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Freetaxreturns 32. Freetaxreturns   Child and Dependent Care Credit Table of Contents Reminders Introduction Useful Items - You may want to see: Tests To Claim the CreditQualifying Person Test Earned Income Test Work-Related Expense Test Joint Return Test Provider Identification Test How To Figure the CreditFiguring Total Work-Related Expenses Earned Income Limit Dollar Limit Amount of Credit How To Claim the CreditTax credit not refundable. Freetaxreturns Employment Taxes for Household Employers Reminders Taxpayer identification number needed for each qualifying person. Freetaxreturns  You must include on line 2 of Form 2441 the name and taxpayer identification number (generally the social security number) of each qualifying person. Freetaxreturns See Taxpayer identification number under Qualifying Person Test, later. Freetaxreturns You may have to pay employment taxes. Freetaxreturns  If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer who has to pay employment taxes. Freetaxreturns Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business. Freetaxreturns See Employment Taxes for Household Employers , later. Freetaxreturns Introduction This chapter discusses the credit for child and dependent care expenses and covers the following topics. Freetaxreturns Tests you must meet to claim the credit. Freetaxreturns How to figure the credit. Freetaxreturns How to claim the credit. Freetaxreturns Employment taxes you may have to pay as a household employer. Freetaxreturns You may be able to claim the credit if you pay someone to care for your dependent who is under age 13 or for your spouse or dependent who is not able to care for himself or herself. Freetaxreturns The credit can be up to 35% of your expenses. Freetaxreturns To qualify, you must pay these expenses so you can work or look for work. Freetaxreturns This credit should not be confused with the child tax credit discussed in chapter 34. Freetaxreturns Dependent care benefits. Freetaxreturns   If you received any dependent care benefits from your employer during the year, you may be able to exclude from your income all or part of them. Freetaxreturns You must complete Form 2441, Part III, before you can figure the amount of your credit. Freetaxreturns See Dependent Care Benefits under How To Figure the Credit, later. Freetaxreturns Useful Items - You may want to see: Publication 501 Exemptions, Standard Deduction, and Filing Information 503 Child and Dependent Care Expenses 926 Household Employer's Tax Guide Form (and Instructions) 2441 Child and Dependent Care Expenses Schedule H (Form 1040) Household Employment Taxes W-7 Application for IRS Individual Taxpayer Identification Number W-10 Dependent Care Provider's Identification and Certification Tests To Claim the Credit To be able to claim the credit for child and dependent care expenses, you must file Form 1040 or Form 1040A, not Form 1040EZ, and meet all the following tests. Freetaxreturns The care must be for one or more qualifying persons who are identified on Form 2441. Freetaxreturns (See Qualifying Person Test . Freetaxreturns ) You (and your spouse if filing jointly) must have earned income during the year. Freetaxreturns (However, see Rule for student-spouse or spouse not able to care for self under Earned Income Test, later. Freetaxreturns ) You must pay child and dependent care expenses so you (and your spouse if filing jointly) can work or look for work. Freetaxreturns (See Work-Related Expense Test , later. Freetaxreturns ) You must make payments for child and dependent care to someone you (and your spouse) cannot claim as a dependent. Freetaxreturns If you make payments to your child, he or she cannot be your dependent and must be age 19 or older by the end of the year. Freetaxreturns You cannot make payments to: Your spouse, or The parent of your qualifying person if your qualifying person is your child and under age 13. Freetaxreturns (See Payments to Relatives or Dependents under Work-Related Expense Test, later. Freetaxreturns ) Your filing status may be single, head of household, or qualifying widow(er) with dependent child. Freetaxreturns If you are married, you must file a joint return, unless an exception applies to you. Freetaxreturns (See Joint Return Test , later. Freetaxreturns ) You must identify the care provider on your tax return. Freetaxreturns (See Provider Identification Test , later. Freetaxreturns ) If you exclude or deduct dependent care benefits provided by a dependent care benefits plan, the total amount you exclude or deduct must be less than the dollar limit for qualifying expenses (generally, $3,000 if one qualifying person was cared for or $6,000 if two or more qualifying persons were cared for). Freetaxreturns (If two or more qualifying persons were cared for, the amount you exclude or deduct will always be less than the dollar limit, since the total amount you can exclude or deduct is limited to $5,000. Freetaxreturns See Reduced Dollar Limit under How To Figure the Credit, later. Freetaxreturns ) These tests are presented in Figure 32-A and are also explained in detail in this chapter. Freetaxreturns Figure 32-A. Freetaxreturns Can You Claim the Credit? Please click here for the text description of the image. Freetaxreturns Figure 32-A Can You Claim the Credit? Qualifying Person Test Your child and dependent care expenses must be for the care of one or more qualifying persons. Freetaxreturns A qualifying person is: Your qualifying child who is your dependent and who was under age 13 when the care was provided (but see Child of divorced or separated parents or parents living apart, later), Your spouse who was not physically or mentally able to care for himself or herself and lived with you for more than half the year, or A person who was not physically or mentally able to care for himself or herself, lived with you for more than half the year, and either: Was your dependent, or Would have been your dependent except that: He or she received gross income of $3,900 or more, He or she filed a joint return, or You, or your spouse if filing jointly, could be claimed as a dependent on someone else's 2013 return. Freetaxreturns Dependent defined. Freetaxreturns   A dependent is a person, other than you or your spouse, for whom you can claim an exemption. Freetaxreturns To be your dependent, a person must be your qualifying child (or your qualifying relative). Freetaxreturns Qualifying child. Freetaxreturns   To be your qualifying child, a child must live with you for more than half the year and meet other requirements. Freetaxreturns More information. Freetaxreturns   For more information about who is a dependent or a qualifying child, see chapter 3. Freetaxreturns Physically or mentally not able to care for oneself. Freetaxreturns   Persons who cannot dress, clean, or feed themselves because of physical or mental problems are considered not able to care for themselves. Freetaxreturns Also, persons who must have constant attention to prevent them from injuring themselves or others are considered not able to care for themselves. Freetaxreturns Person qualifying for part of year. Freetaxreturns   You determine a person's qualifying status each day. Freetaxreturns For example, if the person for whom you pay child and dependent care expenses no longer qualifies on September 16, count only those expenses through September 15. Freetaxreturns Also see Yearly limit under Dollar Limit, later. Freetaxreturns Birth or death of otherwise qualifying person. Freetaxreturns   In determining whether a person is a qualifying person, a person who was born or died in 2013 is treated as having lived with you for more than half of 2013 if your home was the person's home for more than half the time he or she was alive in 2013. Freetaxreturns Taxpayer identification number. Freetaxreturns   You must include on your return the name and taxpayer identification number (generally the social security number) of the qualifying person(s). Freetaxreturns If the correct information is not shown, the credit may be reduced or disallowed. Freetaxreturns Individual taxpayer identification number (ITIN) for aliens. Freetaxreturns   If your qualifying person is a nonresident or resident alien who does not have and cannot get a social security number (SSN), use that person's ITIN. Freetaxreturns The ITIN is entered wherever an SSN is requested on a tax return. Freetaxreturns To apply for an ITIN, see Form W-7. Freetaxreturns   An ITIN is for tax use only. Freetaxreturns It does not entitle the holder to social security benefits or change the holder's employment or immigration status under U. Freetaxreturns S. Freetaxreturns law. Freetaxreturns Adoption taxpayer identification number (ATIN). Freetaxreturns   If your qualifying person is a child who was placed in your