Planning to use Dependent care FSA to pay grandparents for taking care of kid at our home in cash. Should I or them need to show anything on paper in terms of tax filing?

[vhomer1977]

Ok so does that mean I don’t even have to issue a W-2 to my mother. Can I just pay her cash and she claim it as income?

then begs the question is which option to pick as in reality it was a mixture of our house and her home.  

Is one or other method more beneficial for my mother (who is retired and on SS and some investment income) ?

[Hal_Al]

"What if my mother in law is currently unemployed and is collecting unemployment". 

Nothing changes, tax wise.  Unemployment Compensation is  taxable income. as is the baby sitting income.

As to how baby sitting income affects her Unemployment Compensation, you'll nee to contact the state unemployment office.  It's my understanding, that income must be reported in most states and will most likely reduce her compensation. 

[Hal_Al]

Q. Ok so does that mean I don’t even have to issue a W-2 to my mother? Can I just pay her cash and she claim it as income?

A.  As previously stated, a W-2 is not mandatory, but some recommend it.  The most important thing is that she report it as income. 

Q. That begs the question is which option to pick as in reality it was a mixture of our house and her home.  Is one or other method more beneficial for my mother (who is retired and on SS and some investment income).

A.  As previously stated,  Household employee (HSH) is better for her, as she does not have to pay social security and income tax, under the grandma (or $2200) exception.  But, she MUST report the money from the work in her home, as self employment.  I'm not sure if she would be allowed to report the other portion as HSH income, since that work was for the same client (you) as her self employment.  

.

[Kilulululu]

Hi, I read through all the responses and I am still a little bit confused. It seems like there is a grandparents exception applied to pay your parents for babysitting. I am thinking to hire my uncle to babysit my son for a month in my house and I will pay him using DCFSA fund. From what I read, it seems like he is qualified as household employee, does that mean I have to issue him a W2 and pay social security tax and other withholding tax for him since his is not my parent? Thanks!

[Opus 17]

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@Kilulululu wrote:

Hi, I read through all the responses and I am still a little bit confused. It seems like there is a grandparents exception applied to pay your parents for babysitting. I am thinking to hire my uncle to babysit my son for a month in my house and I will pay him using DCFSA fund. From what I read, it seems like he is qualified as household employee, does that mean I have to issue him a W2 and pay social security tax and other withholding tax for him since his is not my parent? Thanks!

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You should review tax topic 756 and publication 926 which is linked there.

https://www.irs.gov/taxtopics/tc756

To spend funds from a DCFSA, you must provide sufficient proof to the plan administrator to satisfy IRS regulations. This might include receipts, canceled checks, and/or a W-10 form with the provider's social security number.  This is separate from income tax reporting.

For income tax purposes, if you pay someone to work in your home, they are your household employee.  If you pay them more than $2,200 in a year, you must give them a W-2.  You must also withhold and pay household employee's tax and social security and medicare tax for the employee, unless they are your child or your parent (or your spouse's parent if you are married). 

For the social security and medicare tax, you have two options.  Option 1 would be to withhold from their pay.  For example, if you agree that the will be paid $100 per day, you would actually pay $92.35 per day.  The $7.65 represents social security and medicare tax.  On your tax return, you will pay $15.30 of household employee tax, which represents $7.65 from the employee and $7.65 from you.

Or, you could pay the employee the straight $100. Your household employee tax would still amount to $15.30, but coming all from you.  (Technically, you are paying $107.65 in wages and withholding $7.65.)

This is all covered here. Publication 926, Household Employer's Tax Guide PDF

If you are only paying your uncle for one month, it may be less than the $2,200 threshold in which case you don't need to issue a W-2 or pay HHE tax.  Your uncle would be on the honor system whether or not to report the income on their tax return without a W-2.  However, you will still need adequate proof of the expense for the DCFSA administrator.

[Edited to add]

Additionally, when you file your tax return, you must provide the name, address and SSN of the care provider in order for the DCFSA to be qualified as tax-free.  This is required regardless of whether the care provider is your employee or not, and regardless of whether they fall above or below the $2,200 threshold for filing a W-2 for them.

[michiganner]

Hi, Patgada, I am having the same problem this year. My wife parents have been in our house to take care of our children for a couple month and I am planning to pay them with the FSA childcare money (even though, they initially didn't ask for money ). I have email FSA to ask to paper work should I do and I never get any reply from them. 

Since your post was from 2019, I am wondering how did you solve this problem. What paper work did you submit to FSA to get the money back and how did you do tax? 

Thank you very much.

[Chillkann]

Thank you for all the responses. It makes amply clear what the process is, except there is one situation that I haven't come across in all the questions and the corresponding replies:

What if a relative who is visiting us from outside the country and does not have an SSN or an ITIN but did help us with taking care of the baby for 6 months, can we pay her via the FSA funds? 

