New Regulations for Form 2441 Credit

IRS released final regulations dealing with the Dependent Care Credit. These regulations include some information we all know very well and some new information. Following is a short summary of some of the provisions in these regulations. In the following the phrase “employed” means “gainfully employed” and “in active search of gainful employment.” The examples are directly from the regulations. We’ve numbered the items just to help separate them.

1 – The purpose of the expense must be to enable the taxpayer to be employed. Work as a volunteer or for a nominal compensation is not gainful employment (Regulation §1.21- 1(c)(1)) (“Nominal compensation” is not defined in the regulations.)

2 – Expenses for a period in which the taxpayer is only employed for part of the period must be allocated to determine the amount applicable to the employment portion of the period. This allocation is done on a daily basis. A day on which the taxpayer works at least 1 hour is a day of work. (Regulation §1.21-1(c)(2)(iii))

However a taxpayer who is required to pay for dependent care on a period basis such as weekly or monthly that includes both days worked and days not worked, the taxpayer is not required to prorate.

A period in which the taxpayer is receiving severance pay or similar compensation but is not working or searching for work is a period during which the taxpayer is not “employed” for the credit.

3 – Expenses for expenses that includes an amount for household services or for other goods or services, a reasonable allocation must be made between qualifying expenses and nonqualifying expenses. Insignificant or minimal amounts for nonqualifying expenses do not need to be allocated. Amounts that are incidental to and inseparably a part of the care are eligible expenses.

Example: Pre-school provides lunch and snacks when caring for a taxpayer’s 3-year old child while the taxpayer is employed. Because these are inseparably part of the care they are eligible expenses.

Example: Child is in boarding school due to her parent being ordered to a combat zone. The expense for the school must be allocated between the education and the care.

4 – Expenses for nursery school, pre-school, or a similar program for children below the level of kindergarten are eligible for the credit if they are for a qualifying individual and employment related. (Regulation §1.21-1(d)(5))

5 – Expenses for day camps or similar programs are eligible without allocation for special services mentioned above in number 3 even if the day camp specializes in a particular activity. Example: 9-year old child is sent to a summer day camp that specializes in computer instruction and activities. The full cost of the summer day camp may be for care although it specializes in a particular activity such as computers.

6 – Transportation by a day care provider is for the care of the child. Transportation by someone other than the day care provider is not for the care of the child.

7 – Certain fees paid may be related to the care even if indirect such as application fees, agency fees, and deposits, if they are required in order to obtain the care. However forfeited deposits and other payments are not for the care of the child if care is not provided. (Regulation §1.21-1(d)(11))

Example: During 2005, taxpayer paid a fee to an agency to obtain the services of an au pair to care for the taxpayer’s children. The au pair began caring for the children during 2006. Since the care did not start in 2005, the agency fee is not for care in 2005. Since the fee was not paid in 2006, the agency fee is not an eligible expense for 2006.

8 – If two or more families occupy common living quarters, each is treated as maintaining a separate household for dependent care purposes. A taxpayer who provides over one-half of the cost of maintaining the separate household is “maintaining the household.” (Regulation §1.21-1(h)(4))

9 – The annual limitation of $3,000/$6,000 is not required to be prorated in the year a qualifying child ceases to be a qualifying child due to reaching age 13, although only expenses incurred prior to the child’s birth date are eligible for the credit.

10 – Earned income of the taxpayer and spouse are taken into account when calculating the credit. In the case of a taxpayer who marries during the year, the earned income of the spouse to whom the taxpayer is married at the end of the year is taken into account. In the case of a divorce, the earned income of the ex-spouse is not taken into account. (Regulation §1.21-2(b)(2))

These regulations are effective for taxable years beginning after they are published as Final Regulations (which has not happened as of our print date). However they can also be applied to taxable years for which the statute of limitations has not expired as of May 24, 2006.