home for adoption and for whom you do not have an SSN, you must get an ATIN for the child. Freetaxreturns File Form W-7A, Application for Taxpayer Identification Number for Pending U. Freetaxreturns S. Freetaxreturns Adoptions. Freetaxreturns Child of divorced or separated parents or parents living apart. Freetaxreturns   Even if you cannot claim your child as a dependent, he or she is treated as your qualifying person if: The child was under age 13 or was not physically or mentally able to care for himself or herself, The child received over half of his or her support during the calendar year from one or both parents who are divorced or legally separated under a decree of divorce or separate maintenance, are separated under a written separation agreement, or lived apart at all times during the last 6 months of the calendar year, The child was in the custody of one or both parents for more than half the year, and You were the child's custodial parent. Freetaxreturns   The custodial parent is the parent with whom the child lived for the greater number of nights in 2013. Freetaxreturns If the child was with each parent for an equal number of nights, the custodial parent is the parent with the higher adjusted gross income. Freetaxreturns For details and an exception for a parent who works at night, see Pub. Freetaxreturns 501. Freetaxreturns   The noncustodial parent cannot treat the child as a qualifying person even if that parent is entitled to claim the child as a dependent under the special rules for a child of divorced or separated parents. Freetaxreturns Earned Income Test To claim the credit, you (and your spouse if filing jointly) must have earned income during the year. Freetaxreturns Earned income. Freetaxreturns   Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment. Freetaxreturns A net loss from self-employment reduces earned income. Freetaxreturns Earned income also includes strike benefits and any disability pay you report as wages. Freetaxreturns   Generally, only taxable compensation is included. Freetaxreturns However, you can elect to include nontaxable combat pay in earned income. Freetaxreturns If you are filing a joint return and both you and your spouse received nontaxable combat pay, you can each make your own election. Freetaxreturns (In other words, if one of you makes the election, the other one can also make it but does not have to. Freetaxreturns ) You should figure your credit both ways and make the election if it gives you a greater tax benefit. Freetaxreturns Members of certain religious faiths opposed to social security. Freetaxreturns   Certain income earned by persons who are members of certain religious faiths that are opposed to participation in Social Security Act programs and have an IRS-approved form that exempts certain income from social security and Medicare taxes may not be considered earned income for this purpose. Freetaxreturns See Earned Income Test in Publication 503. Freetaxreturns Not earned income. Freetaxreturns   Earned income does not include: Pensions and annuities, Social security and railroad retirement benefits, Workers' compensation, Interest and dividends, Unemployment compensation, Scholarship or fellowship grants, except for those reported on a Form W-2 and paid to you for teaching or other services, Nontaxable workfare payments, Child support payments received by you, Income of nonresident aliens that is not effectively connected with a U. Freetaxreturns S. Freetaxreturns trade or business, or Any amount received for work while an inmate in a penal institution. Freetaxreturns Rule for student-spouse or spouse not able to care for self. Freetaxreturns   Your spouse is treated as having earned income for any month that he or she is: A full-time student, or Physically or mentally not able to care for himself or herself. Freetaxreturns (Your spouse also must live with you for more than half the year. Freetaxreturns )   If you are filing a joint return, this rule also applies to you. Freetaxreturns You can be treated as having earned income for any month you are a full-time student or not able to care for yourself. Freetaxreturns   Figure the earned income of the nonworking spouse described under (1) or (2) above as explained under Earned Income Limit , later. Freetaxreturns   This rule applies to only one spouse for any one month. Freetaxreturns If, in the same month, both you and your spouse do not work and are either full-time students or not physically or mentally able to care for yourselves, only one of you can be treated as having earned income in that month. Freetaxreturns Full-time student. Freetaxreturns   You are a full-time student if you are enrolled at a school for the number of hours or classes that the school considers full time. Freetaxreturns You must have been a full-time student for some part of each of 5 calendar months during the year. Freetaxreturns (The months need not be consecutive. Freetaxreturns ) School. Freetaxreturns   The term “school” includes high schools, colleges, universities, and technical, trade, and mechanical schools. Freetaxreturns A school does not include an on-the-job training course, correspondence school, or school offering courses only through the Internet. Freetaxreturns Work-Related Expense Test Child and dependent care expenses must be work-related to qualify for the credit. Freetaxreturns Expenses are considered work-related only if both of the following are true. Freetaxreturns They allow you (and your spouse if filing jointly) to work or look for work. Freetaxreturns They are for a qualifying person's care. Freetaxreturns Working or Looking for Work To be work-related, your expenses must allow you to work or look for work. Freetaxreturns If you are married, generally both you and your spouse must work or look for work. Freetaxreturns One spouse is treated as working during any month he or she is a full-time student or is not physically or mentally able to care for himself or herself. Freetaxreturns Your work can be for others or in your own business or partnership. Freetaxreturns It can be either full time or part time. Freetaxreturns Work also includes actively looking for work. Freetaxreturns However, if you do not find a job and have no earned income for the year, you cannot take this credit. Freetaxreturns See Earned Income Test , earlier. Freetaxreturns An expense is not considered work-related merely because you had it while you were working. Freetaxreturns The purpose of the expense must be to allow you to work. Freetaxreturns Whether your expenses allow you to work or look for work depends on the facts. Freetaxreturns Example 1. Freetaxreturns The cost of a babysitter while you and your spouse go out to eat is not normally a work-related expense. Freetaxreturns Example 2. Freetaxreturns You work during the day. Freetaxreturns Your spouse works at night and sleeps during the day. Freetaxreturns You pay for care of your 5-year-old child during the hours when you are working and your spouse is sleeping. Freetaxreturns Your expenses are considered work-related. Freetaxreturns Volunteer work. Freetaxreturns    For this purpose, you are not considered to be working if you do unpaid volunteer work or volunteer work for a nominal salary. Freetaxreturns Work for part of year. Freetaxreturns   If you work or actively look for work during only part of the period covered by the expenses, then you must figure your expenses for each day. Freetaxreturns For example, if you work all year and pay care expenses of $250 a month ($3,000 for the year), all the expenses are work-related. Freetaxreturns However, if you work or look for work for only 2 months and 15 days during the year and pay expenses of $250 a month, your work-related expenses are limited to $625 (2½ months × $250). Freetaxreturns Temporary absence from work. Freetaxreturns   You do not have to figure your expenses for each day during a short, temporary absence from work, such as for vacation or a minor illness, if you have to pay for care anyway. Freetaxreturns Instead, you can figure your credit including the expenses you paid for the period of absence. Freetaxreturns   An absence of 2 weeks or less is a short, temporary absence. Freetaxreturns An absence of more than 2 weeks may be considered a short, temporary absence, depending on the circumstances. Freetaxreturns Example. Freetaxreturns You pay a nanny to care for your 2-year-old son and 4-year-old daughter so you can work. Freetaxreturns You become ill and miss 4 months of work but receive sick pay. Freetaxreturns You continue to pay the nanny to care for the children while you are ill. Freetaxreturns Your absence is not a short, temporary absence, and your expenses are not considered work-related. Freetaxreturns Part-time work. Freetaxreturns   If you work part-time, you generally must figure your expenses