[Opus 17]

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@Chillkann wrote:

Thank you for all the responses. It makes amply clear what the process is, except there is one situation that I haven't come across in all the questions and the corresponding replies:

What if a relative who is visiting us from outside the country and does not have an SSN or an ITIN but did help us with taking care of the baby for 6 months, can we pay her via the FSA funds? 

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You have two complex issues here, one much more than the other.

First, you need to provide some kind of information about the caregiver to get the FSA administrator to release the funds.  Normally this would be an SSN or ITIN, international tax ID number.  However, a non-resident alien can't usually get an ITIN until they file a tax return.  So you will need to contact the FSA administrator to ask them what documents they would require to release the funds.

Then, tax issues for employers of aliens is complex.  There are two things to resolve first,

a) is the relative your parent (or your spouse's parent)?

b) does your relative pass the substantial presence test, which makes them a resident alien?

https://www.irs.gov/individuals/international-taxpayers/substantial-presence-test

You said "6 months" -- if they are in the US more than half the year (183 or more days) they are a resident alien; if 182 days or less, they are may be a non-resident alien, depending on their time in the US is previous years.

For a resident alien, the tax laws are the same as for a US citizen.  You must pay household employee tax and issue a W-2.  If the person is your parent, you don't have to pay household employee tax, and if you pay less than $2200 in wages, you don't have to issue a W-2.

You must issue the W-2 even if the person is not legally allowed to work in the US -- the IRS won't inform on ICE, but they want their money.  I don't know how you would do this, unless the person already has an ITIN from a previous year.  I suppose you might skip the W-2, and the person includes the income on a tax return with "HHE" next to it, and they can apply for an ITIN as part of filing the tax return.  

If the person is a non-resident alien, you may be required to withhold 30% of their income for tax purposes and send it to the IRS.  They would get it back as a refund if they file a tax return and owe less than 30% income tax.  If they are a non-resident alien, they would file a form 1040-NR which is not covered by Turbotax, they would need a different tax software company.  

Overall, I would say if the person passes the substantial presence test and already has an ITIN, then you can pay them under the same rules as if they were a US citizen, so go ahead and do it if you think you understand those rules.  If the person does not pass the substantial presence test, I would be concerned about all the things that could go wrong, and I'm not sure that your tax savings would be enough to pay for the professional advice you probably need. 

[rontana1]

• @Opus 17 

So here's my question.  Due to Covid we aren't using all of our FSA funds for daycare to pay our typical provider because they shut down for a period of time.  My mother-in-law watched our kids in her home for 3 weeks this summer while we were working so we paid her $1,500 for those three weeks.   We submitted her name, address, ssn, etc. to our FSA plan administrator and were reimbursed that amount.   Now for tax purposes here are my questions:

1.  Does our FSA plan administrator automatically report her information to the IRS once they send us our reimbursement?

2. Do I need to issue her a 1099-Misc?

3.  If I do issue the 1099-Misc do I file that with the IRS too or just hold it since we're individuals and not a company? 

4. Since we won't be claiming the dependent care credit due to use of the FSA funds and not exceeding the amount we allotted do we need to list her on our returns on form 2441 or do we even fill that out at this point?  (in past years we'd use all $5,000 of FSA funds and then claim the 20% on the extra $1,000 since our child care expenses pre-covid were always over $8,000).

5.  Where does my mother-in-law claim the amount we paid her since she provided the services in her home?  Does she need to do a schedule "C" or does she just claim it as other income or somewhere else?  She does not run a daycare, just watched her grandkids to help us out so it's not really a profit making endeavor for her.   

Thanks, just want to make sure I get this right. 

[rontana1]

@Opus 17 
So here's my question. Due to Covid we aren't using all of our FSA funds for daycare to pay our typical provider because they shut down for a period of time. My mother-in-law watched our kids in her home for 3 weeks this summer while we were working so we paid her $1,500 for those three weeks. We submitted her name, address, ssn, etc. to our FSA plan administrator and were reimbursed that amount. Now for tax purposes here are my questions:
1. Does our FSA plan administrator automatically report her information to the IRS once they send us our reimbursement?
2. Do I need to issue her a 1099-Misc?
3. If I do issue the 1099-Misc do I file that with the IRS too or just hold it since we're individuals and not a company?
4. Since we won't be claiming the dependent care credit due to use of the FSA funds and not exceeding the amount we allotted do we need to list her on our returns on form 2441 or do we even fill that out at this point? (in past years we'd use all $5,000 of FSA funds and then claim the 20% on the extra $1,000 since our child care expenses pre-covid were always over $8,000).
5. Where does my mother-in-law claim the amount we paid her since she provided the services in her home? Does she need to do a schedule "C" or does she just claim it as other income or somewhere else? She does not run a daycare, just watched her grandkids to help us out so it's not really a profit making endeavor for her.

Thanks, just want to make sure I get this right.

