[Federal Register Volume 71, Number 100 (Wednesday, May 24, 2006)]
[Proposed Rules]
[Pages 29847-29854]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-7390]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[REG-139059-02]
RIN 1545-BB86


Expenses for Household and Dependent Care Services Necessary for 
Gainful Employment

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations regarding the 
credit for expenses for household and dependent care services necessary 
for gainful employment. The proposed regulations reflect statutory 
amendments under the Deficit Reduction Act of 1984, the Omnibus Budget 
Reconciliation Act of 1987, the Family Support Act of 1988, the Small 
Business Job Protection Act of 1996, the Economic Growth and Tax Relief 
Reconciliation Act of 2001, the Job Creation and Worker Assistance Act 
of 2002, and the Working Families Tax Relief Act of 2004. The proposed 
regulations affect taxpayers who claim the credit for household and 
dependent care services and dependent care providers.

DATES: Written or electronic comments must be received by August 22, 
2006.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-139059-02), room 5203, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand-delivered Monday through Friday 
between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-139059-
02), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
electronic comments directly to the IRS Internet site at http://www.irs.gov/regs or via the Federal eRulemaking Portal at http://www.regulations.gov (IRS and REG-139059-02).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Sara Shepherd (202) 622-4960: Concerning submissions of comments or a 
request for a public hearing, Richard Hurst, 
[email protected], or (202) 622-7180 (not toll free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations, 26 CFR part 1, relating to the credit for household and 
dependent care services necessary for gainful employment (the credit) 
under section 21 of the Internal Revenue Code (Code).
    The credit was originally enacted as section 44A. Final regulations 
under section 44A were published as ''1.44A-1 through 1.44-4 on August 
27, 1979 (section 44A regulations). Section 44A was amended and 
renumbered section 21 by sections 423 and 471, respectively, of the 
Deficit Reduction Act of 1984 (Pub. L. 98-369, 98 Stat. 494). Section 
21 was amended by section 10101 of the Omnibus Budget Reconciliation 
Act of 1987 (Pub. L. 100-203, 101 Stat. 1330), section 703 of the 
Family Support Act of 1988 (Pub. L. 100-485, 102 Stat. 2343), section 
1615 of the Small Business Job Protection Act of 1996 (Pub. L. 104-188, 
110 Stat. 1755), section 204 of the Economic Growth and Tax Relief 
Reconciliation Act of 2001 (Pub. L. 107-16, 115 Stat. 38), section 418 
of the Job Creation and Worker Assistance Act of 2002 (Pub. L. 107-147, 
116 Stat. 21), and sections 203 and 207 of the Working Families Tax 
Relief Act of 2004 (Pub. L. 108-311, 118 Stat. 1166), as well as other 
legislation that enacted clerical and conforming changes.
    Section 21 allows a nonrefundable credit for a percentage of 
expenses for household and dependent care services necessary for 
gainful employment. For taxable years beginning after December 31, 
2004, the credit is available to a taxpayer if there are one or more 
qualifying individuals with respect to that taxpayer. For those years, 
a qualifying individual is defined in section 21(b)(1) as the 
taxpayer's dependent (as defined in section 152(a)(1)) who has not 
attained age 13, the taxpayer's dependent who is physically or mentally 
incapable of self-care and who has the same principal place of abode as 
the taxpayer for more than one-half of the taxable year, or the 
taxpayer's spouse who is physically or mentally incapable of self-care 
and who has the same principal place of abode as the taxpayer for more 
than one-half of the taxable year.
    For taxable years beginning before January 1, 2005, the credit is 
available to taxpayers who maintained households that include one or 
more qualifying individuals. For those years, a qualifying individual 
is defined in section 21(b)(1) as the taxpayer's dependent (as defined 
in section 151(c) as then in effect) under age 13, the taxpayer's 
dependent who is physically or mentally incapable of self-care, or the 
taxpayer's spouse who is physically or mentally incapable of self-care.

[[Page 29848]]

    Under section 21(a), the amount of the credit is equal to the 
applicable percentage of employment-related expenses paid by the 
taxpayer during the taxable year. The applicable percentage ranges from 
20 percent to 35 percent depending on the taxpayer's adjusted gross 
income. Section 21(c) limits the amount of employment-related expenses 
that may be taken into account in determining the credit in any taxable 
year to $2,400 if there is one qualifying individual and $4,800 if 
there are two or more qualifying individuals. These amounts are 
increased, respectively, to $3,000 and $6,000 in taxable years 
beginning after December 31, 2002, and before January 1, 2011.
    Section 21(d) further limits the amount of employment-related 
expenses that may be taken into account in determining the credit to 
the lesser of the earned income of the taxpayer or the taxpayer's 
spouse (if any). The earned income for each month in which a taxpayer's 
spouse is a full-time student or incapable of self-care is deemed to be 
$200 (for one qualifying individual) or $400 (for two or more 
qualifying individuals), increased to $250 and $500 for taxable years 
beginning after December 31, 2002, and before January 1, 2011.
    Section 21(b)(2) defines employment-related expenses as amounts 
paid for household services and expenses for the care of a qualifying 
individual that enable the taxpayer to be gainfully employed for any 
period for which there are one or more qualifying individuals with 
respect to the taxpayer.

Explanation of Provisions

1. Overview

    The proposed regulations incorporate many of the rules in the 
section 44A regulations, but are renumbered, restructured, and revised 
to improve clarity. The proposed regulations reflect statutory 
amendments enacted since publication of the section 44A regulations. 
Accordingly, the proposed regulations include a change in the 
definition of a qualifying individual, a reduction in the maximum age 
of a qualifying child from under 15 to under 13, and an increase in the 
maximum amount of creditable expenses and the monthly amount of deemed 
earned income of a spouse who is a full-time student or incapable of 
self-care for taxable years beginning after December 31, 2002, and 
before January 1, 2011. The proposed regulations provide additional 
rules that address significant issues that have arisen administratively 
since publication of the section 44A regulations and expand the number 
of examples. The substantive revisions, additions, and significant 
clarifications to the section 44A regulations are described below.