for each day. Freetaxreturns However, if you have to pay for care weekly, monthly, or in another way that includes both days worked and days not worked, you can figure your credit including the expenses you paid for days you did not work. Freetaxreturns Any day when you work at least 1 hour is a day of work. Freetaxreturns Example 1. Freetaxreturns You work 3 days a week. Freetaxreturns While you work, your 6-year-old child attends a dependent care center, which complies with all state and local regulations. Freetaxreturns You can pay the center $150 for any 3 days a week or $250 for 5 days a week. Freetaxreturns Your child attends the center 5 days a week. Freetaxreturns Your work-related expenses are limited to $150 a week. Freetaxreturns Example 2. Freetaxreturns The facts are the same as in Example 1 except the center does not offer a 3-day option. Freetaxreturns The entire $250 weekly fee may be a work-related expense. Freetaxreturns Care of a Qualifying Person To be work-related, your expenses must be to provide care for a qualifying person. Freetaxreturns You do not have to choose the least expensive way of providing care. Freetaxreturns The cost of a paid care provider may be an expense for the care of a qualifying person even if another care provider is available at no cost. Freetaxreturns Expenses are for the care of a qualifying person only if their main purpose is the person's well-being and protection. Freetaxreturns Expenses for household services qualify if part of the services is for the care of qualifying persons. Freetaxreturns See Household services , later. Freetaxreturns Expenses not for care. Freetaxreturns   Expenses for care do not include amounts you pay for food, lodging, clothing, education, and entertainment. Freetaxreturns However, you can include small amounts paid for these items if they are incidental to and cannot be separated from the cost of caring for the qualifying person. Freetaxreturns   Child support payments are not for care and do not qualify for the credit. Freetaxreturns Education. Freetaxreturns   Expenses for a child in nursery school, preschool, or similar programs for children below the level of kindergarten are expenses for care. Freetaxreturns Expenses to attend kindergarten or a higher grade are not expenses for care. Freetaxreturns Do not use these expenses to figure your credit. Freetaxreturns   However, expenses for before- or after-school care of a child in kindergarten or a higher grade may be expenses for care. Freetaxreturns   Summer school and tutoring programs are not for care. Freetaxreturns Example 1. Freetaxreturns You take your 3-year-old child to a nursery school that provides lunch and educational activities as a part of its preschool childcare service. Freetaxreturns The lunch and educational activities are incidental to the childcare, and their cost cannot be separated from the cost of care. Freetaxreturns You can count the total cost when you figure the credit. Freetaxreturns Example 2. Freetaxreturns You place your 10-year-old child in a boarding school so you can work full time. Freetaxreturns Only the part of the boarding school expense that is for the care of your child is a work-related expense. Freetaxreturns You can count that part of the expense in figuring your credit if it can be separated from the cost of education. Freetaxreturns You cannot count any part of the amount you pay the school for your child's education. Freetaxreturns Care outside your home. Freetaxreturns   You can count the cost of care provided outside your home if the care is for your dependent under age 13 or any other qualifying person who regularly spends at least 8 hours each day in your home. Freetaxreturns Dependent care center. Freetaxreturns   You can count care provided outside your home by a dependent care center only if the center complies with all state and local regulations that apply to these centers. Freetaxreturns   A dependent care center is a place that provides care for more than six persons (other than persons who live there) and receives a fee, payment, or grant for providing services for any of those persons, even if the center is not run for profit. Freetaxreturns Camp. Freetaxreturns   The cost of sending your child to an overnight camp is not considered a work-related expense. Freetaxreturns The cost of sending your child to a day camp may be a work-related expense, even if the camp specializes in a particular activity, such as computers or soccer. Freetaxreturns Transportation. Freetaxreturns   If a care provider takes a qualifying person to or from a place where care is provided, that transportation is for the care of the qualifying person. Freetaxreturns This includes transportation by bus, subway, taxi, or private car. Freetaxreturns However, transportation not provided by a care provider is not for the care of a qualifying person. Freetaxreturns Also, if you pay the transportation cost for the care provider to come to your home, that expense is not for care of a qualifying person. Freetaxreturns Fees and deposits. Freetaxreturns   Fees you paid to an agency to get the services of a care provider, deposits you paid to an agency or preschool, application fees, and other indirect expenses are work-related expenses if you have to pay them to get care, even though they are not directly for care. Freetaxreturns However, a forfeited deposit is not for the care of a qualifying person if care is not provided. Freetaxreturns Example 1. Freetaxreturns You paid a fee to an agency to get the services of the nanny who cares for your 2-year-old daughter while you work. Freetaxreturns The fee you paid is a work-related expense. Freetaxreturns Example 2. Freetaxreturns You placed a deposit with a preschool to reserve a place for your 3-year-old child. Freetaxreturns You later sent your child to a different preschool and forfeited the deposit. Freetaxreturns The forfeited deposit is not for care and so is not a work-related expense. Freetaxreturns Household services. Freetaxreturns   Expenses you pay for household services meet the work-related expense test if they are at least partly for the well-being and protection of a qualifying person. Freetaxreturns   Household services are ordinary and usual services done in and around your home that are necessary to run your home. Freetaxreturns They include the services of a housekeeper, maid, or cook. Freetaxreturns However, they do not include the services of a chauffeur, bartender, or gardener. Freetaxreturns See Household Services in Publication 503 for more information. Freetaxreturns   In this chapter, the term housekeeper refers to any household employee whose services include the care of a qualifying person. Freetaxreturns Taxes paid on wages. Freetaxreturns   The taxes you pay on wages for qualifying child and dependent care services are work-related expenses. Freetaxreturns See Employment Taxes for Household Employers , later. Freetaxreturns Payments to Relatives or Dependents You can count work-related payments you make to relatives who are not your dependents, even if they live in your home. Freetaxreturns However, do not count any amounts you pay to: A dependent for whom you (or your spouse if filing jointly) can claim an exemption, Your child who was under age 19 at the end of the year, even if he or she is not your dependent, A person who was your spouse any time during the year, or The parent of your qualifying person if your qualifying person is your child and under age 13. Freetaxreturns Joint Return Test Generally, married couples must file a joint return to take the credit. Freetaxreturns However, if you are legally separated or living apart from your spouse, you may be able to file a separate return and still take the credit. Freetaxreturns Legally separated. Freetaxreturns   You are not considered married if you are legally separated from your spouse under a decree of divorce or separate maintenance. Freetaxreturns You may be eligible to take the credit on your return using head of household filing status. Freetaxreturns Married and living apart. Freetaxreturns   You are not considered married and are eligible to take the credit if all the following apply. Freetaxreturns You file a return apart from your spouse. Freetaxreturns Your home is the home of a qualifying person for more than half the year. Freetaxreturns You pay more than half the cost of keeping up your home for the year. Freetaxreturns Your spouse does not live in your home for the last 6 months of the year. Freetaxreturns Costs of keeping up a home. Freetaxreturns   The costs of keeping up a home normally include property taxes, mortgage interest, rent, utility charges, home repairs, insurance on the home, and food eaten at home. Freetaxreturns   The costs of keeping up a home do not include payments for clothing, education, medical