How do I get around the fact that TurboTax is not recognizing S-corp income as earned income (Schedule K) for dependent care expenses?

[ri4kki]

We are unable to enter child care credit expenses in TurboTax. My husband is a business owner and has an S corporation. Turbotax does not recognize that as earned income. I keep getting a response that we don't qualify due to no earned income from both parents.

[LudwigVan_fan]

Earned income is a requirement for tax credit for dependent care expenses.

Earned income includes wages, commissions, net-earnings from self-employment subject to self-employment tax, net Sch C, net Sch F, etc.

Income reported on Sch K-1 from an 1120S is NOT considered earned income.  It is not subject to self-employment tax or subject to FICA withholding.  Therefore, it is not considered earned income for any purposes that require earned income.

Having worked for the 1120S corporation, your husband should have taken a W-2 wage out of the the corporation.  That would be compensation/earned income.

See the following:

https://www.irs.gov/uac/about-publication-503

https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/earned-income

Note: when they say you own a business, they are referring to Sch C and/or Sch F where the earnings are subject to self-employment tax.

If this were a Sch K-1 from a 1065, and the K-1 indicated the earnings were subject to self-employment tax, then that would be considered earned income. 

[kfitzpatrick4]

We have the same problem as the original poster and my husband's income IS being reported on a 1065 as subject to self-employment tax. You said: "If this were a Sch K-1 from a 1065, and the K-1 indicated the earnings were subject to self-employment tax, then that would be considered earned income." Yet, Turbotax is not recognizing this as earned income. (We confirmed this by instead adding the income as self-employed income and then the tax credit shows up. However, that obviously then double-counts the income as a K-1 and Self-Employed income.)

[LudwigVan_fan]

I know more about tax law...not the ins and outs of entering information into TT.

I'm not sure how to solve your problem, other than to carefully enter the information from the K-1 into TT.  I would guess that when you enter the income from the K-1, it should ask or there should be a box to check to show that the income is subject to self-employment.  I would hope that if that is entered correctly, SE tax should be computed on the K-1 income to SE tax.  If the SE tax is there, then it should show up it as earned income.

I'm guessing your problem is data entry into the correct boxes in TT.  Hopefully someone else would be able to tell you exactly how to enter it.

[tagteam]

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@kfitzpatrick4 wrote:

Yet, Turbotax is not recognizing this as earned income. 

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If the 1065 and your K-1 was prepared properly, according to your assertion that the income is subject to self-employment tax, then there should be a figure on Line 14 (with an A code).

[duraiyarasan]

I thought it was bug in Turbo Tax, seems it's not.

We are not eligible even though a person has W2 income and his/her spouse have K1 (Business Income). My spouse worked and owner for the business. Seems the business owner have to take Salary (W2) or worked as Independent contractor (1099)

[DianeC958]

If the K-1 is from an S-Corp then Yes the owner needs to take a W-2 wage from the business. 

If the business is a partnership (form 1065) then the amount that are considered wages show in Box 14 of the K-1 to be taxed for Social Security and Medicare.

If neither of these situations occurred for 2019 then your spouse is not showing any earned income which makes you ineligible for the Child Care Credit.

What is Earned Income?

@duraiyarasan

[LudwigVan_fan]

If you receive a W-2, wage income, that should qualify.  But if the business is an 1120S and you don't take a salary, the ordinary income distribution on the 1120S K-1 does not qualify as earned income.  Same for a partnership unless the income from the partnership is in the boxes for SE income.

The problem might be that unless the spouse is either a student or receiving earned income, you wouldn't qualify for the child care credit.  It was meant to help out people who are working for earned income and/or students.  That was the original intent.