Thorny tax question re: child care

Factual Questions
1

Let me apologize in advance for any glaring misconceptions in my understanding of the tax code. Let me tell you my problem, and you can tell me where I’ve misunderstood things, OR how to solve it, OR why I should feel better about this.

First, the background. The tax code offers some child-care cost relief to working families. For example, we’re allowed to set aside $5000 out of my paychecks (pre-tax) and use that to pay for childcare. Typical reimbursement account. Okay, the government has (wisely, I think) set up regulations where to qualify for the break, both adults in the house (or the only adult, if you’re a single parent) are working. This makes sense. If you’re not working, then paying for childcare is more a personal choice than a necessity for earning a living. Otherwise, we could, say, decide to wind-surf full-time while we still get the tax cut on child care. Not right. I agree with that.

Now, the way the government determines that you’re “working” and qualify is by saying both spouses must each earn at least $5000 (the same amount we’re allowed to siphon off tax-free into that reimbursement account). Fine.

Except here is the problem and some personal details. We ARE a working family. I’m the steady 9-6 girl with salary and benefits. Mr. Cranky, however, is in an unusual working situation. He works for royalties on software he helped create. He keeps working on the software to get future royalties. That’s why we have Cranky Jr. in daycare. Despite not being paid wages, Mr. Cranky is busy and is not free to take care of offpsring.

Here’s the thing, though. Apparently royalties don’t count as the wages, etc that get you defined as a busily working parent. So unless Mr. Cranky can show $5000 in other forms of work earnings, we don’t qualify for any tax break on child care. And people, it’s been a lean, lean year for royalties. We’ve been living off our savings from some past good years. It’s the nature of the business, no big deal, but we could truly use the tax break. Childcare costs nearly $10,000 a year for us, and getting to pay for half of that with tax-free bucks is a big help.

Do I have this right? Is there a way to “appeal” this rule? I believe we qualify for what the law INTENDS to do, but simply don’t fit the particular regulations.

2

Let me qualify my answer by saying that I have no expertise in the exact area you’re questioning, but I have years of experience in sorting through tax codes as it relates to child-care reimbursement.

The short answer to your question: It ain’t gonna happen.

The IRS will take a look at income for the purpose of establishing your right to use the child-care reimbursement. If both parents don’t have an income, then the IRS is gonna say “Well, you could’ve been taking care of the kid(s), if you weren’t earning an income.” The only caveat to that, I believe, is if you can prove you were looking for work full-time. If that’s not the case, you’re SOL.

As I said, though, I’m not an expert in these matters. Your best bet is to consult a CPA or a tax attorney.

3

Thanks, Sauron. We do have a CPA that does our taxes, but if there are any exceptions he doesn’t seem to know about them. At least he didn’t last year.

Be happy to hear from anyone else, too. I understand why the IRS would say “Go get income, or stop working to take care of kid” but he is working. Grrrr. We didn’t have kids when he entered into this arrangement, and had no idea of the tax implications in the future. If we had, maybe we could have arranged some modification in how he is compensated. Moral of this story: go see a lawyer about any unusual compensation arrangements before you accept them. Period.

4

Have you contacted the IRS on this directly? Hot tip - keep calling until you get the answer you want. Document who you spoke with, and when, and what they told you. If the IRS comes back and says the info you were given was wrong, you will owe back taxes, but no fines. My mom has done this many times (my sister’s partner works for the IRS, and told her to do this), because the rules on ministry benefits and pay are funky, and often open to interpretation. She’s called as many as 15 times to get a ‘good’ answer - the more differences in the interpretation of the initial few calls, the more likely you’ll find the opening you are looking for. If everyone says the same thing, you are probably out of luck.

I suspect that you won’t get the break you are looking for, but it is worth calling and talking to 3 or 4 tax advisors, and their managers, just on the off-chance someone will have some help for you.