treatment, vacations, life insurance, transportation, or mortgage principal. Freetaxreturns   They also do not include the purchase, permanent improvement, or replacement of property. Freetaxreturns For example, you cannot include the cost of replacing a water heater. Freetaxreturns However, you can include the cost of repairing a water heater. Freetaxreturns Death of spouse. Freetaxreturns   If your spouse died during the year and you do not remarry before the end of the year, you generally must file a joint return to take the credit. Freetaxreturns If you do remarry before the end of the year, the credit can be claimed on your deceased spouse's return. Freetaxreturns Provider Identification Test You must identify all persons or organizations that provide care for your child or dependent. Freetaxreturns Use Form 2441, Part I, to show the information. Freetaxreturns If you do not have any care providers and you are filing Form 2441 only to report taxable income in Part III, enter “none” in line 1, column (a). Freetaxreturns Information needed. Freetaxreturns   To identify the care provider, you must give the provider's: Name, Address, and Taxpayer identification number. Freetaxreturns   If the care provider is an individual, the taxpayer identification number is his or her social security number or individual taxpayer identification number. Freetaxreturns If the care provider is an organization, then it is the employer identification number (EIN). Freetaxreturns   You do not have to show the taxpayer identification number if the care provider is a tax-exempt organization (such as a church or school). Freetaxreturns In this case, enter “Tax-Exempt” in the space where Form 2441 asks for the number. Freetaxreturns   If you cannot provide all of the information or if the information is incorrect, you must be able to show that you used due diligence (discussed later) in trying to furnish the necessary information. Freetaxreturns Getting the information. Freetaxreturns   You can use Form W-10 to request the required information from the care provider. Freetaxreturns If you do not use Form W-10, you can get the information from one of the other sources listed in the instructions for Form W-10 including: A copy of the provider's social security card, A copy of the provider's completed Form W-4 if he or she is your household employee, A copy of the statement furnished by your employer if the provider is your employer's dependent care plan, or A letter or invoice from the provider if it shows the information. Freetaxreturns    You should keep this information with your tax records. Freetaxreturns Do not send Form W-10 (or other document containing this information) to the Internal Revenue Service. Freetaxreturns Due diligence. Freetaxreturns   If the care provider information you give is incorrect or incomplete, your credit may not be allowed. Freetaxreturns However, if you can show that you used due diligence in trying to supply the information, you can still claim the credit. Freetaxreturns   You can show due diligence by getting and keeping the provider's completed Form W-10 or one of the other sources of information just listed. Freetaxreturns Care providers can be penalized if they do not provide this information to you or if they provide incorrect information. Freetaxreturns Provider refusal. Freetaxreturns   If the provider refuses to give you their identifying information, you should report on Form 2441 whatever information you have (such as the name and address). Freetaxreturns Enter “See Attached Statement” in the columns calling for the information you do not have. Freetaxreturns Then attach a statement explaining that you requested the information from the care provider, but the provider did not give you the information. Freetaxreturns Be sure to write your name and social security number on this statement. Freetaxreturns The statement will show that you used due diligence in trying to furnish the necessary information. Freetaxreturns U. Freetaxreturns S. Freetaxreturns citizens and resident aliens living abroad. Freetaxreturns   If you are living abroad, your care provider may not have, and may not be required to get, a U. Freetaxreturns S. Freetaxreturns taxpayer identification number (for example, an SSN or EIN). Freetaxreturns If so, enter “LAFCP” (Living Abroad Foreign Care Provider) in the space for the care provider's taxpayer identification number. Freetaxreturns How To Figure the Credit Your credit is a percentage of your work-related expenses. Freetaxreturns Your expenses are subject to the earned income limit and the dollar limit. Freetaxreturns The percentage is based on your adjusted gross income. Freetaxreturns Figuring Total Work-Related Expenses To figure the credit for 2013 work-related expenses, count only those you paid by December 31, 2013. Freetaxreturns Expenses prepaid in an earlier year. Freetaxreturns   If you pay for services before they are provided, you can count the prepaid expenses only in the year the care is received. Freetaxreturns Claim the expenses for the later year as if they were actually paid in that later year. Freetaxreturns Expenses not paid until the following year. Freetaxreturns   Do not count 2012 expenses that you paid in 2013 as work-related expenses for 2013. Freetaxreturns You may be able to claim an additional credit for them on your 2013 return, but you must figure it separately. Freetaxreturns See Payments for prior year's expenses under Amount of Credit in Publication 503. Freetaxreturns    If you had expenses in 2013 that you did not pay until 2014, you cannot count them when figuring your 2013 credit. Freetaxreturns You may be able to claim a credit for them on your 2014 return. Freetaxreturns Expenses reimbursed. Freetaxreturns   If a state social services agency pays you a nontaxable amount to reimburse you for some of your child and dependent care expenses, you cannot count the expenses that are reimbursed as work-related expenses. Freetaxreturns Example. Freetaxreturns You paid work-related expenses of $3,000. Freetaxreturns You are reimbursed $2,000 by a state social services agency. Freetaxreturns You can use only $1,000 to figure your credit. Freetaxreturns Medical expenses. Freetaxreturns   Some expenses for the care of qualifying persons who are not able to care for themselves may qualify as work-related expenses and also as medical expenses. Freetaxreturns You can use them either way, but you cannot use the same expenses to claim both a credit and a medical expense deduction. Freetaxreturns   If you use these expenses to figure the credit and they are more than the earned income limit or the dollar limit, discussed later, you can add the excess to your medical expenses. Freetaxreturns However, if you use your total expenses to figure your medical expense deduction, you cannot use any part of them to figure your credit. Freetaxreturns    Amounts excluded from your income under your employer's dependent care benefits plan cannot be used to claim a medical expense deduction. Freetaxreturns Dependent Care Benefits If you receive dependent care benefits, your dollar limit for purposes of the credit may be reduced. Freetaxreturns See Reduced Dollar Limit , later. Freetaxreturns But, even if you cannot take the credit, you may be able to take an exclusion or deduction for the dependent care benefits. Freetaxreturns Dependent care benefits. Freetaxreturns   Dependent care benefits include: Amounts your employer paid directly to either you or your care provider for the care of your qualifying person while you work, The fair market value of care in a daycare facility provided or sponsored by your employer, and Pre-tax contributions you made under a dependent care flexible spending arrangement. Freetaxreturns Your salary may have been reduced to pay for these benefits. Freetaxreturns If you received benefits as an employee, they should be shown in box 10 of your Form W-2. Freetaxreturns See Statement for employee , later. Freetaxreturns Benefits you received as a partner should be shown in box 13 of your Schedule K-1 (Form 1065) with code O. Freetaxreturns Enter the amount of these benefits on Form 2441, Part III, line 12. Freetaxreturns Exclusion or deduction. Freetaxreturns   If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your income. Freetaxreturns Your employer can tell you whether your benefit plan qualifies. Freetaxreturns To claim the exclusion, you must complete Part III of Form 2441. Freetaxreturns You cannot use Form 1040EZ. Freetaxreturns   If you are self-employed and receive benefits from a qualified dependent care benefit plan, you are treated as both employer and employee. Freetaxreturns Therefore, you would not get an exclusion from wages. Freetaxreturns Instead, you would get a deduction on Form 1040, Schedule C, line 14; Schedule E, line 19 or 28; or Schedule