[Opus 17]

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@rontana1 wrote:

1. I don't know.

2. No.  Only businesses need to issue 1099s.

3. See 2.

4. You still need to file form 2441 to reconcile the DCFSA with your spending.  The DCFSA is reported in box 10 of your W-2 so Turbotax will require you to complete the form.  You will indicate how much you paid for qualified care, and also how much money was either forfeited or carried forward to 2021 in the account.  If all the money was either spent for qualified care or forfeited, you won't owe any additional tax, but you have to report it so form 2441 resolves the W-2 box 10 amount. 

5. Normally for a business she would include a schedule C in her return.  She reports the income, deducts expenses, and pays income tax plus self-employment tax on the net profit.  Expenses for a home day care can include meals and a share of the rent or mortgage, utilities and so on.  Although the household expenses might be a small amount for only 3 weeks. 

Since this is not an ongoing trade or business, she could report it as hobby income, and only pay income tax and not the self-employment tax, but she can't deduct expenses. 

[Chillkann]

@Opus 17 Thank you. To follow up on the thread below:

a) is the relative your parent (or your spouse's parent)? -- Yes, my Mother In Law.

b) does your relative pass the substantial presence test, which makes them a resident alien? -- Yes she does since she couldn't travel back due to COVID restrictions and exceeded 183 days with an extended visa.

The DCSA plan administrator has agreed to disburse the amount and asked us for the VISA number  to be included in their form for disbursement. I plan to apply for an ITIN for my Mother In-law and also issue a W2 since the amount is over $2,200. Once I have the ITIN, I will contact the DCSA plan administrator and update the VISAnumber with the ITIN number.

My question is, what if in the process of applying for ITIN something goes wrong and the ITIN is not issued, then is there a way that I can return the money back to DCSA? or can I have it reported as taxable income via a Tax amendment and attach a cover letter explaining the circumstances? In short, once the money is disbursed from the DCSA account, can it be returned or filed as a taxable income?

[Opus 17]

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@Chillkann wrote:

My question is, what if in the process of applying for ITIN something goes wrong and the ITIN is not issued, then is there a way that I can return the money back to DCSA? or can I have it reported as taxable income via a Tax amendment and attach a cover letter explaining the circumstances? In short, once the money is disbursed from the DCSA account, can it be returned or filed as a taxable income?

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We're getting outside my expertise, @pk might be able to help.

The tricky thing is that a person can't normally get an ITIN unless they file a return showing US income, unless they fall into one of the exception categories.  If you can get an ITIN quickly and without filing a return, I would do that.  Assuming you can't, your order of actions will probably be something like this:

1. Parent files a tax return listing household employee income, without a W-2.  They would put the income on line 1 and write "HSH" next to it.  This can probably be done in Turbotax online by searching for "household employee" in the program, it should be in the "other uncommon income" section.

2. Parent mails the W-7, any required proof, and the tax return, to the IRS address for processing the ITIN application.  

3. The IRS assigns an ITIN, mails it to your MIL, and forwards the tax return for processing.

4. You use the ITIN to claim the dependent care credit/FSA reimbursement on form 2441.  This means you may file your tax return late.  Get an extension if needed.

5. You skip filing the W-2 this year since it's basically impossible (at best, you would be filing it very late.)

Here is another possible workflow.

1. Parent files a tax return using "HSH" to declare the income, and sends it along with the ITIN application to the IRS office.
2. At the same time, you file your tax return.  Without a valid  tax number for the care provider, you leave the SSN field blank.  Turbotax won't let you e-file but should let you print your return.  Write "ITIN applied for" in the box for the caregiver's tax number.  Sign the return and file by mail, and include a written statement that gives your mother-in-law's name, date of birth, address, visa number, and explains that she is reporting the income on a tax return that has been filed with an ITIN application.  

On the issue of the DCFSA, the IRS places the compliance burden on the administrator, not you.  There's nothing in the law that I know of that would require you to repay the money, or pay a penalty on your tax return if no ITIN were issued.  

[ss74]

I probably have a similar question to most of these posts but maybe a slightly different scenario. I paid my in-laws ($2150) last year to provide care for my son at their house using our dependent care FSA. Where do my in-laws input this income information in Turbotax? They are not my dependents.

[Opus 17]

@ss74 

someone who is paid to perform a service in  their own home would generally be considered self-employed. They would be required to file a schedule C to report their business income, deduct any business expenses, and pay income tax plus self-employment tax on the net profit.

If the DCFSA checks were made out to one grandparent, it would be simplest for that grandparent to have a schedule C and declare all the money as their business income. However, if both grandparents actually perform services, it would be legally acceptable for both grandparents to include a schedule C on their tax return each reporting their share of the income and expenses. (But more complicated.)

Expenses can include transportation (if they transported the child to activities out of the home and if they have records), can include meals, and potentially a deduction of part of their utilities and other household expenses for business use of their home.

Some IRS information is here.  
https://www.irs.gov/pub/irs-pdf/p587.pdf