I am a grandmother, and I want to help pay for the tuition for my grandchild’s day care and education at a nice day care facility. Then, my daughter and son-in-law can work without worry. They own their own business, and they both need to focus some quality time on the business, while maintaining my grandson as top priority. My toddler grandson will benefit from the education and interaction with the other children at this particular day care, but it is darn expensive. Should I give the money directly to my daughter or to the day care? Is there a tax advantage one way or another?
– Grandmother of the best grandchild ever…
You have asked a very important financial question, particularly given that your daughter owns a business with her husband. There are two possibilities that should be evaluated: (1) Should the business have a Dependent Care Flexible Spending Account? Or (2) Should your daughter simply use Form 2441 for the tax credit for day care? The CPA for the business should carefully evaluate the option that leaves the most dollars in the hands of your extended family, rather than the hands of the government.
Unfortunately, under the scenario you are describing, the tax benefits are not likely available to you, so the money should be given to your daughter directly, and she should pay the day care. This gift will be subject to the gift tax rules, which allow you to make an annual gift of $14,000 in 2014 and 2015 without consideration of other gift tax rules.
Now let’s discuss the two options:
Option One for Tax Savings is the Dependent Care Flexible Spending Account, which your daughter would have to create within her business. With the Dependent Care Flexible Spending Account created by your daughter’s business, your daughter can contribute $5000 (which is the limit for married filing jointly) to a Dependent Care Flexible Spending Account (FSA) of pre-tax income from her paycheck from the business. As an example of the savings, if your daughter is in the 28 percent federal bracket for income taxes, her family saves $2050 in taxes, when you add up federal, state, FICA, and Medicare taxes.
Option Two is IRS Tax Form 2441 for the Child and Dependent Care Credit. There are generally two qualifications for the tax credit under Form 2441:
- The dependent is a qualifying child under age 13, which your toddler grandson is; and
- the child is a member of the household taking the tax credit. The second qualification is the one that you, as the grandmother, cannot meet in this case, and thus it will be better to give the money to your daughter and let her pay the day care
A noncustodial parent may not treat the child as a “qualifying child” even if the noncustodial parent receives the dependency exemption.
In addition, as with most tax benefits, the child care tax credits are phased out for higher income individuals. It is this phase-out for higher income individuals that creates the necessity of really comparing the tax savings under Form 2441 to the tax savings under the Dependent Care Flexible Spending Account. In some cases, you may be able to use the FSA for the first $5000, and then apply for the Child and Dependent Care Tax Credit for amounts over that limit
For more information, you might read IRS Publication 503, Child and Dependent Care Expenses.
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This blog revised from a previous column published in the Rhino Times.