F, line 15. Freetaxreturns To claim the deduction, you must use Form 2441. Freetaxreturns   The amount you can exclude or deduct is limited to the smallest of: The total amount of dependent care benefits you received during the year, The total amount of qualified expenses you incurred during the year, Your earned income, Your spouse's earned income, or $5,000 ($2,500 if married filing separately). Freetaxreturns The definition of earned income for the exclusion or deduction is the same as the definition used when figuring the credit except that earned income for the exclusion or deduction does not include any dependent care benefits you receive. Freetaxreturns See Earned Income Limit, later. Freetaxreturns    You can choose to include your nontaxable combat pay in earned income when figuring your exclusion or deduction, even if you choose not to include it in earned income for the earned income credit or the credit for child and dependent care expenses. Freetaxreturns Statement for employee. Freetaxreturns   Your employer must give you a Form W-2 (or similar statement) showing in box 10 the total amount of dependent care benefits provided to you during the year under a qualified plan. Freetaxreturns Your employer will also include any dependent care benefits over $5,000 in your wages shown on your Form W-2 in box 1. Freetaxreturns Effect of exclusion on credit. Freetaxreturns   If you exclude dependent care benefits from your income, the amount of the excluded benefits: Is not included in your work-related expenses, and Reduces the dollar limit, discussed later. Freetaxreturns Earned Income Limit The amount of work-related expenses you use to figure your credit cannot be more than: Your earned income for the year if you are single at the end of the year, or The smaller of your or your spouse's earned income for the year if you are married at the end of the year. Freetaxreturns Earned income is defined under Earned Income Test , earlier. Freetaxreturns For purposes of item (2), use your spouse's earned income for the entire year, even if you were married for only part of the year. Freetaxreturns Separated spouse. Freetaxreturns   If you are legally separated or married and living apart from your spouse (as described under Joint Return Test , earlier), you are not considered married for purposes of the earned income limit. Freetaxreturns Use only your income in figuring the earned income limit. Freetaxreturns Surviving spouse. Freetaxreturns   If your spouse died during the year and you file a joint return as a surviving spouse, you may, but are not required to, take into account the earned income of your spouse who died during the year. Freetaxreturns Community property laws. Freetaxreturns   You should disregard community property laws when you figure earned income for this credit. Freetaxreturns You or your spouse is a student or not able to care for self. Freetaxreturns   Your spouse who is either a full-time student or not able to care for himself or herself is treated as having earned income. Freetaxreturns His or her earned income for each month is considered to be at least $250 if there is one qualifying person in your home, or at least $500 if there are two or more. Freetaxreturns Spouse works. Freetaxreturns   If your spouse works during that month, use the higher of $250 (or $500) or his or her actual earned income for that month. Freetaxreturns Spouse qualifies for part of month. Freetaxreturns    If your spouse is a full-time student or not able to care for himself or herself for only part of a month, the full $250 (or $500) still applies for that month. Freetaxreturns You are a student or not able to care for self. Freetaxreturns   These rules also apply if you are a student or not able to care for yourself and you are filing a joint return. Freetaxreturns For each month or part of a month you are a student or not able to care for yourself, your earned income is considered to be at least $250 (or $500). Freetaxreturns If you also work during that month, use the higher of $250 (or $500) or your actual earned income for that month. Freetaxreturns Both spouses qualify. Freetaxreturns   If, in the same month, both you and your spouse are either full-time students or not able to care for yourselves, only one spouse can be considered to have this earned income of $250 (or $500) for that month. Freetaxreturns Dollar Limit There is a dollar limit on the amount of your work-related expenses you can use to figure the credit. Freetaxreturns This limit is $3,000 for one qualifying person, or $6,000 for two or more qualifying persons. Freetaxreturns If you paid work-related expenses for the care of two or more qualifying persons, the applicable dollar limit is $6,000. Freetaxreturns This $6,000 limit does not need to be divided equally among them. Freetaxreturns For example, if your work-related expenses for the care of one qualifying person are $3,200 and your work-related expenses for another qualifying person are $2,800, you can use the total, $6,000, when figuring the credit. Freetaxreturns Yearly limit. Freetaxreturns   The dollar limit is a yearly limit. Freetaxreturns The amount of the dollar limit remains the same no matter how long, during the year, you have a qualifying person in your household. Freetaxreturns Use the $3,000 limit if you paid work-related expenses for the care of one qualifying person at any time during the year. Freetaxreturns Use $6,000 if you paid work-related expenses for the care of more than one qualifying person at any time during the year. Freetaxreturns Reduced Dollar Limit If you received dependent care benefits that you exclude or deduct from your income, you must subtract that amount from the dollar limit that applies to you. Freetaxreturns Your reduced dollar limit is figured on Form 2441, Part III. Freetaxreturns See Dependent Care Benefits , earlier, for information on excluding or deducting these benefits. Freetaxreturns Example 1. Freetaxreturns George is a widower with one child and earns $24,000 a year. Freetaxreturns He pays work-related expenses of $2,900 for the care of his 4-year-old child and qualifies to claim the credit for child and dependent care expenses. Freetaxreturns His employer pays an additional $1,000 under a dependent care benefit plan. Freetaxreturns This $1,000 is excluded from George's income. Freetaxreturns Although the dollar limit for his work-related expenses is $3,000 (one qualifying person), George figures his credit on only $2,000 of the $2,900 work-related expenses he paid. Freetaxreturns This is because his dollar limit is reduced as shown next. Freetaxreturns   George's Reduced Dollar Limit 1) Maximum allowable expenses for one qualifying person $3,000 2) Minus: Dependent care benefits George excludes from income −1,000 3) Reduced dollar limit on expenses George can use for the credit $2,000 Example 2. Freetaxreturns Randall is married and both he and his wife are employed. Freetaxreturns Each has earned income in excess of $6,000. Freetaxreturns They have two children, Anne and Andy, ages 2 and 4, who attend a daycare facility licensed and regulated by the state. Freetaxreturns Randall's work-related expenses are $6,000 for the year. Freetaxreturns Randall's employer has a dependent care assistance program as part of its cafeteria plan, which allows employees to make pre-tax contributions to a dependent care flexible spending arrangement. Freetaxreturns Randall has elected to take the maximum $5,000 exclusion from his salary to cover dependent care expenses through this program. Freetaxreturns Although the dollar limit for his work- related expenses is $6,000 (two or more qualifying persons), Randall figures his credit on only $1,000 of the $6,000 work-related expense paid. Freetaxreturns This is because his dollar limit is reduced as shown next. Freetaxreturns   Randall's Reduced Dollar Limit 1) Maximum allowable expenses for two qualifying persons $6,000 2) Minus: Dependent care benefits Randall selects from employer's cafeteria plan and excludes from income −5,000 3) Reduced dollar limit on expenses Randall can use for the credit $1,000 Amount of Credit To determine the amount of your credit, multiply your work-related expenses (after applying the earned income and dollar limits) by a percentage. Freetaxreturns This percentage depends on your adjusted gross income shown on Form 1040, line 38, or Form 1040A, line 22. Freetaxreturns The following table shows the percentage to use based on adjusted gross income. Freetaxreturns   IF your adjusted gross income is: THEN the percentage is:       Over   But not over         $0   $15,000   35%       15,000   17,000   34%       17,000   19,000   33%       19,000   21,000   32%       21,000   23,000   31%       23,000   25,000   30%       25,000   27,000   29%       27,000   29,000   28%       29,000   31,000   