2. Taxable Year of Credit

    Section 21 refers interchangeably to expenses ``paid'' by the 
taxpayer and expenses ``incurred'' by the taxpayer. Section 1.44A-
1(a)(3) reconciles this use of various tax accounting terms by 
providing that, regardless of the taxpayer's method of accounting, the 
credit is allowable only for expenses both ``paid'' during the taxable 
year and ``incurred'' during the taxable year or an earlier taxable 
year. The proposed regulations restate this rule in plain language and 
provide that the credit is allowable only in the taxable year in which 
the services are provided or the taxable year in which the expenses are 
paid, whichever is later, regardless of the taxpayer's method of 
accounting.

3. Special Rule for Children of Separated or Divorced Parents

    Section 21(e)(5) provides that, in the case of a child of divorced 
or separated parents, only the custodial parent may claim the credit, 
regardless of whether the noncustodial parent may claim the dependency 
exemption under section 152(e). The proposed regulations define 
custodial parent consistently with section 152(e)(3)(A) as the parent 
with whom the child shares the same principal place of abode for the 
greater portion of the calendar year.

4. Employment-Related Expenses

    Under section 21(b)(2)(A), expenses are employment-related only if 
(1) the expenses are primarily for household services or for the care 
of a qualifying individual, and (2) the taxpayer's purpose in obtaining 
the services is to enable the taxpayer to be gainfully employed.
a. Nature of the Services Provided
(1) Expenses for Nursery School and Kindergarten
    The section 44A regulations provide that expenses are primarily for 
the care of a qualifying individual if the primary nature of the 
services is to ensure the qualifying individual's well-being and 
protection. Amounts paid for food, lodging, clothing, or education are 
not for the care of a qualifying individual. However, if these services 
are incidental to and inseparably a part of the care of a qualifying 
individual, the entire amount of the expense is deemed to be for care.
    Section 1.44A-1(c)(3)(i).
    Section 1.44A-1(c)(3)(i) provides an example that concludes that 
the full amount paid to a nursery school is for the care of a 
qualifying child even though the school furnishes lunch and educational 
services. Although intended to illustrate the incidental services rule, 
the example assumes that expenses for nursery school are for care. 
Section 1.44A-1(c)(3)(i) also provides that expenses for education in 
the first or higher grade are not for the care of a qualifying 
individual. The section 44A regulations do not address expenses for 
kindergarten.
    The proposed regulations provide the rule that the expenses of pre-
school or similar programs below the kindergarten level are for care 
and may be employment-related expenses, if otherwise qualified, 
although education may be a significant part of these programs. The 
proposed regulations clarify the existing rule that expenses for 
programs at the level of kindergarten and above, however, are primarily 
for education and, therefore, are not employment-related expenses.
(2) Specialty Day Camps
    Section 21(b)(2)(A) provides that expenses for overnight camps are 
not employment-related expenses. Expenses for day camps may be 
employment-related expenses, if otherwise qualified. The IRS has 
received many inquiries about whether the cost of a day camp that 
specializes in a particular activity, such as soccer or computers, may 
be an employment-related expense. To provide certainty for taxpayers 
and enhance administrability, the proposed regulations provide that the 
full amount paid for a day camp or similar program may be for the care 
of a qualifying individual although the camp specializes in a 
particular activity.
(3) Transportation Expenses
    Section 1.44A-1(c)(3)(i) provides that expenses for transportation 
of a qualifying individual between the taxpayer's household and a place 
outside the taxpayer's household where care is provided are not for 
care. The proposed regulations provide that the cost of transportation 
(such as transportation to a day camp or to an after-school program not 
on school premises) furnished by a dependent care provider may be an 
employment-related expense if all other applicable requirements are 
satisfied.
(4) Other Expenses For Care
    Section 1.44A-1(c)(1)(i) provides that employment taxes that a 
taxpayer pays are employment-related expenses if the related wages are 
employment-related expenses. Rev. Rul. 76-288 (1976-2 C.B. 83) holds 
that additional costs for a care

[[Page 29849]]

provider's room and board are employment-related expenses. The proposed 
regulations incorporate these rules. Additionally, the proposed 
regulations clarify that indirect expenses such as application and 
agency fees may be employment-related expenses if the taxpayer is 
required to pay the expenses to obtain the care.
b. Expenses To Enable the Taxpayer To Be Gainfully Employed
    Under section 21(b)(2)(A), an expense may be an employment-related 
expense only if its purpose is to enable the taxpayer to be gainfully 
employed. Section 1.44A-1(c)(1)(i) provides that an expense must be 
incurred while the taxpayer is gainfully employed or is in active 
search of gainful employment. An expense is not employment-related, 
however, merely because the services are provided while the taxpayer is 
employed. Rather, the purpose of the expense must be to enable the 
taxpayer to be gainfully employed.
    Rev. Rul. 76-278 (1976-2 C.B. 84) holds that expenses for dependent 
care services during a taxpayer's 6-month absence from work due to 
illness do not qualify as employment-related expenses although the 
taxpayer was gainfully employed during that period. The expenses were 
not for the purpose of enabling the taxpayer to be gainfully employed 
because the expenses did not contribute to the taxpayer's ability to be 
gainfully employed during the absence.
    Section 1.44A-1(c)(1)(ii) provides that a taxpayer must allocate on 
a daily basis expenses that relate to a period during only part of 
which the taxpayer is gainfully employed or in search of gainful 
employment. The proposed regulations clarify how this rule applies to 
temporary absences from work and part-time employment. The proposed 
regulations provide that, in general, dependent care expenses for a 
period in which the taxpayer is absent from work (whether paid or 
unpaid) are not employment-related expenses. However, for 
administrative convenience, short, temporary absences from work, such 
as for minor illness or vacation, are disregarded for taxpayers who 
must pay for dependent care expenses on a weekly or longer basis. 
Whether an absence is short and temporary depends on the facts and 
circumstances. The IRS and the Treasury Department request comments on 
appropriate periods to constitute temporary absence safe harbors.
    The proposed regulations provide that, in general, taxpayers who 
work part-time must allocate expenses between days worked and days not 
worked. However, taxpayers who work part-time but are required to pay 
for dependent care expenses on a weekly or longer basis are not 
required to allocate expenses between days worked and days not worked.

