Part 3: Tax-Free Day-Care Assistance
You can provide day care tax-free to all employees up to a maximum of $5,000 per year ($2,500 if married filing separately). The self-employed are considered employees under this rule. Hooray! Even partnerships can offer this benefit to partners who are treated as employees. Moreover, you can either pay for the employees’ day care directly or reimburse the employees for the expenses. How’s that for flexibility? However, you cannot discriminate in favor of highly compensated people or owners or stockholders who have a 5 percent or more interest in stock or profits of the company, and there are limitations on the benefits that can accrue to the owners as well. This will be discussed below.
Requirements to Bulletproof Tax-Free Day Care from the IRS
In order to receive this benefit tax-free, you must meet all the following requirements:
- The plan must provide employees with dependent care to children who are under age 13 or to any other dependents who are either physically or mentally incapable of caring for themselves.
- You must have a separate, written plan. It doesn’t have to be long and fancy, but you must have a plan in writing that shows who will get the benefits and what these benefits will be. You also have to notify the other employees of the availability of this benefit. You just can’t keep it secret. Nice try!
- A company cannot discriminate in favor of highly compensated employees, more than 5 percent owners, or more than 5 percent stockholders. However, even if a company is found to be discriminating, those employees who are not highly compensated or do not own 5 percent or more of the stock or more than 5 percent of the business will have their benefits tax-free.
- The employee must provide some documentation to the employer, such as the name, address, and Social Security Number or Taxpayer Identification Number of the provider. See your accountant about this.
- Even if you give this benefit to everyone, you can’t have more than 25 percent of the total benefits go to any stockholder or business owner who owns more than 5 percent of the stock or the business.
Sandy’s note: I personally find this extremely irritating, not to mention idiotic, that Congress would place a limit on the benefits available to owners even if they don’t discriminate. This only complicates the tax law. Why place a limit on benefits to business owners if there’s no discrimination? In addition, placing limits on benefits to owners hurts the small-business owner who may not have lots of employees, and in many cases, these people need the help the most.
I should note that you cannot have your child be the day-care provider if he or she is under age 19 by year’s end or your dependent even if over age 19. Once your child hits age 19 and stops being your dependent, he or she can be a qualified provider for the other children.
The same rule would apply to any other relative, such as an employee’s parents. If an employee pays one of his or her parents to take care of the employee’s children, these payments would be tax-free if the parent was not a dependent of the employee. This might be a great way to get your parents some money and to take care of your child-care problems at the same time.
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