27%       31,000   33,000   26%       33,000   35,000   25%       35,000   37,000   24%       37,000   39,000   23%       39,000   41,000   22%       41,000   43,000   21%       43,000   No limit   20%   How To Claim the Credit To claim the credit, you can file Form 1040 or Form 1040A. Freetaxreturns You cannot claim the credit on Form 1040EZ. Freetaxreturns Form 1040 or 1040A. Freetaxreturns   You must complete Form 2441 and attach it to your Form 1040 or 1040A. Freetaxreturns Enter the credit on Form 1040, line 48, or Form 1040A, line 29. Freetaxreturns Limit on credit. Freetaxreturns   The amount of credit you can claim is generally limited to the amount of your tax. Freetaxreturns For more information, see the Instructions for Form 2441. Freetaxreturns Tax credit not refundable. Freetaxreturns   You cannot get a refund for any part of the credit that is more than this limit. Freetaxreturns Recordkeeping. Freetaxreturns You should keep records of your work-related expenses. Freetaxreturns Also, if your dependent or spouse is not able to care for himself or herself, your records should show both the nature and the length of the disability. Freetaxreturns Other records you should keep to support your claim for the credit are described earlier under Provider Identification Test . Freetaxreturns Employment Taxes for Household Employers If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer. Freetaxreturns If you are a household employer, you will need an employer identification number (EIN) and you may have to pay employment taxes. Freetaxreturns If the individuals who work in your home are self-employed, you are not liable for any of the taxes discussed in this section. Freetaxreturns Self-employed persons who are in business for themselves are not household employees. Freetaxreturns Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business. Freetaxreturns If you use a placement agency that exercises control over what work is done and how it will be done by a babysitter or companion who works in your home, the worker is not your employee. Freetaxreturns This control could include providing rules of conduct and appearance and requiring regular reports. Freetaxreturns In this case, you do not have to pay employment taxes. Freetaxreturns But, if an agency merely gives you a list of sitters and you hire one from that list, and pay the sitter directly, the sitter may be your employee. Freetaxreturns If you have a household employee, you may be subject to: Social security and Medicare taxes, Federal unemployment tax, and Federal income tax withholding. Freetaxreturns Social security and Medicare taxes are generally withheld from the employee's pay and matched by the employer. Freetaxreturns Federal unemployment (FUTA) tax is paid by the employer only and provides for payments of unemployment compensation to workers who have lost their jobs. Freetaxreturns Federal income tax is withheld from the employee's total pay if the employee asks you to do so and you agree. Freetaxreturns For more information on a household employer's tax responsibilities, see Publication 926 and Schedule H (Form 1040) and its instructions. Freetaxreturns State employment tax. Freetaxreturns   You may also have to pay state unemployment tax. Freetaxreturns Contact your state unemployment tax office for information. Freetaxreturns You should also find out whether you need to pay or collect other state employment taxes or carry workers' compensation insurance. Freetaxreturns For a list of state unemployment tax agencies, visit the U. Freetaxreturns S. Freetaxreturns Department of Labor's website. Freetaxreturns A link to that website is in Publication 926, or you can find it with an online search. Freetaxreturns Prev  Up  Next   Home   More Online Publications
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Freetaxreturns 2. Freetaxreturns   Accounting Periods and Methods Table of Contents Introduction Useful Items - You may want to see: Accounting Periods Accounting MethodsCash Method Accrual Method Combination Method Inventories Uniform Capitalization Rules Special Methods Change in Accounting Method Introduction You must figure your taxable income and file an income tax return for an annual accounting period called a tax year. Freetaxreturns Also, you must consistently use an accounting method that clearly shows your income and expenses for the tax year. Freetaxreturns Useful Items - You may want to see: Publication 538 Accounting Periods and Methods See chapter 12 for information about getting publications and forms. Freetaxreturns Accounting Periods When preparing a statement of income and expenses (generally your income tax return), you must use your books and records for a specific interval of time called an accounting period. Freetaxreturns The annual accounting period for your income tax return is called a tax year. Freetaxreturns You can use one of the following tax years. Freetaxreturns A calendar tax year. Freetaxreturns A fiscal tax year. Freetaxreturns Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Freetaxreturns A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Freetaxreturns Calendar tax year. Freetaxreturns   A calendar tax year is 12 consecutive months beginning January 1 and ending December 31. Freetaxreturns   You must adopt the calendar tax year if any of the following apply. Freetaxreturns You do not keep books. Freetaxreturns You have no annual accounting period. Freetaxreturns Your present tax year does not qualify as a fiscal year. Freetaxreturns Your use of the calendar tax year is required under the Internal Revenue Code or the Income Tax Regulations. Freetaxreturns   If you filed your first income tax return using the calendar tax year and you later begin business as a sole proprietor, you must continue to use the calendar tax year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval. Freetaxreturns For more information, see Change in tax year, later. Freetaxreturns   If you adopt the calendar tax year, you must maintain your books and records and report your income and expenses for the period from January 1 through December 31 of each year. Freetaxreturns Fiscal tax year. Freetaxreturns   A fiscal tax year is 12 consecutive months ending on the last day of any month except December. Freetaxreturns A 52-53-week tax year is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of a month. Freetaxreturns   If you adopt a fiscal tax year, you must maintain your books and records and report your income and expenses using the same tax year. Freetaxreturns   For more information on a fiscal tax year, including a 52-53-week tax year, see Publication 538. Freetaxreturns Change in tax year. Freetaxreturns   Generally, you must file Form 1128, Application To Adopt, Change, or Retain a Tax Year, to request IRS approval to change your tax year. Freetaxreturns See the Instructions for Form 1128 for exceptions. Freetaxreturns If you qualify for an automatic approval request, a user fee is not required. Freetaxreturns If you do not qualify for automatic approval, a ruling must be requested. Freetaxreturns See the instructions for Form 1128 for information about user fees if you are requesting a ruling. Freetaxreturns Accounting Methods An accounting method is a set of rules used to determine when and how income and expenses are reported. Freetaxreturns Your accounting method includes not only the overall method of accounting you use, but also the accounting treatment you use for any material item. Freetaxreturns You choose an accounting method for your business when you file your first income tax return that includes a Schedule C for the business. Freetaxreturns After that, if you want to change your accounting method, you must generally get IRS approval. Freetaxreturns See Change in Accounting Method, later. Freetaxreturns Kinds of methods. Freetaxreturns   Generally, you can use any of the following accounting methods. Freetaxreturns Cash method. Freetaxreturns An accrual method. Freetaxreturns Special methods of accounting for certain items of income and expenses. Freetaxreturns Combination method using elements of two or more of the above. Freetaxreturns You must use the same accounting method to figure your taxable income and to keep your books. Freetaxreturns Also, you must use an accounting method that clearly shows your income. Freetaxreturns Business and personal items. Freetaxreturns   You can account for business and personal items under different accounting methods. Freetaxreturns For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items. Freetaxreturns Two or more businesses. Freetaxreturns   If you have two or more separate and distinct businesses, you can use a different accounting method for each if the method clearly reflects the income of each business. Freetaxreturns They are separate and distinct only if you