5. Limitations on Amount Creditable

a. Application of Dollar Limitation to Two or More Qualifying 
Individuals
    Under section 21(c), the amount of employment-related expenses that 
a taxpayer may take into account in any taxable year is $2,400 for one 
qualifying individual and $4,800 for more than one qualifying 
individual (increased to $3,000 and $6,000 for taxable years beginning 
after December 31, 2002, and before January 1, 2011). The proposed 
regulations clarify that a taxpayer may apply the limitation for two or 
more qualifying individuals in unequal proportions. Thus, if in taxable 
year 2004 a taxpayer pays $4,000 of employment-related expenses for the 
care of one child and $2,000 for another child, the taxpayer may take 
into account the full $6,000.
b. Earned Income Limitation
    Section 21(d) provides that the amount of employment-related 
expenses that may be taken into account during any taxable year cannot 
exceed the taxpayer's earned income or, if married, the earned income 
of the taxpayer's spouse (whichever is less). A spouse who is a full-
time student or is incapable of self-care is deemed to have earned 
income for each month of not less than $200 if there is one qualifying 
individual or $400 if there are two or more qualifying individuals with 
respect to the taxpayer for the taxable year. These amounts are 
increased, respectively, to $250 and $500 for taxable years beginning 
after December 31, 2002, and before January 1, 2011. Section 1.44A-
2(b)(2) provides a definition of earned income that is similar to the 
definition under section 32 (relating to the earned income credit) and 
the regulations thereunder. Since this regulation was issued, the 
section 32 definition has changed several times. For ease of 
administration, the proposed regulations simplify the definition of 
earned income by cross-referencing the definition under section 32.
    Section 1.44A-2(b)(3)(ii) defines a full-time student as a student 
pursuing a full-time course of study, which cannot be exclusively at 
night. The proposed regulations delete the night school restriction.

6. Cost of Maintaining a Household

    For taxable years beginning before January 1, 2005, section 
21(a)(1) provides that the credit is available to a taxpayer who 
maintains a household that includes one or more qualifying individuals. 
For those years, section 21(e)(1) provides that a taxpayer is treated 
as maintaining a household for any period only if over half the cost of 
maintaining the household is furnished by the taxpayer or by the 
taxpayer and spouse (if any). Section 1.44A-1(d)(3) defines cost of 
maintaining a household substantially identically to the definition in 
Sec.  1.2-2(d) (relating to the head of household filing status). For 
simplicity, the proposed regulations cross-reference to the definition 
of cost of maintaining a household in Sec.  1.2-2(d) without regard to 
the last sentence of that paragraph. In lieu of that sentence, the 
proposed regulations provide that, for purposes of section 21, the cost 
of maintaining a household does not include the value of services 
performed in the household by the taxpayer or a qualifying individual, 
or expenses paid or reimbursed by another person.

7. Principal Place of Abode

    For taxable years beginning after December 31, 2004, the principal 
place of abode test statutorily replaces the maintaining a household 
test. Under section 21(b)(1), a qualifying individual must have the 
same principal place of abode as the taxpayer for more than one-half of 
the taxable year. For simplicity, the proposed regulations provide that 
principal place of abode has the same meaning as in section 152 and the 
regulations thereunder.

8. Definition of Marital Status

    Under section 21(e)(2), the credit is allowed to married taxpayers 
only if they file a joint return. Section 21(e)(3) provides that 
taxpayers who are legally separated under a decree of divorce or 
separate maintenance are not married. The proposed regulations, in 
general, adopt the rules of section 7703 and the regulations thereunder 
to determine whether taxpayers are married for purposes of section 21. 
However, to maintain continued consistency with section 21(e)(3), the 
proposed regulations provide, in addition, that taxpayers who are 
legally separated under a decree of divorce or separate maintenance are 
not married.

9. Payments to Related Individuals

    Section 21(e)(6) provides that payments to a taxpayer's dependent 
or child under age 19 do not qualify for the credit. Payments to a 
relative may qualify for the credit if the relative is not a dependent. 
The proposed regulations clarify that payments to either the

[[Page 29850]]

taxpayer's spouse or to a parent of the taxpayer's child who is not the 
taxpayer's spouse do not qualify for the credit. This rule is 
consistent with the requirement that a married couple must file a joint 
return to qualify for the credit, and with the principle that the tax 
treatment of a payment with respect to a child may be affected by an 
individual's underlying legal obligation to the child. See section 
21(e)(2); compare section 677(b).

10. Proposed Effective Date

    The regulations are proposed to apply to taxable years ending after 
the date the regulations are published as final regulations in the 
Federal Register. However, taxpayers may apply the proposed regulations 
in taxable years for which the period of limitation on credit or refund 
under section 6511 has not expired as of May 24, 2006.

11. Effect on Other Documents

    When finalized, the regulations would obsolete Rev. Rul. 76-278 
(1976-2 C.B. 84) and Rev. Rul. 76-288 (1976-2 C.B. 83).

Special Analyses

    This notice of proposed rulemaking is not a significant regulatory 
action as defined in Executive Order 12866. Therefore, a regulatory 
assessment is not required. Section 553(b) of the Administrative 
Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. 
Because the regulations do not impose a collection of information on 
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
does not apply. Pursuant to section 7805(f) of the Code, this notice of 
proposed rulemaking will be submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on its impact on small 
business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and 8 
copies) or electronic comments that are submitted timely to the IRS. 
The IRS and the Treasury Department request comments on the clarity of 
the proposed rules and how they can be made easier to understand. All 
comments will be available for public inspection and copying. A public 
hearing will be scheduled if requested in writing by any person who 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the public hearing will be 
published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Warren Joseph 
of the Office of Associate Chief Counsel (Income Tax and Accounting). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are proposed to be amended as 
follows:

PART I--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.21-1 also issued under 26 U.S.C. 21(f).
    Section 1.21-2 also issued under 26 U.S.C. 21(f).
    Section 1.21-3 also issued under 26 U.S.C. 21(f).
    Section 1.21-4 also issued under 26 U.S.C. 21(f) * * *


Sec.  1.21-1  [Redesignated]

    Par. 2. Section 1.21-1 is redesignated 1.15-1.
    Par. 3. Sections 1.21-1, 1.21-2, 1.21-3, and 1.21-4 are added to 
read as follows:


Sec.  1.21-1  Expenses for household and dependent care services 
necessary for gainful employment.

