Going back to school? What you need to know about the child care credit

A couple can claim the Child and Dependent Care Credit — commonly called the “child care credit” for short — if they pay someone to watch the kids while they’re at work. But suppose one spouse plans to go back to school this fall. Can you still claim the credit? It depends.

Generally, the credit is equal to 20 percent of the first $3,000 of qualified expenses related to caring for one child under age 13, or $6,000 for two or more children underage 13. Therefore, your maximum credit is typically $600 for one child and $1,200 for two or more children. A higher percentage is available for certain low-income taxpayers.

What expenses qualify for the child care credit? The credit can be claimed for:

  • Babysitters
  • Day care centers
  • Nursery schools
  • Summer day camps (but not overnight camps)

How do you qualify for the child care credit?
To qualify, the expenses will need to have been incurred for you and your spouse to be “gainfully employed.” A married couple is gainfully employed if one spouse works full time and the other works full time, part time or is a full-time student. A full-time student attends classes for at least five months (not necessarily consecutive) out of the year.

Say your spouse took a four-week course earlier this year and now has enrolled full time at college, beginning in September. You’ll end up with child care costs because your spouse will be at school and you work full time. That means you might claim the child care credit, subject to the usual limits.

One more thing to remember — the qualified expenses are further limited to the earned income of the lower-earning spouse. This could affect couples where one spouse attends school. During the months a spouse is a full-time student, the tax law presumes an earned income of $250 for one child and $500 for two or more children.

Take advantage of the annual gift tax exclusion

As the end-of-year holidays approach, you may decide to be extra generous to your loved ones. Specifically, by giving your family members gifts that are usually sheltered by the annual gift tax exclusion. Not only does this reduce the size of your taxable estate, it can minimize the overall income tax bite for your family.

How does the annual gift tax exclusion work?
Under the annual gift tax exclusion, you can give each recipient cash or property valued up to $14,000 free of gift tax without eroding any of your unified estate and gift tax exemption. This exclusion is adjusted every year for inflation in increments of $1,000, but hasn’t budged in recent years. The exclusion is doubled for joint gifts made by married couples.

For example, suppose you have three adult children and seven grandchildren. You and your spouse could each give every child and grandchild a gift of $14,000 in December to celebrate the holidays. Then you both could give each family member another $14,000 in January. In just two months, you and your spouse could reduce your taxable estate by a total of $560,000 ($28,000 x 10 recipients x 2 years)!

Normally, you don’t have to file a gift tax return to benefit from the annual gift tax exclusion, but your spouse must consent to joint gifts on a return.

How does the family save?
Assuming you’re in a high tax bracket and the recipients are in a lower tax bracket, any subsequent earnings from the cash or property you gift will result in reduced tax.

Special rules come into play if you give gifts of property that have appreciated or depreciated in value. Contact Dye & Whitcomb if you’d like to discuss your situation.

IRA-to-IRA rollovers: Once is enough!

The tax rules are relatively lenient for rollovers to a traditional IRA. For instance, if you transfer funds from your 401(k) plan to an IRA within 60 days, there’s no tax liability on the transfer. Similarly, if you transfer funds from one IRA to another within the 60-day window — say, for investment reasons — you avoid tax for the current year. In effect, this gives you 60 days to use the money as you see fit. It’s like getting an interest-free loan from the IRS, albeit for just two months.

However, be aware of a special wrinkle. The tax law also says that you’re limited to just one IRA-to-IRA rollover for the year. In a 2014 tax court case involving this once-a-year rule (Bobrow, TC Memo 2014-21), the limit was applied to all the IRAs owned by the taxpayer, not each one separately. This is different from the previous interpretation by many tax commentators and even the IRS itself.

The facts in this case can be confusing, but here’s all you need to know. The taxpayer argued that the one-year limit didn’t apply to another IRA he owned after he completed an IRA-to-IRA rollover. The tax court disallowed his rollovers within the next 12 months. Subsequently, the IRS decreed that it would follow the court’s ruling. If you’re in a similar position, be aware that you can’t use multiple rollovers within the same year.

What happens if you violate the once-a-year rule? The transfer is treated as a taxable distribution, so you’ll be taxed at your regular tax rate on the portion representing deductible contributions and earnings. What’s more, you might face additional tax complications. For example, a 10 percent penalty generally applies to taxable IRA distributions made before age 59½.

The best approach is to avoid potential problems by strictly observing the IRA rollover rules. Contact our Ft Collins, Colorado Accountants office a call if you have questions specific to your situation.

Do you know what a Muni is?

In today’s tax environment, nothing is certain. However, as things stand now, high-income taxpayers may continue to value municipal bonds (“munis”) and muni bond funds. Just consider these four tax incentives.

  1. Interest income from munis is exempt from federal income tax. This is a major benefit to taxpayers in the top tax brackets, especially when compared to taxable investments. For example, to someone in the top 39.6 percent tax bracket, a AAA-rated muni earning 4 percent is preferable to a taxable corporate bond earning 5 percent.

  2. Interest income from munis is exempt from state income tax if issued by a municipality or other authority within your state. This is a significant “double tax break” for residents of high-tax states.

  3. Interest income from munis doesn’t count toward your adjusted gross income (AGI) for tax return purposes. This could increase certain tax benefits, such as deductions for medical expenses or charitable gifts, or avoid cutbacks.

  4. Interest income from munis doesn’t count in the tax calculation of the net investment income tax (NII). Currently, a 3.8 percent surcharge applies to the lower amount of your NII (which includes most investment income items) or modified adjusted gross income (MAGI) above $200,000 for single filers and $250,000 for joint filers.

While these tax incentives exist, this should not lead you to believe munis are completely tax-free. For example, if you buy certain munis, called “private activity bonds,” it may create alternative minimum tax (AMT) complications. You will owe capital gains tax when you sell munis at a profit.

Also, remember that there’s more to investing than just taxes. Take all the relevant financial factors into account, including the suitability of munis in your portfolio. The rules related to munis are complex and can change. Contact Dye and Whitcomb, Fort Collins CPA’s  if you need help.