maintain complete and separate books and records for each business. Freetaxreturns Cash Method Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. Freetaxreturns However, if an inventory is necessary to account for your income, you must generally use an accrual method of accounting for sales and purchases. Freetaxreturns For more information, see Inventories, later. Freetaxreturns Income Under the cash method, include in your gross income all items of income you actually or constructively receive during your tax year. Freetaxreturns If you receive property or services, you must include their fair market value in income. Freetaxreturns Example. Freetaxreturns On December 30, 2012, Mrs. Freetaxreturns Sycamore sent you a check for interior decorating services you provided to her. Freetaxreturns You received the check on January 2, 2013. Freetaxreturns You must include the amount of the check in income for 2013. Freetaxreturns Constructive receipt. Freetaxreturns   You have constructive receipt of income when an amount is credited to your account or made available to you without restriction. Freetaxreturns You do not need to have possession of it. Freetaxreturns If you authorize someone to be your agent and receive income for you, you are treated as having received it when your agent received it. Freetaxreturns Example. Freetaxreturns Interest is credited to your bank account in December 2013. Freetaxreturns You do not withdraw it or enter it into your passbook until 2014. Freetaxreturns You must include it in your gross income for 2013. Freetaxreturns Delaying receipt of income. Freetaxreturns   You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. Freetaxreturns You must report the income in the year the property is received or made available to you without restriction. Freetaxreturns Example. Freetaxreturns Frances Jones, a service contractor, was entitled to receive a $10,000 payment on a contract in December 2013. Freetaxreturns She was told in December that her payment was available. Freetaxreturns At her request, she was not paid until January 2014. Freetaxreturns She must include this payment in her 2013 income because it was constructively received in 2013. Freetaxreturns Checks. Freetaxreturns   Receipt of a valid check by the end of the tax year is constructive receipt of income in that year, even if you cannot cash or deposit the check until the following year. Freetaxreturns Example. Freetaxreturns Dr. Freetaxreturns Redd received a check for $500 on December 31, 2013, from a patient. Freetaxreturns She could not deposit the check in her business account until January 2, 2014. Freetaxreturns She must include this fee in her income for 2013. Freetaxreturns Debts paid by another person or canceled. Freetaxreturns   If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as income. Freetaxreturns If you receive income in this way, you constructively receive the income when the debt is canceled or paid. Freetaxreturns For more information, see Canceled Debt under Kinds of Income in chapter 5. Freetaxreturns Repayment of income. Freetaxreturns   If you include an amount in income and in a later year you have to repay all or part of it, you can usually deduct the repayment in the year in which you make it. Freetaxreturns If the amount you repay is over $3,000, a special rule applies. Freetaxreturns For details about the special rule, see Repayments in chapter 11 of Publication 535, Business Expenses. Freetaxreturns Expenses Under the cash method, you generally deduct expenses in the tax year in which you actually pay them. Freetaxreturns This includes business expenses for which you contest liability. Freetaxreturns However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Freetaxreturns Expenses paid in advance. Freetaxreturns   You can deduct an expense you pay in advance only in the year to which it applies. Freetaxreturns Example. Freetaxreturns You are a calendar year taxpayer and you pay $1,000 in 2013 for a business insurance policy effective for one year, beginning July 1. Freetaxreturns You can deduct $500 in 2013 and $500 in 2014. Freetaxreturns Accrual Method Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. Freetaxreturns The purpose of an accrual method of accounting is to match income and expenses in the correct year. Freetaxreturns Income—General Rule Under an accrual method, you generally include an amount in your gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Freetaxreturns Example. Freetaxreturns You are a calendar year accrual method taxpayer. Freetaxreturns You sold a computer on December 28, 2013. Freetaxreturns You billed the customer in the first week of January 2014, but you did not receive payment until February 2014. Freetaxreturns You must include the amount received for the computer in your 2013 income. Freetaxreturns Income—Special Rules The following are special rules that apply to advance payments, estimating income, and changing a payment schedule for services. Freetaxreturns Estimated income. Freetaxreturns   If you include a reasonably estimated amount in gross income, and later determine the exact amount is different, take the difference into account in the tax year in which you make the determination. Freetaxreturns Change in payment schedule for services. Freetaxreturns   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a lower rate until you complete the services and then receive the difference. Freetaxreturns Advance payments for services. Freetaxreturns   Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. Freetaxreturns However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. Freetaxreturns However, you cannot postpone including any payment beyond that tax year. Freetaxreturns   For more information, see Advance Payment for Services under Accrual Method in Publication 538. Freetaxreturns That publication also explains special rules for reporting the following types of income. Freetaxreturns Advance payments for service agreements. Freetaxreturns Prepaid rent. Freetaxreturns Advance payments for sales. Freetaxreturns   Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods you hold primarily for sale to your customers in the ordinary course of your business. Freetaxreturns If the advance payments are for contracts involving both the sale and service of goods, it may be necessary to treat them as two agreements. Freetaxreturns An agreement includes a gift certificate that can be redeemed for goods. Freetaxreturns Treat amounts that are due and payable as amounts you received. Freetaxreturns   You generally include an advance payment in income for the tax year in which you receive it. Freetaxreturns However, you can use an alternative method. Freetaxreturns For information about the alternative method, see Publication 538. Freetaxreturns Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Freetaxreturns The all-events test has been met. Freetaxreturns The test has been met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Freetaxreturns Economic performance has occurred. Freetaxreturns Economic performance. Freetaxreturns   You generally cannot deduct or capitalize a business expense until economic performance occurs. Freetaxreturns If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or as the property is used. Freetaxreturns If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Freetaxreturns An exception allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. Freetaxreturns For more information on economic performance, see Economic Performance under Accrual Method in Publication 538. Freetaxreturns Example. Freetaxreturns You are a calendar year taxpayer and use an accrual method of accounting. Freetaxreturns You buy office supplies in December 2013. Freetaxreturns You receive the supplies and the bill in December, but you pay the bill in January 2014. Freetaxreturns You can deduct the expense in 2013 because all events that fix the fact of liability have occurred, the amount of the liability could be reasonably determined, and economic performance occurred in that year. Freetaxreturns Your office supplies may qualify as a recurring expense. Freetaxreturns In that case, you can deduct them in 2013 even if the supplies are not delivered until 2014 (when economic performance occurs). Freetaxreturns Keeping inventories. Freetaxreturns   When the production, purchase, or sale of merchandise is an income-producing factor in your business, you must generally take inventories into account at the beginning and the end of your tax year. Freetaxreturns If you must account for an inventory, you must generally use an accrual method of accounting for your purchases and sales. Freetaxreturns For more information, see Inventories , later. Freetaxreturns Special rule for related persons. Freetaxreturns   You cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until