A Conversation With TaxMama on Special Employer Credit

Tomika in North Carolina is at her wit’s end trying to get answers from the IRS about child-care credits or benefits. She asked TaxMama.

Dear TaxMama,

I have been on the phone with the IRS for 45 minutes and transferred to at least ten departments to get the answer to this question. Which to my dismay I still don't have an answer so I decided to go to the PRO.

I have an employer that wants to offer dependant care assistance to only ONE employee. The type of business is a daycare provider. The employer wants to offer an hourly wage plus $100 per week for childcare benefits to one employee.

Here’s what I am trying to find out:

1) Dependant Care Assistance Program: Does this have to be setup under a Cafeteria Plan to receive pre-tax benefits?
2) Does this have to be offered to all employees?
3) Does this have to be included as wages or does it qualify for the $5000 exclusion (Pub 15-B).
4) From a tax standpoint would the employee still be able to receive the child tax credit if she took the $5000 pre-tax exclusion?
5) Which option benefits the employer best and which option benefits the employee best?

I know this is a loaded question, but I don't want to do something and at the end of the year find out another option would have benefited the employee/employer best?

I would really appreciate your expertise. I really don't have another hour to give to the IRS.

Dear Tomika,

I hear your pain. Been there on hold, too. Too many times.

If I couldn't call my personal contacts at the IRS, I'd probably go prematurely gray waiting for answers. So, let's see if I can answer some of your questions, if not all.

You asked

1.Dependant Care Assistance Program: does this have to be setup under a Cafeteria Plan to receive pre-tax benefits?

No. The employer may pay this instead of making it a pre-tax deduction. But there will have to be a written benefits plan.

2. Does this have to be offered to all employees?

If the employer is paying for it, then yes. He/she must offer the same deal to all eligible employees. Usually that means full-time employees who have worked for the company for a designated period of time.

If the employee is paying for it from pre-tax wages, again yes. And what a good benefit this would be for the employers, too! The employers won't be paying their share of Social Security or Medicare taxes (7.65%), federal and state unemployment taxes, workers compensation insurance, or other fees based on wages. So, the cost of the cafeteria plan is usually absorbed by the tax savings.

3. Does this have to be included as wages or does it qualify for the $5000 exclusion (Pub 15-B).

If the employer pays for it, it's not included in taxable wages. And if the employee pays for it via a cafeteria plan, it would be using pre-tax wages. Which leads right into the answer to your next question ....

4. From a tax standpoint would the employee still be able to receive the child tax credit if she took the $5000 pre-tax exclusion?

You may still be able to get the credit for up to $1,000 of care expenses if you have two children. The second page of Form 2441 has a place to enter the benefit you've already received. Remember, the total allowable expenses on Form 2441 (for 2 children) are $6,000. http://www.irs.gov/pub/irs-pdf/f2441.pdf

5. Which option benefits the employer best and which option benefits the employee best?

The truth is, employers benefits most, and save the most money overall when they have a dedicated, focused employee, who isn't constantly distracted and worried about her child. Or chasing around trying to find someone to take care of her child because she can't afford to pay child-care.

It's incredibly hard to find and keep good employees. Hiring and training costs, errors during the learning curve can be crippling costs for an employer.

Any employer with good sense would do anything reasonably possible to accommodate some who'll do a good job. Just yesterday, an employer sitting in my office discussing ways to attract and keep employees.

So, back to your question, which is better for the employee?

To have the employer pay the costs directly to the child care provider.

And about the employer? Heck, if the boss pays 100% of the costs, they can deduct the costs as employee benefits. They save all the payroll taxes and related costs.
And now I’m going to tell you a secret.

Hardly anyone knows about this special employer credit. It’s for providing child care facilities. IRS will grant the employer 25% of the cost. You would use Form 8882
http://www.irs.gov/pub/irs-pdf/f8882.pdf . And the big secret is – you don’t have to provide or build the facilities – just pay the appropriate care provider directly.

Your state may add their share of credits. California offers 30% credit. But I don't see one in North Carolina. You'll need to ask the state Department of Revenue. You're smart to do the research before talking to your boss. Doing research about what’s in it for your boss is a great starting point to negotiate wages and benefits.

Now, it's up to your boss to ask his or her tax professionals to get a benefits advisor to come in and work it all out.

Eva Rosenberg is the founder of TaxMama.com and an enrolled agent licensed to represent taxpayers before the IRS. She is the author of the book, Small Business Taxes Made Easy http://www.amazon.com/exec/obidos/tg/detail/-/0071441689/ , declared to be one of the best tax books of 2005 by Entrepreneur Magazine (Dec. 2005).

© Eva Rosenberg 2006, originally published in MarketWatch.com


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