    (a) In general. (1) Section 21 allows a credit to a taxpayer 
against the tax imposed by chapter 1 for employment-related expenses 
for household services and care (as defined in paragraph (d) of this 
section) of a qualifying individual (as defined in paragraph (b) of 
this section). The purpose of the expenses must be to enable the 
taxpayer to be gainfully employed (as defined in paragraph (c) of this 
section). For taxable years beginning after December 31, 2004, a 
qualifying individual must have the same principal place of abode (as 
defined in paragraph (g) of this section) as the taxpayer for more than 
one-half of the taxable year. For taxable years beginning before 
January 1, 2005, the taxpayer must maintain a household (as defined in 
paragraph (h) of this section) that includes one or more qualifying 
individuals.
    (2) The amount of the credit is equal to the applicable percentage 
of the employment-related expenses that may be taken into account by 
the taxpayer during the taxable year (but subject to the limits 
prescribed in Sec.  1.21-2). Applicable percentage means 35 percent 
reduced by 1 percentage point for each $2,000 (or fraction thereof) by 
which the taxpayer's adjusted gross income for the taxable year exceeds 
$15,000, but not less than 20 percent. For example, if a taxpayer's 
adjusted gross income is $31,850, the applicable percentage is 26 
percent.
    (3) Expenses may be taken into account, regardless of the 
taxpayer's method of accounting, only in the taxable year the services 
are provided or the taxable year the expenses are paid, whichever is 
later.
    (4) The requirements of section 21 and Sec. Sec.  1.21-1 through 
1.21-4 are applied at the time the services are provided, regardless of 
when the expenses are paid.
    (b) Qualifying individual--(1) In general. For taxable years 
beginning after December 31, 2004, a qualifying individual is--
    (i) The taxpayer's dependent (who is a qualifying child within the 
meaning of section 152) who has not attained age 13;
    (ii) The taxpayer's dependent who is physically or mentally 
incapable of self-care and who has the same principal place of abode as 
the taxpayer for more than one-half of the taxable year; or
    (iii) The taxpayer's spouse who is physically or mentally incapable 
of self-care and who has the same principal abode as the taxpayer for 
more than one-half of the taxable year.
    (2) Taxable years beginning before January 1, 2005. For taxable 
years beginning before January 1, 2005, a qualifying individual is--
    (i) The taxpayer's dependent for whom the taxpayer is entitled to a 
deduction for a personal exemption under section 151(c) and who is 
under age 13;
    (ii) The taxpayer's dependent who is physically or mentally 
incapable of self-care; or
    (iii) The taxpayer's spouse who is physically or mentally incapable 
of self-care.
    (3) Qualification on a daily basis. The status of an individual as 
a qualifying individual is determined on a daily basis. An individual 
is not a qualifying individual on the day the status terminates.
    (4) Physical or mental incapacity. An individual is physically or 
mentally incapable of self-care if, as a result of a physical or mental 
defect, the

[[Page 29851]]