you make the payment and the corresponding amount is includible in the related person's gross income. Freetaxreturns Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. Freetaxreturns If a deduction is not allowed under this rule, the rule will continue to apply even if your relationship with the person ends before the expense or interest is includible in the gross income of that person. Freetaxreturns   Related persons include members of your immediate family, including only brothers and sisters (either whole or half), your spouse, ancestors, and lineal descendants. Freetaxreturns For a list of other related persons, see section 267 of the Internal Revenue Code. Freetaxreturns Combination Method You can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. Freetaxreturns However, the following restrictions apply. Freetaxreturns If an inventory is necessary to account for your income, you must generally use an accrual method for purchases and sales. Freetaxreturns (See, however, Inventories, later. Freetaxreturns ) You can use the cash method for all other items of income and expenses. Freetaxreturns If you use the cash method for figuring your income, you must use the cash method for reporting your expenses. Freetaxreturns If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Freetaxreturns If you use a combination method that includes the cash method, treat that combination method as the cash method. Freetaxreturns Inventories Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory and use the accrual method for purchases and sales of merchandise. Freetaxreturns However, the following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Freetaxreturns These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Freetaxreturns A qualifying taxpayer under Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2. Freetaxreturns A qualifying small business taxpayer under Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18. Freetaxreturns Qualifying taxpayer. Freetaxreturns   You are a qualifying taxpayer if: Your average annual gross receipts for each prior tax year ending on or after December 17, 1998, is $1 million or less. Freetaxreturns (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing by 3. Freetaxreturns ) Your business is not a tax shelter, as defined under section 448(d)(3) of the Internal Revenue Code. Freetaxreturns Qualifying small business taxpayer. Freetaxreturns   You are a qualifying small business taxpayer if: Your average annual gross receipts for each prior tax year ending on or after December 31, 2000, is more than $1 million but not more than $10 million. Freetaxreturns (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Freetaxreturns ) You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Freetaxreturns Your principal business activity is an eligible business (described in Publication 538 and Revenue Procedure 2002-28). Freetaxreturns Business not owned or not in existence for 3 years. Freetaxreturns   If you did not own your business for all of the 3-tax-year period used in figuring your average annual gross receipts, include the period of any predecessor. Freetaxreturns If your business has not been in existence for the 3-tax-year period, base your average on the period it has existed including any short tax years, annualizing the short tax year's gross receipts. Freetaxreturns Materials and supplies that are not incidental. Freetaxreturns   If you account for inventoriable items as materials and supplies that are not incidental, you will deduct the cost of the items you would otherwise include in inventory in the year you sell the items, or the year you pay for them, whichever is later. Freetaxreturns If you are a producer, you can use any reasonable method to estimate the raw material in your work in process and finished goods on hand at the end of the year to determine the raw material used to produce finished goods that were sold during the year. Freetaxreturns Changing accounting method. Freetaxreturns   If you are a qualifying taxpayer or qualifying small business taxpayer and want to change to the cash method or to account for inventoriable items as non-incidental materials and supplies, you must file Form 3115, Application for Change in Accounting Method. Freetaxreturns See Change in Accounting Method, later. Freetaxreturns More information. Freetaxreturns    For more information about the qualifying taxpayer exception, see Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2. Freetaxreturns For more information about the qualifying small business taxpayer exception, see Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18. Freetaxreturns Items included in inventory. Freetaxreturns   If you are required to account for inventories, include the following items when accounting for your inventory. Freetaxreturns Merchandise or stock in trade. Freetaxreturns Raw materials. Freetaxreturns Work in process. Freetaxreturns Finished products. Freetaxreturns Supplies that physically become a part of the item intended for sale. Freetaxreturns Valuing inventory. Freetaxreturns   You must value your inventory at the beginning and end of each tax year to determine your cost of goods sold (Schedule C, line 42). Freetaxreturns To determine the value of your inventory, you need a method for identifying the items in your inventory and a method for valuing these items. Freetaxreturns   Inventory valuation rules cannot be the same for all kinds of businesses. Freetaxreturns The method you use to value your inventory must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Freetaxreturns Your inventory practices must be consistent from year to year. Freetaxreturns More information. Freetaxreturns   For more information about inventories, see Publication 538. Freetaxreturns Uniform Capitalization Rules Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for production or resale activities. Freetaxreturns Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Freetaxreturns You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Freetaxreturns Activities subject to the uniform capitalization rules. Freetaxreturns   You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit. Freetaxreturns Produce real or tangible personal property. Freetaxreturns For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Freetaxreturns Acquire property for resale. Freetaxreturns Exceptions. Freetaxreturns   These rules do not apply to the following property. Freetaxreturns Personal property you acquire for resale if your average annual gross receipts are $10 million or less. Freetaxreturns Property you produce if you meet either of the following conditions. Freetaxreturns Your indirect costs of producing the property are $200,000 or less. Freetaxreturns You use the cash method of accounting and do not account for inventories. Freetaxreturns For more information, see Inventories, earlier. Freetaxreturns Special Methods There are special methods of accounting for certain items of income or expense. Freetaxreturns These include the following. Freetaxreturns Amortization, discussed in chapter 8 of Publication 535, Business Expenses. Freetaxreturns Bad debts, discussed in chapter 10 of Publication 535. Freetaxreturns Depletion, discussed in chapter 9 of Publication 535. Freetaxreturns Depreciation, discussed in Publication 946, How To Depreciate Property. Freetaxreturns Installment sales, discussed in Publication 537, Installment Sales. Freetaxreturns Change in Accounting Method Once you have set up your accounting method, you must generally get IRS approval before you can change to another method. Freetaxreturns A change in your accounting method includes a change in: Your overall method, such as from cash to an accrual method, and Your treatment of any material item. Freetaxreturns To get approval, you must file Form 3115, Application for Change in Accounting Method. Freetaxreturns You can get IRS approval to change an accounting method under either the automatic change procedures or the advance consent request procedures. Freetaxreturns You may have to pay a user fee. Freetaxreturns For more information, see the form instructions. Freetaxreturns Automatic change procedures. Freetaxreturns   Certain taxpayers can presume to have IRS approval to change their method of accounting. Freetaxreturns The approval is granted for the tax year for which the taxpayer requests a change (year of change), if the taxpayer complies with the provisions of the automatic change procedures. Freetaxreturns No user fee is required for an application filed under an automatic change procedure generally covered in Revenue Procedure 2002-9. Freetaxreturns   Generally, you must use Form 3115 to request an automatic change. Freetaxreturns For more information, see the Instructions for Form 3115. Freetaxreturns Prev  Up  Next   Home   More Online Publications