One of our clients had an interesting tax return. The Dependent Care Deduction on Form 1040, page 2, line 48 was not allowed in this instance.
The tax code provides a deduction for when both spouses work and a young child is cared for. The deduction is limited to $3,000 when there is only one child.
In this instance, the wife works and gets a W-2. She elected to have $ 5,000 withheld for the fringe benefit "Dependent care benefits."
Her W-2 shows that $ 5,000 in box 10. She paid a qualified child care organization $5,610. You might guess her deduction would be based on the $610 net out-of-pocket expense. Not in this case. Form 2441 shows the limits that apply to the tax credit for dependent care.
This couple had some bad luck with an investment in a limited-liability corporation (LLC) a long time ago. When all the dust settled, they owed the IRS a lot of tax from prior tax years.
In 2010, they withdrew about $ 92,000 from IRAs to pay the IRS. Since those were regular IRA accounts, that was all taxable income. That increased their Adjusted Gross Income and their 2010 tax.
The husband's small business had a small loss in 2010. The economic downturn was the main cause.
The Dependent Care tax credit on page 2, line 48 is limited to the LOWER of the net earned income of either spouse. In this case, zero earned income applies because the husband's business had a small loss. Additionally, the IRA distributions increased their taxable income so much, no tax credit was allowed for the child care.
In addition to no tax credit for the child care expenses, the tax rules require the return to show an additional $ 5,000 of Wage income on Form 1040, line 7, for the Dependent care deducted from her wages. It's like she did not participate in the "cafeteria plan" for fringe benefits for child care at all. That increased her wages and their income tax.
However, we elected the Optional method on Schedule SE for husband. He then had self-employment tax of $686. AND, now the child tax credit on line 51 of $ 750 is allowed (instead of $550) because the Optional method "taxes" the $5,000 and her taxable wages are reduced by $5,000 and the Adjusted Gross Income is reduced. This election with the other related changes saved $625 for this year's tax.
I'm reminded of the idea someone had: Why don't we require every member of Congress to prepare their own income tax return? They could use the IRS publications and instructions, but they must do their own return with no help other than the IRS regular help telephone line.
Maybe if Congress would really understand how unfair, complicated and confusing the income tax laws are, then we at last could get a simplified tax law. Many other countries have changed to just a flat-tax approach.
Did you hear, "People in the same boat should help each other." - Chinese proverb.
• John Bullis is a certified public accountant, personal financial specialist and certified senior adviser serving Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs, LLC.
