If you are currently caring for a foster child, or considering doing so, there are several tax benefits of which you should be aware. This analysis is pertinent for those that will be taking a foster child into their home—for reasons other than profit—and that an agency is going to make monthly payments for so long as you provide the foster care. Questions that arise are how foster parents should treat those payments for tax purposes, whether you can deduct your expenses in raising the foster child, and whether there are any other tax aspects to providing foster care.
Exclusion of the payments from the agency from your income. You will be able to exclude the payments only if the payments are made under a foster care program of a state or local government and the agency making the payments is either part of the state or local government or is licensed or certified by the state or local government. Also, the agency which is placing the child with you must be either part of the state or local government or licensed or certified by the state or local government.
If your foster child has no physical, mental or emotional handicaps, another requirement for exclusion is that the payments be made for caring for the child in your principal home. The payments must be made because you are paying expenses in supporting the child and not for the value of your services. Expenses for the support of the child include expenses for shelter, food, utilities, furniture and household incidentals, recreation, transportation, clothing, education, medical care, grooming and other personal needs and a spending allowance.
If your child has a physical, mental or emotional handicap, you can also exclude from income any payments which the payor designates in writing as having been made because (and which are actually made because) the state has determined that the payments are necessary to compensate you, beyond your expenses, for additional care provided by you in your principal home because of the handicap.
Charitable deductions for unreimbursed expenses. If the placing agency is a government agency or an agency exempt from income taxes and eligible to receive contributions for which the giver can get a charitable deduction (aka a 501(c)(3) organization, you can get a charitable deduction for unreimbursed out-of-pocket expenses paid by you for the support of the child. Support includes those expenses described above for the income exclusion. You may take the charitable deduction only if the foster parents have no profit motive in providing the care and the foster child does not also qualify as the foster parents’ dependent.
You should keep records of the expenses to meet the general requirements for a charitable deduction and so that the purposes of the payments to you can be compared with the expenses for which you wish to take a charitable deduction. Any portion of the payments to you that doesn’t reimburse you for those expenses won’t reduce your charitable deduction, even if the portion is excludible from your income as described above. For example, say that you receive $10,000 of excludible payments from the agency, of which $4,000 is allocable to your out-of-pocket expenses for the child, and $6,000 to indirect expenses, such as the child’s share of the cost of shelter. (One way to make this allocation is by consulting the manual used by the agency that makes the payments.) Your actual out-of-pocket expenses amount to $5,000. In that case, you will be entitled to a $1,000 charitable deduction ($5,000 − $4,000) in addition to the $10,000 exclusion.
The records should include an expense journal (noting the purpose, amount, date and payee for each expense), cancelled checks and receipts. You will also need to get from the placement agency, each year before the earlier of when you file your return or the return due date (including extensions), a written statement containing a description of the service you are performing, the dates of service, a statement of whether or not the agency is providing any goods and services to you in exchange for your unreimbursed expenses and, if so, a description and good faith estimate of the value of such goods and services.
To qualify for the charitable deduction, the expenses must be paid during the tax year, should be for the exclusive benefit of your foster child and shouldn’t be paid to buy or improve property in which you retain any interest. You may, however, deduct an allocable share of a collective family expense. For example, you may deduct the share of your utility bills reflecting the additional use necessitated by the foster child.
This discussion of your possible charitable deduction assumes that none of your expenses are for property, which, if you sold it, would require you to report a tax gain and that no single item of property that you contribute to your child’s support is worth more than $500. You should be aware also that there are overall limitations on the total amount of charitable deductions you are allowed for a year. They depend on the nature of the placement agency and the other organizations to which you make charitable contributions, the nature and use of any non-cash contributions which you make to other organizations and possible carryovers of deferred charitable deductions to the tax year in question. I am, of course, available to discuss with you how these overall limitations apply to your situation.
Dependency deduction for foster child. You can claim a dependency deduction for a foster child for any year in which the child had the same principal place of abode as you for more than half the year and didn’t provide more than half of his or her own support. It makes no difference how much income the child had, so long as the child (1) was less than 19 years of age at year-end or (2) was less than 24 years of age at year-end and was a full-time student for five months during the year.
In determining whether the child provided more than half of his or her own support, payments you receive for care of the foster child from a child placement agency are considered support provided by the agency. Similarly, payments from a state or county for foster care are considered support provided by the state or county.
Child Tax Credit. The child tax credit allows you to claim a credit of $1,000 for each qualifying child. Thus, for example, a taxpayer with four qualifying children will be entitled to a credit of $4,000.
A qualifying child is someone who (1) lives in your home for over half the year, (2) is your child, stepchild, adopted child, or foster child, or your brother or sister or stepsibling (or a descendant of any of these), (3) is under 17 years old at the close of the year, (4) does not provide over half of his or her own support for the year, and (5) is a U.S. citizen or resident. For tax years beginning after Dec. 31, 2008, the qualifying child must also be younger than you, must not file a joint return (other than a joint return filed solely to get a refund), and must be someone for whom you are allowed a dependency deduction. Special “tie-breaking” rules apply where a person may be claimed as the qualifying child of more than one taxpayer.
Head-of-household filing status. If your foster child qualifies as your dependent under the above rules, and (a) you paid more than half the cost of keeping up your home for the year, (b) you are unmarried the end of the tax year, (c) you aren’t a “surviving spouse” (that is, your spouse didn’t die in the two years before this tax year and you meet certain other requirements), and (d) you weren’t a nonresident alien at any time during the tax year, then you are entitled to file your income tax return as “head of household.” This entitles you to lower tax rates and a higher standard deduction than single taxpayers or married taxpayers who file separate returns.
If you have any questions about the above rules, please call me and we can discuss your situation.
Steve Trojan, CPA is owner of SMT & Associates, Inc, a Crystal Lake IL based tax and accounting firm, and Complete Payroll Inc, (www.completepayrollinc.com) a payroll processing firm.