individual is incapable of caring for the individual's hygiene or 
nutritional needs, or requires full-time attention of another person 
for the individual's own safety or the safety of others. The inability 
of an individual to engage in any substantial gainful activity or to 
perform the normal household functions of a homemaker or care for minor 
children by reason of a physical or mental condition does not of itself 
establish that the individual is physically or mentally incapable of 
self-care.
    (5) Special test for divorced or separated parents--(i) Scope. This 
paragraph (b)(5) applies to a child (as defined in section 152(f)(1) 
for taxable years beginning after December 31, 2004, and in section 
151(c)(3) for taxable years beginning before January 1, 2005) who--
    (A) Is under age 13 or is physically or mentally incapable of self-
care;
    (B) Receives over one-half of his or her support during the 
calendar year from one or both parents who are divorced or legally 
separated under a decree of divorce or separate maintenance or who are 
separated under a written separation agreement; and
    (C) Is in the custody of one or both parents for more than one-half 
of the calendar year.
    (ii) Custodial parent allowed the credit. A child to whom this 
paragraph (b)(5) applies is the qualifying individual of only one 
parent in any taxable year and is the qualifying child of the custodial 
parent even if the noncustodial parent may claim the dependency 
exemption for that child for that taxable year. See section 152(e). The 
custodial parent is the parent with whom a child shared the same 
principal place of abode for the greater portion of the calendar year. 
See section 152(e)(3)(A).
    (c) Gainful employment--(1) In general. Expenses are employment-
related expenses only if they are for the purpose of enabling the 
taxpayer to be gainfully employed. The expenses must be for the care of 
a qualifying individual or household services provided during periods 
in which the taxpayer is gainfully employed or is in active search of 
gainful employment. Employment may consist of service within or outside 
the taxpayer's home and includes self-employment. An expense is not 
employment-related merely because it is paid or incurred while the 
taxpayer is gainfully employed. The purpose of the expense must be to 
enable the taxpayer to be gainfully employed. Whether the purpose of an 
expense is to enable the taxpayer to be gainfully employed depends on 
the facts and circumstances of the particular case. Work as a volunteer 
or for a nominal consideration is not gainful employment.
    (2) Determination of period of employment on a daily basis--(i) In 
general. Expenses paid for a period during only part of which the 
taxpayer is gainfully employed or in active search of gainful 
employment must be allocated on a daily basis.
    (ii) Exception for short temporary absences. A taxpayer who is 
gainfully employed and who pays for dependent care expenses on a 
weekly, monthly, or annual basis is not required to allocate expenses 
during short, temporary absences from work, such as for vacation or 
minor illness. Whether an absence is a short, temporary absence is 
determined based on all the facts and circumstances.
    (iii) Part-time employment. A taxpayer who is employed part-time 
generally must allocate expenses for dependent care between days worked 
and days not worked. However, if a taxpayer employed part time is 
required to pay for dependent care on a periodic basis (such as weekly 
or monthly) that includes both days worked and days not worked, the 
taxpayer is not required to allocate the expenses. A day on which the 
taxpayer works at least 1 hour is a day of work.
    (3) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. B, the custodial parent of two qualifying children, 
hires a housekeeper for a monthly salary to care for the children 
while B is gainfully employed. B becomes ill and as a result is 
absent from work for 4 months. B continues to pay the housekeeper to 
care for the children while B is absent from work. During this 4-
month period, B performs no employment services, but receives 
payments under her employer's wage continuation plan. Although B may 
be considered to be gainfully employed during her absence from work, 
the absence is not a short, temporary absence within the meaning of 
paragraph (c)(2)(ii) of this section, and her payments for household 
and dependent care services during the period of illness are not for 
the purpose of enabling her to be gainfully employed. B's expenses 
are not employment-related expenses, and she may not take the 
expenses into account under section 21.
    Example 2. C works 5 days per week and his child attends a 
dependent care center (that complies with all state and local 
requirements) to enable C to be gainfully employed. The dependent 
care center requires payment for periods of no less than 1 week. C 
takes 2 days off from work as vacation days. Under paragraph 
(c)(2)(ii) of this section, C is absent from work on a short, 
temporary basis, and is not required to allocate expenses between 
days working and days not working. The entire fee for that week may 
be an employment-related expense under section 21.
    Example 3. D works 3 days per week and her child attends a 
dependent care center (that complies with all state and local 
requirements) to enable her to be gainfully employed. The dependent 
care center allows payment for any 3 days per week for $150 or 5 
days per week for $250. D enrolls her child for 5 days per week. 
Under paragraph (c)(2)(iii) of this section, D must allocate her 
expenses for dependent care between days worked and days not worked. 
Three-fifths of the $250, or $150 per week, may be an employment-
related expense under section 21.
    Example 4. The facts are the same as in Example 3, except that 
the dependent care center does not offer a 3-day option. The entire 
$250 weekly fee may be an employment-related expense under section 
21.

    (d) Care of qualifying individual and household services--(1) In 
general. To qualify for the dependent care credit, expenses must be for 
the care of a qualifying individual. Expenses are for the care of a 
qualifying individual if the primary function is to assure the 
individual's well-being and protection. Not all expenses relating to a 
qualifying individual are provided for the individual's care. Amounts 
paid for food, lodging, clothing, or education are not for the care of 
a qualifying individual. If, however, the care is provided in such a 
manner that the expenses cover other goods or services that are 
incidental to and inseparably a part of the care, the full amount is 
for care.
    (2) Allocation of expenses. If an expense is partly for household 
services or for the care of a qualifying individual and partly for 
other goods or services, a reasonable allocation must be made. Only so 
much of the expense that is allocable to the household services or care 
of a qualifying individual is an employment-related expense.
    An allocation must be made if a housekeeper or other domestic 
employee performs household duties and cares for the qualifying 
children of the taxpayer and also performs other services for the 
taxpayer. No allocation is required, however, if the expense for the 
other purpose is minimal or insignificant or if an expense is partly 
attributable to the care of a qualifying individual and partly to 
household services.
    (3) Household services. Expenses for household services may be 
employment-related expenses if the services are provided in connection 
with the care of a qualifying individual. The household services must 
be the performance in and about the taxpayer's home of ordinary and 
usual services

[[Page 29852]]

necessary to the maintenance of the household and attributable to the 
care of the qualifying individual. Services of a housekeeper are 
household services within the meaning of this paragraph (d)(3) if part 
of those services is provided to the qualifying individual. Such 
services as are provided by chauffeurs, bartenders, or gardeners are 
not household services.
    (4) Manner of providing care. The manner of providing the care need 
not be the least expensive alternative available to the taxpayer. The 
cost of a paid caregiver may be an expense for the care of a qualifying 
individual even if another caregiver is available at no cost.
    (5) School or similar program. Expenses for a child in nursery 
school, pre-school, or similar programs for children below the level of 
kindergarten are for the care of a qualifying individual and may be 
employment-related expenses. Expenses for a child in kindergarten or a 
higher grade are not for the care of a qualifying individual. However, 
expenses for before- or after-school care of a child in kindergarten or 
a higher grade may be for the care of a qualifying individual.
    (6) Overnight camps. Expenses for overnight camps are not 
employment-related expenses.
    (7) Day camps. The cost of a day camp or similar program may be for 
the care of a qualifying individual and an employment-related expense, 
without allocation under paragraph (d)(2) of this section, even if the 
day camp specializes in a particular activity.
    (8) Transportation. The cost of transportation by a dependent care 
provider of a qualifying individual to or from a place where care of 
that qualifying individual is provided may be for the care of the 
qualifying individual. The cost of transportation not provided by a 
dependent care provider is not for the care of the qualifying 
individual.
    (9) Employment taxes. Taxes under section 3111 (relating to the 
Federal Insurance Contributions Act) and 3301 (relating to the Federal 
Unemployment Tax Act) and similar state payroll taxes are employment-
related expenses if paid in respect of wages that are employment-
related expenses.
    (10) Room and board. The additional cost of providing room and 
board for a caregiver over usual household expenditures may be an 
employment-related expense.
    (11) Indirect expenses. Expenses that relate to but are not 
directly for the care of a qualifying individual, such as application 
fees, agency fees, and deposits, may be for the care of a qualifying 
individual and may be employment-related expenses if the taxpayer is 
required to pay the expenses to obtain the related care. However, 
forfeited deposits and other payments are not for the care of a 
qualifying individual if care is not provided.
    (12) Examples. The provisions of this paragraph (d) are illustrated 
by the following examples:

