# U.S. Child and Dependent Care Expenses: Odd?



## BBCWatcher (Dec 28, 2012)

I stumbled into a quirky and potentially advantageous part of the U.S. tax code that's worth a bit of discussion. It relates to the Child and Dependent Care Expenses non-refundable tax credit, available to qualified filers via IRS Form 2441. Like some other tax credits, it gets "quirky" when the Foreign Earned Income Exclusion and/or Foreign Tax Credit are in the mix.

This particular tax credit is usually available when you have paid caregiver expenses for a child (below "babysitter age" more or less) or for a disabled individual, and those expenses are incurred so you (and your spouse) can work. That's the basic idea, though of course there are some detailed rules. There doesn't seem to be any income limit to this particular tax credit -- it doesn't phase out. It's at least difficult to qualify if your filing status is Married Filing Separately. In a "typical" household both mom and dad must have earned income, and the lower earning spouse helps determine the cap on the credit. It's a nonrefundable credit, so you have to have some U.S. tax liability to get some benefit -- for example, U.S. income tax on interest income.

For U.S. persons overseas this credit gets pretty weird. If you don't take the Foreign Earned Income Exclusion (and only take the Foreign Tax Credit), no problem. This tax credit behaves more or less as you'd expect. However, if you do take the FEIE, then odd things happen. The instructions to Form 2441 appear to indicate that the FEIE is not disqualifying (not taken into account) when determining which spouse has the lower earned income. That's on lines 4 and 5 of the form. Even if the lower earning spouse's entire earned income is shielded with the FEIE, that's OK. Later, though, the form takes a look at _household_ Adjusted Gross Income as another check. AGI includes the effects of the FEIE, so if both spouses are fully shielded then that's the end of this tax credit -- it zeroes out. But if at least one spouse earns above the FEIE (member of the "Six Percent Club"), or if at least one spouse has non-shielded (U.S. source/non-foreign) earned income, then you stay in the game. Or, to say it another way, in this situation if you're both "middle class," tough luck, but if at least one of you isn't, congratulations.

This particular tax credit has already been a bit controversial because it seems to be targeted at more well-to-do households who spend comparatively more money on paid childcare and who have an income tax liability to offset. As far as I can tell millionaires and billionaires can qualify for this one. At least the credit itself is capped, so it's not an unlimited giveaway, and there's a fairly weak/crude percentage adjustment in the credit calculation to give lower income earners a slightly bigger break. The interplay with the FEIE is an example where the skew toward upper income filers is even more pronounced.

If you are more middle class (most of us), one way you might be able to make this tax credit work for your household is if one spouse spends a little time earning money in a U.S. source role, if possible. Something like $11,000 would be ideal. That'd accomplish several things including maintaining Social Security disability coverage, qualifying for U.S. IRA contributions, and qualifying for this tax credit (and perhaps others like the Child Tax Credit/Additional Child Tax Credit). In other words, from what I can tell those households with a mix of FEIE-shielded and non-FEIE shields earned income can do quite well. This tax credit is also yet another reason, if you live in a comparatively high income tax jurisdiction, to consider skipping the FEIE altogether.

This particular tax credit doesn't help if you're overseas, fully shielded with the FEIE, and have no income tax liability remaining on your passive income (because you don't have enough passive income or the passive income is already foreign taxed at or above U.S. rates). It's not a refundable tax credit, and (unlike the Additional Child Tax Credit), it won't help you beat zero. However, it might be modestly helpful in boosting your excess Foreign Tax Credits if that's the situation you're in.

Anybody else seeing what I'm seeing?


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## BBCWatcher (Dec 28, 2012)

As an update, the IRS has released draft instructions for the 2015 edition of IRS Form 2441. The draft instructions make clear that excluded income (via the FEIE) should not be included in lines 4 and 5. Consequently if the FEIE wipes out at least one spouse's earned income then this particular tax credit disappears.

The draft instructions are subject to change of course, but that's what the revised instructions say at the moment.


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