Tax optimization strategies for Grandparent watching Grandchild

[John201]

My mother watches our daughter on a full-time basis.  She refuses any payment for her services, so it should be pretty vanilla from a tax standpoint, but there are some unique aspects of our arrangement that have me thinking we could better optimize both of our tax situations.  

Here's the basic facts:

• She watches our 2YO daughter at our condo on a full-time basis while my wife and I work
• She resides at a 2nd condo we purchased for her to live in during the week.  She lives 2 hours away in a different state.  We pay all expenses related to the 2nd condo
• She does not accept payment for her services
• She is retired, but my father is still employed.
• She incurs travel expenses to get here
• We do not claim any childcare expenses on our tax return

Does anyone have any ideas of how to optimize both of our tax situations? We've kept it rather simple to date but it feels like we could be smarter about the situation.

Thanks,

John

[NCperson]

are you deducting the taxes and interest costs on the other condo as a 'second home'? 

[Hal_Al]

Taxes are complicated, but basically there's no tax advantages to be had from your situation.

The most common variant is where it is necessary for the grandparent to claim the income in order to allow the parents to claim the dependent care credit.  There is an exception to the "nanny tax" (social security and Medicare tax) when the grandparent sits in your home.  But, income tax is still due.

Mileage is not deductible. 

Adding her income to your parents joint return might put them in a higher bracket. At a minimum, her income would be taxed at their marginal rate. 

[John201]

@NCperson Yes for tax purposes we classified the 2nd condo as a 'second home'  and not an investment

[Opus 17]

If you are eligible for a dependent care flexible spending account at work, to which the maximum contribution is $5000, we can imagine a scenario where you are in the 22% or 24% tax bracket and your parents are in the 15% bracket. If you paid your mother the $5000, then you would save about $1200 on your taxes and your parents would pay about $750 extra on their taxes.  Whether that small advantage is really worth it is for you and your parents to decide.

If you were not eligible to contribute to an FSA,  you would barely break even by claiming the child care expense credit, because the eligible wages and percentage of savings are lower for that credit.  And if your parents are in the same or higher tax bracket than you, then whatever you save will be more than offset by increased taxes paid by them.

The math really only works to everyone’s advantage when the grandparents taxable income is low enough that the wages paid to them are not subject to income tax.