    Example 1. To be gainfully employed, E sends his 3-year old 
child to a pre-school. The pre-school provides lunch and snacks. 
Under paragraph (d)(1) of this section, E is not required to 
allocate expenses between care and the lunch and snacks because the 
lunch and snacks are incidental to and inseparably a part of the 
care. Therefore, E may treat the full amount paid to the pre-school 
as for the care of his child.
    Example 2. F, a member of the armed forces, is ordered to a 
combat zone. To be able to comply with the orders, F places her 10-
year old child in boarding school. The school provides education, 
meals, and housing to F's child in addition to care. Under paragraph 
(d)(2) of this section, F must allocate the cost of the boarding 
school between expenses for care and expenses for education and 
other services not constituting care. Only the part of the cost of 
the boarding school that is for the care of F's child is an 
employment-related expense under section 21.
    Example 3. To be gainfully employed, G employs a full-time 
housekeeper to care for G's two children, aged 9 and 13 years. The 
housekeeper regularly performs household services of cleaning and 
cooking and drives G to and from G's place of employment, a trip of 
15 minutes each way. Under paragraph (d)(3) of this section, the 
chauffeur services are not household services. G is not required to 
allocate a portion of the expense of the housekeeper to the 
chauffeur services, however, because the chauffeur services are 
minimal and insignificant. Further, no allocation under paragraph 
(d)(2) of this section is required to determine the portion of the 
expenses attributable to the care of the 13-year old child (not a 
qualifying individual) because the household expenses are in part 
attributable to the care of the 9-year old child. Accordingly, the 
entire expense of employing the housekeeper is an employment-related 
expense. The amount that G may take into account as an employment-
related expense under section 21, however, is limited to the amount 
allowable for one qualifying individual.
    Example 4. To be gainfully employed, H sends her 9-year old 
child to a summer day camp that specializes in computer instruction 
and activities. Under paragraph (d)(7) of this section, the full 
cost of the summer day camp may be for care although it specializes 
in a particular activity, computers.
    Example 5. In 2004, J pays a fee to an agency to obtain the 
services of an au pair to care for J's qualifying children to enable 
J to be gainfully employed. The au pair begins caring for J's 
children in 2005. Under paragraph (d)(11) of this section, the fee 
paid in 2004 may be an employment-related expense. However, under 
paragraph (a)(3) of this section, J may not take the expense into 
account under section 21 until 2005, when the au pair first provides 
the care.
    Example 6. K places a deposit with a pre-school to reserve a 
place for her child. K sends the child to another pre-school and 
forfeits the deposit. Under paragraph (d)(11) of this section, the 
forfeited deposit is not an employment-related expense.

    (e) Services outside the taxpayer's household--(1) In general. The 
credit is allowable for expenses for services performed outside the 
taxpayer's household only if the care is for one or more qualifying 
individuals who are described in this section at--
    (i) Paragraph (b)(1)(i) or (b)(2)(i); or
    (ii) Paragraph (b)(2)(ii) or (b)(2)(iii) and regularly spend at 
least 8 hours each day in the taxpayer's household.
    (2) Dependent care centers--(i) In general. The credit is allowable 
for services provided by a dependent care center only if--
    (A) The center complies with all applicable laws and regulations, 
if any, of a state or local government, such as state or local 
licensing requirements and building and fire code regulations; and
    (B) The requirements provided in this paragraph (e) are met.
    (ii) Definition. The term dependent care center means any facility 
that provides full-time or part-time care for more than six individuals 
(other than individuals who reside at the facility) on a regular basis 
during the taxpayer's taxable year, and receives a fee, payment, or 
grant for providing services for the individuals (regardless of whether 
the facility is operated for profit). For purposes of the preceding 
sentence, a facility is presumed to provide full-time or part-time care 
for six or fewer individuals on a regular basis during the taxpayer's 
taxable year if the facility has six or fewer individuals (including 
the taxpayer's qualifying individual) enrolled for full-time or part-
time care on the day the qualifying individual is enrolled in the 
facility (or on the first day of the taxable year the qualifying 
individual attends the facility if the qualifying individual was 
enrolled in the facility in the preceding taxable year) unless the 
Internal Revenue Service demonstrates that the facility provides full-
time or part-time care for more than six individuals on a regular basis 
during the taxpayer's taxable year.
    (f) Reimbursed expenses. Employment-related expenses for which the 
taxpayer is reimbursed (for example, under a dependent care assistance 
program) may not be taken into account for purposes of the credit.
    (g) Principal place of abode. For purposes of this section, the 
term

[[Page 29853]]

principal place of abode has the same meaning as in section 152 and the 
regulations thereunder.
    (h) Maintenance of a household--(1) In general. For taxable years 
beginning before January 1, 2005, the credit is available only to 
taxpayers who maintain households that include one or more qualifying 
individuals. A taxpayer maintains a household for the taxable year (or 
lesser period) only if the taxpayer (and spouse, if applicable) 
occupies the household and furnishes over one-half of the cost for the 
taxable year (or lesser period) of maintaining the household. The 
household must be the principal place of abode (within the meaning of 
section 152 and the regulations thereunder) for the taxable year of the 
taxpayer and the qualifying individual or individuals described in 
paragraph (b) of this section.
    (2) Cost of maintaining a household. (i) Except as provided in 
paragraph (h)(2)(ii) of this section, for purposes of this section, the 
term cost of maintaining a household has the same meaning as in Sec.  
1.2-2(d) without regard to the last sentence thereof.
    (ii) The cost of maintaining a household does not include the value 
of services performed in the household by the taxpayer or by a 
qualifying individual described in paragraph (b) of this section or any 
expense paid or reimbursed by another person.
    (3) Monthly proration of annual costs. In determining the cost of 
maintaining a household for a period of less than a taxable year, the 
cost for the entire taxable year must be prorated on the basis of the 
number of calendar months within that period. A period of less than a 
calendar month is treated as a full calendar month.
    (4) Two or more families. If two or more families occupy living 
quarters in common, each of the families is treated as maintaining a 
separate household. A taxpayer is maintaining a household if the 
taxpayer provides more than one-half of the cost of maintaining the 
separate household. For example, if two unrelated taxpayers with their 
respective children occupy living quarters in common and each taxpayer 
pays more than one-half of the household costs for each respective 
family, each taxpayer is treated as maintaining a household.
    (i) Reserved.
    (j) Expenses qualifying as medical expenses--(1) In general. A 
taxpayer may not take an amount into account as both an employment-
related expense under section 21 and an expense for medical care under 
section 213.
    (2) Examples. The provisions of this paragraph (j) are illustrated 
by the following examples:

