Child Care Expenses: Deductible?

I’m getting a really late start on writing today because it’s been kid-intensive: My older girl’s school was closed today due to a teacher in-service, and on top of that we had a dentist appointment both for her and her little brother. But even on regular school days, getting work done for my husband and I is a crazy juggle since we have a 2.5-year-old who’s not in school and we no longer have a regular child care provider. We had about 10 hours of help per week from our wonderful sitter Emily, until December at which point she “retired” due to the imminent arrival of her own first child. (Congrats Emily!) So for the moment, we’re muddling through on our own and cobbling together some plans for summer and fall.

One silver lining of paying out all that money for child care is that some of it (not enough, in my opinion) is deductible — but not as a business expense. Here’s an excerpt from my book on deductibility of child care expenses.

Child Care Expenses: Deductible?

If you have young children and own a business, child care may certainly seem like an ordinary and necessary expense for you to be able to run your business, right? Unfortunately, the IRS doesn’t see it that way. Costs of day care for your little ones are not considered “ordinary and necessary” expenses of running a business and are thus not deductible business expenses.

The good news is that there are other ways to get favorable tax treatment for any amounts you spend on child care. One is to claim the federal child care tax credit on your personal return. Another is to set up a child care center at your business that qualifies for a tax deduction.

Child Care Tax Credit

Expenses for child care may be deductible on your personal income taxes. If you qualify, you may claim a federal tax credit of 20% to 35% of your annual child care costs. You can claim up to $3,000 of expenses for one dependent, and $6,000 for two or more dependents. Your credit is then calculated by multiplying your claimed expenses (up to the limits mentioned above) by the percentage that applies to you; the percentage is determined by your income level. (You’ll find the rate schedule in IRS Publication 503, Child and Dependent Care Expenses.)

For example, if you and your husband paid a nanny $10,000 per year to care for your three children after school, you’d be allowed to claim $6,000 of those expenses (the maximum you could claim for two or more children). If you jointly earned $75,000 that year, you could write off 20% of that amount, based on the IRS’s rate schedule. This translates into a credit of $1,200 ($6,000 x 20%).

To qualify:

• Your child(ren) must be under 13 years old and live with you. There are more detailed rules for divorced parents who share custody; see IRS Publication 503, Child and Dependent Care Expenses.
• You (and your spouse, if you are married) must work, look for work, or be a full-time student. Single parents qualify if they are working or attending school full time, even if the child’s other parent is not.
• You (and your spouse, if you are married) must have earned income for the year.
• Your child care provider must be someone whom you can’t claim as a dependent, such as an older sibling. This may include a licensed day care provider, preschool, grandparent (if the grandparent is not your dependent), or an on-the-books nanny—but can’t include anyone you pay under the table.
• For more details, see IRS Publication 503, Child and Dependent Care Expenses.

—From The Women’s Small Business Start-Up Kit 2nd ed. (Nolo).