Suppose a top company employee is pregnant. The family faces child care logistical issues—not to mention the cost—when the employee comes back to work.
At the very least, these outside concerns will distract your employee. At the worst, you run the risk the employee will quit. Strategy: Set up a company dependent care assistance plan. If you meet certain requirements, the IRS treats the first $5,000 in assistance paid to an employee as a tax-free .
What’s more, your company can deduct the dependent care payments. Plus, it becomes a significant enticement for other top-quality employees.
To qualify for the tax breaks, the dependent must be under age 13 and physically or mentally unable to care for himself or herself, or a spouse who is physically or mentally incapable of self-care.
In addition, the dependent care assistance plan must meet certain nondiscrimination rules. For example:
- The plan must be in writing.
- The benefits provided during the year to someone owning 5 percent or more of the company (either directly or indirectly) can’t exceed 25 percent of the plan’s total benefits.
- The average benefits paid to the company’s rank and file must be at least 55 percent of the average benefit paid to highly compensated employees.
For 2007, the law considers a highly compensated employee to be someone earning more than $100,000 or a 5 percent-or-more business owner.
Finally, you can’t skirt those nondiscrimination rules by claiming dependent care expenses as “ordinary and necessary” business expenses (see box). It’s important to stay within the tax-law boundaries.
Can an employee claim the dependent care credit (commonly called the “child care credit”) if he or she also benefits from a dependent care assistance plan? Not for the same expenses. But employees usually come out ahead under the plan.
Reason: The tax credit is generally equal to 20 percent of the first $3,000 of expenses for one child; $6,000 for two or more children. So the maximum tax savings for one child comes in at $600 (20 percent of $3,000). In contrast, someone in the 28 percent tax bracket saves $1,400 in tax (28 percent of $5,000). Also, the payments are exempt from FICA and other payroll taxes.
Note that an employee still can claim the child care credit for allowable excess costs (i.e., up to $1,000 over the $5,000 dollar cap for caring for two or more children).