Child-care-pretax-with-Sch-C-loss

Question of the Week 10/23/19: Reporting dependent care benefits with a
Schedule C loss
Q. The clients are a married couple; the husband is self-employed and the wife is a
salaried employee at a local company. As she has done for the past few years, in 2019 she
contributed the maximum $5,000 to her employer’s dependent care FSA for their three-year
old’s day care. They have used the entire dependent care benefit. Unfortunately, the
husband’s business took a downturn mid-year and he will most likely have an operating
loss for the year. Since his 2019 earned income is $0, will her entire $5,000 DCB be
taxable?
A. Possibly not. The client may be able to use a special self-employment tax calculation
that will provide earned income for dependent care benefit (DCB) purposes.
Ordinarily, self-employed taxpayers report net profit from self-employment less the
deduction for one-half of self-employment tax as their earned income on Form 2441, Child
and Dependent Care Expenses. A taxpayer with a loss thus has no earned income for
either the credit for child and dependent care expenses or for tax-free DCBs.
Your client may be able to use an optional method to figure net earnings from selfemployment.
For a nonfarm business to qualify:
• Current year net profits must be less than $5,891 and less than 72.189% of gross
income, and
• The business must have net earnings from self-employment of at least $400 in any
two of the prior three years.
A business with a loss would meet the first requirement. If the second requirement is met
as well, your client can figure self-employment tax on two-thirds of gross income to a
maximum of $5,440. For example, if your client’s business had gross income of $10,000,

optional self-employment income would be the maximum $5,440, which is less than
$6,666 ($10,000 × 2/3).
For DCB purposes, earned income to include on Form 2441 is equal to the optional selfemployment
income less one-half of self-employment tax. Continuing with the example,
earned income would be $5,024 ($5,440 – $416) and the entire $5,000 DCB would be taxfree.
If the client doesn’t qualify for the optional method the DCB would be taxable.
The optional method is usually beneficial for taxpayers, but the tax savings as well as any
changes to refundable credit calculations (earned income credit and additional child tax
credit) should be weighed against the self-employment tax obligation. The optional
method may be used for a maximum of five years.
See the Form 2441 Instructions and Schedule SE Instructions.
H&R Block Info
Originally published in the 10/23/19 edition of TAX in the News
Legal & IRS Information
IRS Publications
Pub. 503, Child and Dependent Care Expenses
IRS Forms/Instructions
Schedule SE (Form 1040) Instructions
Form 2441 Instructions
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