    Example 1.  During 2004, L has $6,500 of employment-related 
expenses for the care of his child who is physically incapable of 
self-care. The expenses are for services performed in L's household 
that also qualify as expenses for medical care under section 213. Of 
the total expenses, L may take into account $3,000 under section 21. 
L may deduct the balance of the expenses, or $3,500, as expenses for 
medical care under section 213 to the extent the expenses exceed 7.5 
percent of L's adjusted gross income.
    Example 2.  The facts are the same as in Example 1, however, L 
first takes into account the $6,500 of expenses under section 213. L 
deducts $500 as an expense for medical care, which is the amount by 
which the expenses exceed 7.5 percent of his adjusted gross income. 
L may not take into account the $6,000 balance as employment-related 
expenses under section 21 because he has taken the full amount of 
the expenses into account in computing the amount deductible under 
section 213.

    (k) Substantiation. A taxpayer claiming a credit for employment-
related expenses must maintain adequate records or other sufficient 
evidence to substantiate the expenses in accordance with section 6001 
and the regulations thereunder.
    (l) Effective date. This section and Sec. Sec.  1.21-2 through 
1.21-4 apply to taxable years ending after the date these regulations 
are published as final regulations in the Federal Register. However, 
taxpayers may apply this section and Sec. Sec.  1.21-2 through 1.21-4 
in taxable years for which the period of limitation on credit or refund 
under section 6511 has not expired as of May 24, 2006.


Sec.  1.21-2  Limitations on amount creditable.

    (a) Annual dollar limitation. (1) The amount of employment-related 
expenses that may be taken into account under Sec.  1.21-1(a) for any 
taxable year cannot exceed--
    (i) $2,400 ($3,000 for taxable years beginning after December 31, 
2002, and before January 1, 2011) if there is one qualifying individual 
with respect to the taxpayer at any time during the taxable year; or
    (ii) $4,800 ($6,000 for taxable years beginning after December 31, 
2002, and before January 1, 2011) if there are two or more qualifying 
individuals with respect to the taxpayer at any time during the taxable 
year.
    (2) The amount determined under paragraph (a)(1) of this section is 
reduced by the aggregate amount excludable from gross income under 
section 129 for the taxable year.
    (3) A taxpayer may take into account the total amount of 
employment-related expenses that do not exceed the annual dollar 
limitation although the amount of employment-related expenses 
attributable to one qualifying individual exceeds 50 percent of the 
limitation. For example, a taxpayer with expenses in 2004 of $4,000 for 
one qualifying individual and $1,500 for a second qualifying individual 
may take into account the full $5,500.
    (4) A taxpayer is not required to prorate the annual dollar 
limitation if a qualifying individual ceases to qualify (for example, 
by turning age 13) during the taxable year. However, the taxpayer may 
take into account only expenses that qualify under Sec.  1.21-1(a)(3) 
before the disqualifying event.
    (b) Earned income limitation--(1) In general. The amount of 
employment-related expenses that may be taken into account under 
section 21 for any taxable year cannot exceed--
    (i) For a taxpayer who is not married at the close of the taxable 
year, the taxpayer's earned income for the taxable year; or
    (ii) For a taxpayer who is married at the close of the taxable 
year, the lesser of the taxpayer's earned income or the earned income 
of the taxpayer's spouse for the taxable year.
    (2) Determination of spouse. For purposes of this paragraph (b), a 
taxpayer must take into account only the earned income of a spouse to 
whom the taxpayer is married at the close of the taxable year. The 
spouse's earned income for the entire taxable year is taken into 
account, however, even though the taxpayer and the spouse were married 
for only part of the taxable year. The taxpayer is not required to take 
into account the earned income of a spouse who died or was divorced or 
separated from the taxpayer during the taxable year. See Sec.  1.21-
3(b) for rules providing that certain married taxpayers legally 
separated or living apart are treated as not married.
    (3) Definition of earned income. For purposes of this section, the 
term earned income has the same meaning as in section 32(c)(2) and the 
regulations thereunder.
    (4) Attribution of earned income to student or incapacitated 
spouse. (i) For purposes of this section, a spouse is deemed, for each 
month during which the spouse is a full-time student or is a qualifying 
individual described in Sec.  1.21-1(b)(1)(iii) or Sec.  .21-
1(b)(2)(iii), to be gainfully employed and to have earned income of not 
less than--
    (A) $200 ($250 for taxable years beginning after December 31, 2002, 
and before January 1, 2011) if there is one qualifying individual with 
respect to the

