Paying a grandparent to care for children
With two-earner couples now the norm, who’s at home to take care of the baby? Sometimes, the ideal solution is to hire (and pay) Grandma. With so many people out of work, Grandma may be among them. She can probably use the money. Who better to give your children loving care?
But how do you handle paying Grandma? Is it a gift? Is she a household employee, needing a W-2 and full withholding? Are there any special provisions allowing you to skip some of the withholding? Is the income even taxable to her?
There are two ways that Grandma can care for your children. In her home — or yours. If she cares for them in her own home, she’s in business for herself. You need to issue her a Form 1099-MISC. Grandma reports the income and deducts her office-in-home expenses using the special Day Care Center rules (see IRS Publication 587). She even gets to use a special set of standard numbers to write off the cost of meals and snacks for the children — just in case she hasn’t been keeping track (also in IRS Publication 587).
Okay, that was easy. Now, what’s if she works in your home?
Actually, there’s a provision that allows you to pay her without deducting FICA and Medicare taxes. Since you can get away with that, you can also get away with not even preparing a W-2. But Grandma will still have to report that income. And it gets a bit confusing without that W-2. So, be kind. Put Grandma on the payroll so you have a paperwork trail, and so she gets a W-2. That way, Grandma won’t have to jump through complicated hoops when she files her own tax return.
Suppose you want to get some tax breaks for hiring Grandma — or for any child care expenses?
The flexible spending account at work allows you to set aside up to $5,000 for child care. That money comes right off the top of your paycheck without ever being taxed. You get that money back when you submit receipts for child-care payments to the administrator.
One taxpayer was distressed to learn that his child-care expenses did not qualify for this benefit — after he had set up the flexible spending plan deductions. Why?
In order to qualify for this benefit, you need to meet some standards.
First, you must make the payments to a child-care provider. You need to provide their name, address and Social Security number or Employer ID number. The EIN isn’t necessary if it’s an exempt organization like a religious organization, the YMCA, or other nonprofit. So far, Grandma qualifies.
Second, you need to be eligible to qualify under the child- and dependent-care credit rules. That means the child care is necessary so that you are freed up to work. Both parents must be working or disabled or full-time students in order to qualify for each month’s benefits. In other words, there must be either earned income, or the IRS equivalent. When you are a full-time student or disabled, the IRS provides an allowance of $250 per month, per child, for up to two children.
Say this taxpayer’s wife is a stay-at-home mom. She’s neither a student nor disabled. So…they don’t qualify for either the child- and dependent-care credit — or the flexible spending account.
The big problem for them will be — how will they get that $5,000 back? Once you set up the annual deductions, can you change them? If not, that wife will have to go work or become a full-time student in order to recover the $5,000 payroll withholding. Ouch!
Child- and Dependent-Care Credit
Speaking of the child- and dependent-care credit, you file to claim it on Form 2441. You’re allowed to use up to $3,000 worth of expenses for up to two children. The credit is a percentage of those expenses, ranging from 35% down to 20% as your income rises. However, since this is a nonrefundable credit, it’s generally never worth more than about $1,200.
Nonrefundable means the credit only reduces your tax liability. If your income and tax liability are low, say $600, and your credit is $1,050, you still only get to use $600 of it. The rest is wasted.
What if you have a flexible spending account (FSA) at work, or if your employer pays for your child care? You must deduct those amounts from your $3,000 or $6,000 allowance — and those reimbursements may wipe out your credit entirely.
But the flexible-spending account and having the employer pay for your child care are better deals anyway. Always opt for that if you qualify and those options are available.
Huh? Employer-paid child care?
This is one of the most overlooked credits available to the self-employed.
Yes, your employer may offer that to you as a tax-free benefit. This is a terrific idea for a company with many young workers with children. Heck, this is even a great idea for someone who is self-employed and only has his or her own children.
What’s the credit worth? A lot — both on a federal and state level.
First of all, the employer gets a deduction for the child-care benefits. Then, there’s a tax credit for the employer-provided child-care facility. Form 8882 provides for a credit worth 25% of the child-care expenses up to $150,000. Naturally, you must reduce your child-care deduction by the amount of the credit. (Note: Tax credits reduce your taxes dollar for dollar.)
There’s even an extra 10% credit available when you must pay a referral service to evaluate your child and determine the appropriate child-care provider.
Payments to Grandma are not likely to qualify for this benefit — unless Grandma gets licensed as a child-care provider. After all, your siblings might want to hire Grandma too. The employer may either set up its own child-care facility to get this credit — or pay someone who already has a licensed facility.
What now?
As an employee, it may be too late to take advantage of some of these benefits for this year — unless you start a new job. But as an employer, especially a self-employed business, you can still explore these options for 2013.
On the other hand, if your expenses in 2012 qualified for any of these benefits, including the Form 8882 credits, put your tax return on extension and do some research.
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