the taxes discussed in this section. Self-employed persons who are in business for themselves are not household employees. Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business.

If you use a placement agency that exercises control over what work is done and how it will be done by a babysitter or companion who works in your home, that person is not your employee. This control could include providing rules of conduct and appearance and requiring regular reports. In this case, 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.

If you have a household employee you may be subject to:

Social security and Medicare taxes are generally withheld from the employee's pay and matched by the employer. Federal unemployment (FUTA) tax is paid by the employer only and provides for payments of unemployment compensation to workers who have lost their jobs. Federal income tax is withheld from the employee's total pay if the employee asks you to do so and you agree.

For more information on a household employer's tax responsibilities, see Publication 926 and Schedule H (Form 1040) and its instructions.

The following example shows how to figure the credit for child and dependent care expenses for two children when employer-provided dependent care benefits are involved. The filled-in Form 2441 is shown at the end of this chapter.