A new tax law takes
effect for 2021 that provides big handouts for families with children. The
child tax credit is going to $3,000 ($3,600 for those five and under), and half
of it will be coming in monthly checks! That is automatic. There is also a
significant increase in the child care tax credit. That is what I will
be discussing.
The Old Child Care Tax Credit
According to the
prior law, you got a 20% credit for the cost of care in preschool and day camp
for under age 13. The maximum costs considered were $3,000 for one child and $6,000
for two or more. You could therefore save a maximum of $1,200. ($6,000 x 20% = $1,200).
This credit was non-refundable. That means that if your tax liability was $500
and your tax credit was $1,000, your taxes went down to zero but you did not
get any money back. Therefore, you only saved a total of $500. The concept is
that daycare is a “work expense” to allow woman to go to work.
The New Law
1) The credit has
increased to 50% of your costs. 2) It is based on $8,000 for one child and $16,000
for two or more children. 3) It is fully refundable. 4) As before, both parents
must be working or be students. And 5) as before, it is for preschool and day
camp under age 13.
Note: To get the
full 50%, your income has to be under AGI of $125,000. As your income increases,
the percentage goes down. You could therefore be saving $8,000 on your taxes.
That is a lot of money!
What’s the Catch?
Now for the
sensitive part of the law: In order to claim this credit, you have to fill out
the name, address, and ID number (typically the social security number) of the
care provider. This rule has been on the books for many years. The purpose of
this requirement is as follows: The government suspects that child care
providers might not be reporting their income. Therefore, the government says
to the parent, if you want this tax credit, please tell us who got the money so
we can make sure that they are paying their taxes. Makes sense. But it does put the onus on care
providers to report their income.
Let’s deal with
this in two parts: preschool and day camp.
Preschool: First of all, preschool is defined as up
to two grade levels before first grade. In plain English, kindergarten (five-year-olds)
does not count. Stated differently, up to and including nursery counts. (Some
schools call kindergarten pre-one-A. The previous grade might then be called kindergarten,
but I assume it is considered nursery for tax purposes.) If your child goes to
a standard school, there are no issues. Simply claim the tuition and put down
the name of the school. You actually do not even need the school’s ID number
since it is a nonprofit.
Many people use home-based
day care, called playgroups. The provider will need to supply her social
security number in order for the parents to claim the credit. And since the tax
savings to the parents is so great, they are probably only going to use a day
care provider who supplies this information.
When playgroup morahs report their income, this is what
happens: On their profit, they will owe: social security tax of 14%, state tax
of 8%, and federal tax of 12% (or more, if they are in a higher tax bracket). This
can total 44%! Now the good news: Since this is a business, they can deduct
expenses and are only paying taxes on the profit. Clearly, calculating and
tallying expenses is critical.
Typical expenses
are: 1) school supplies, such as arts and crafts or classroom furniture; 2) cell
phone fees; 3) internet fees; 4) car expenses for driving for business; 5) cost
of a smart phone and laptop; 6) software purchases; and 7) most important of
all, tax preparation fees. You are using your car for business when you go to
the store to buy supplies or go to the bank to deposit checks. Furthermore, you
can claim home office expenses, and this is significant since the law allows
for a significant leniency for home office for day care. When you add up the
expenses, your profit decreases, and you only pay taxes on the profit. The teacher’s
income tax expense will be significantly less than the tax savings for the
parents.
Day camps and backyard camps: If your child is
going to a standard camp, such as those run by our schools, this is very
straightforward. You just enter the name of the school. What about our good old
back yard camps? This is a big question, and there is probably a half a million
dollars of tax savings on the table here in Baltimore alone.
The simple plan
would be the following: Let us assume that the ones running the camp are under
18. They could file a tax return and report this business with its revenue,
expenses, and profit. Since their income will probably be relatively low, they
will not owe federal or state taxes. The teen will owe only 14%. If 14% is too
high, there is plan B. Let’s lay out the steps:
1) The parents own
the camp, and the teen works for the parents.
2) The parents get
a federal ID number. If they want, they can get a business name from the state
and have an official business. Hence, I can form a business named Park Heights Summer
Camp.
3) When the child
works for the parents, there is no requirement to pay social security taxes.
4) The parents can
pay a salary to the children running the camp, and it is all tax free.
5) The parents can
also claim all the expenses listed above, including the home office expense, so
the parents will have no profit.
6) In the case of
playgroups, the owner’s children can be paid tax free if they are doing work
for the business.
Other Issues
The state of
Maryland also gives a credit so the total savings is easily 58%. However, I am
not sure if they are upping the limit to $16,000 as the feds did.
A disabled child
can be over age 12. An elderly parent claimed as a dependent would apparently be
eligible for this credit if they need care.
What if your child
turns 13 during camp? That’s a good question. Call me.
A nonworking parent
must be a student to qualify, and the definition of school is pretty relaxed.
No need for accreditation.
Conclusion
An important message to parents: You need to
address this now! When you file taxes in 2022, you will discover that you have
lost out on a big tax savings, and then it might be too late to fix things. If backyard camps do not address this, a large amount
of money will be lost. Think of this: Assuming that a summer camp run by Bais
Yaakov or TA charges $1,500 for the summer, and a backyard camp charges $700, it
turns out that the cost, after tax savings, of the official camp makes it cheaper
than the backyard camp!
If you have more questions,
please reach out so we can discuss.
Eli Pollock CPA can be reached at elipollock2@yahoo.com.