[[Page 29854]]

taxpayer at any time during the taxable year; or
    (B) $400 ($500 for taxable years beginning after December 31, 2002, 
and before January 1, 2011) if there are two or more qualifying 
individuals with respect to the taxpayer at any time during the taxable 
year.
    (ii) For purposes of this paragraph (b)(4), a full-time student is 
an individual who is enrolled at and attends an educational institution 
during each of 5 calendar months of the taxpayer's taxable year for the 
number of course hours considered to be a full-time course of study. 
The enrollment for 5 calendar months need not be consecutive. See 
section 152(f)(2) (for taxable years beginning after December 31, 
2004), or section 151(c)(4) (for taxable years beginning before January 
1, 2005), and the regulations thereunder.
    (iii) Earned income may be attributed under this paragraph (b)(4), 
in the case of any husband and wife, to only one spouse in any month.
    (c) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1.  In 2004, M, who is married, pays employment-related 
expenses of $5,000 for the care of one qualifying individual. M's 
earned income for the taxable year is $40,000 and her husband's 
earned income is $2,000. M did not exclude any dependent care 
assistance under section 129. Under paragraph (b)(1) of this 
section, M may take into account under section 21 only the amount of 
employment-related expenses that does not exceed the lesser of her 
earned income or the earned income of her husband, or $2,000.
    Example 2. The facts are the same as in Example 1 except that 
M's husband is a full-time student for 9 months of the taxable year 
and has no earned income. Under paragraph (b)(4) of this section, 
M's husband is deemed to have earned income of $2,250. M may take 
into account $2,250 of employment-related expenses under section 21.
    Example 3.  For all of 2004, N is a full-time student and O, N's 
husband, is an individual who is incapable of self-care (as defined 
in Sec.  1.21-1(b)(1)(iii)). N and O have no earned income and pay 
expenses of $5,000 for O's care. Under paragraph (b)(4) of this 
section, either N or O may be deemed to have $3,000 of earned 
income. However, earned income may be attributed to only one spouse 
under paragraph (b)(4)(iii) of this section. Under the limitation in 
paragraph (b)(1)(ii) of this section, the lesser of N's or O's 
earned income is zero. N and O may not take the expenses into 
account under section 21.

    (d) Cross-reference. For an additional limitation on the credit 
under section 21, see section 26.


Sec.  1.21-3  Special rules applicable to married taxpayers.

    (a) Joint return requirement. No credit is allowed under section 21 
for taxpayers who are married (within the meaning of section 7703 and 
the regulations thereunder) at the close of the taxable year unless the 
taxpayer and spouse file a joint return for the taxable year. See 
section 6013 and the regulations thereunder relating to joint returns 
of income tax by husband and wife.
    (b) Taxpayers treated as not married. The requirements of paragraph 
(a) of this section do not apply to a taxpayer who is legally separated 
under a decree of divorce or separate maintenance or who is treated as 
not married under section 7703(b) and the regulations thereunder 
(relating to certain married taxpayers living apart). A taxpayer who is 
treated as not married under this paragraph (b) is not required to take 
into account the earned income of the taxpayer(s) spouse for purposes 
of applying the earned income limitation on the amount of employment-
related expenses under Sec.  1.21-2(b).
    (c) Death of married taxpayer. If a married taxpayer dies during 
the taxable year and the survivor may make a joint return with respect 
to the deceased spouse under section 6013(a)(3), the credit is allowed 
for the year only if a joint return is made. If, however, the surviving 
spouse remarries before the end of the taxable year in which the 
deceased spouse dies, a credit may be allowed on the decedent spouse(s 
separate return.


Sec.  1.21-4  Payments to certain related individuals.

    (a) In general. A credit is not allowed under section 21 for any 
amount paid by the taxpayer to an individual--
    (1) For whom a deduction under section 151(c) (relating to 
deductions for personal exemptions for dependents) is allowable either 
to the taxpayer or the taxpayer's spouse for the taxable year;
    (2) Who is a child of the taxpayer (within the meaning of section 
152(f)(1) for taxable years beginning after December 31, 2004, and 
section 151(c)(3) for taxable years beginning before January 1, 2005) 
and is under age 19 at the close of the taxable year;
    (3) Who is the spouse of the taxpayer at any time during the 
taxable year; or
    (4) Who is the parent of the taxpayer's child who is a qualifying 
individual described in Sec.  1.21-1(b)(1)(i) or Sec.  1.21-1(b)(2)(i).
    (b) Payments to partnerships or other entities. In general, 
paragraph (a) of this section does not apply to services performed by 
partnerships or other entities. If, however, the partnership or other 
entity is established or maintained primarily to avoid the application 
of paragraph (a) of this section to permit the taxpayer to claim the 
credit, for purposes of section 21, the payments of employment-related 
expenses are treated as made directly to each partner or owner in 
proportion to that partner's or owner's ownership interest. Whether a 
partnership or other entity is established or maintained to avoid the 
application of paragraph (a) of this section is determined based on the 
facts and circumstances, including whether the partnership or other 
entity is established for the primary purpose of caring for the 
taxpayer's qualifying individual or providing household services to the 
taxpayer.
    (c) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. P pays $5,000 to her mother for the care of P's 5-
year old child during 2004. The expenses otherwise qualify as 
employment-related expenses. P's mother is not her dependent. P may 
take into account under section 21 the amounts paid to her mother 
for the care of P's child.
    Example 2.  Q, who is divorced and has custody of his 5-year old 
child, pays $6,000 during 2004 to R, who is his ex-wife and the 
child's mother, for the care of the child. The expenses otherwise 
qualify as employment-related expenses. Under paragraph (a)(4) of 
this section, Q may not take into account under section 21 the 
amounts paid to R because R is the child's mother.
    Example 3.  The facts are the same as in Example 2, except that 
R is not the mother of Q's child. Q may take into account under 
section 21 the amounts paid to R.


Sec. Sec.  1.44A-1 through 1.44A-4  [Removed]

    Par. 4. Sections 1.44A-1, 1.44A-2, 1.44A-3, and 1.44A-4 are 
removed.


Sec.  1.214-1  [Removed]

    Par. 5. Section 1.214-1 is removed.


Sec. Sec.  1.214A-1 through 1.214A-5  [Removed]

    Par. 6. Sections 1.214A-1, 1.214A-2, 1.214A-3, 1.214A-4, and 
1.214A-5 are removed.

PART 602-OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 7. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


Sec.  602.101  [Amended]

    Par. 8. In Sec.  602.101, paragraph (b) is amended by removing the 
entries for Sec. Sec.  1.44A-1 and 1.44A-3.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
 [FR Doc. E6-7390 Filed 5-23-06; 8:45 am]
BILLING CODE 4830-01-P