Learning Objectives

1. Summarize the differences between the federal and California Child and Dependent Care credit and how to report the difference.
2. Describe the availability of the College Access Credit.
3. Identify who may claim the Child Adoption Credit and what costs may be used to determine the amount of credit.
4. Determine who is eligible to claim the Earned Income Credit and how to calculate it.
5. Recognize when a credit for excess California SDI or VPDI withheld may be claimed.
6.  Determine who is eligible to claim the New Employment Credit and how to calculate it.
7. Determine when a taxpayer qualifies for the Nonrefundable Renter’s Credit.
8. Recognize California credits that have been repealed, have carryover provisions, and/or are subject to recapture.

Key Terms

• Child Adoption Credit
• Credit Recapture
• Custodial Parent
• Excess SDI/VPDI Credit
• Form 3506
• Form 3540
• Form 3554
• New Employment Credit
• Renter’s Credit
• Repealed Credits
• Schedule P (540)

Introduction

Most federal credits do not have a California counterpart.  Some federal credits have a similar California version and California also has many unique credits (some of which of been repealed but carryover amounts may still be used – see Repealed Credits section at the end of this chapter).

With the exception of exemption credits (see Module 1) all credits are taken in a certain order and are subject to limits.  Some reduce only ordinary tax; others reduce Alternative Minimum Tax (AMT).  If credits are left after tax is reduced to zero, some of them can be carried forward.  Some credits that have been repealed but were not used in full in prior years may still reduce a current year tax.

The Credit Chart below shows current credits in alphabetical order.  However, credits are applied in a specific order.

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Form 540, lines 43 and 44 permit up to 2 credits to be shown.  If there are more than 2 credits, CA Schedule P (540), Part III, is used to determine the amount of each credit and the order in which it can be used.  The chart pictured on page 4 displays current credits and the section of Part III they belong in.  The Section numbers, A & B, indicate the order in which credits are applied.  For example, A1 is the first section, A2 the second until all of Section A has been determined.  Section B is next and follows the same sequence, i.e., B1, B2 and so on.

Schedule P (540)

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When the taxpayer has more than two credits to claim on Section A or Section B of Schedule P (540), the total amounts from those credits should be entered on Form 540, line 45.

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Credit Table Instructions:[4]

• Find your credits in the Credit Table
• See which sections are identified under “Offset Tax in Section”
• Take the credit only in the sections the Credit Table identifies for your credit
• Use the credit in the earliest section possible
• Complete each section before going to the next section

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It should be clear by now that California credits comprise a large and complex environment.  Students should expect to spend plenty of time with Schedule P instructions.

Objective #1:  Child and Dependent Care Expense Credit

The California credit begins with a percentage of the allowable federal credit, which means the federal credit must be computed first.  Then other rules may reduce (or eliminate) that percentage amount.

Some of the additional conditions:

• Credit is not allowed for care that is provided outside California
• Nonresident taxpayers may not claim the credit, unless they have earned income (wages or net self-employment income) from working in California
• No credit is allowed if the federal AGI exceeds $100,000
• The credit is nonrefundable and there is no carryover provision
• Married couples and RDPs must file a joint California return (see Married Persons or RDPs Filing Separate Tax Returns later for exceptions)[6]

• Taxpayer lived apart from their spouse/RDP at all times during the last 6 months of the tax year
• The qualifying individual lived with the taxpayer more than half the tax year
• The taxpayer provided more than half the cost of maintaining the home in which both taxpayer and qualifying individual lived

The California percentage is based initially on the federal AGI (table below).  Because the California credit is a percentage of the Federal credit, the Federal amounts must be determined before the taxpayer can figure the California credit on Form FTB 3506.  The amount of California credit varies with the Federal AGI and is determined by multiplying the Federal Credit amount by the applicable percentage from the chart below.

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Military taxpayers have some specific rules as well.

• Servicemember domiciled outside of California – active duty pay is considered earned income from California sources
• Servicemember domiciled outside of California – Federal AGI is reduced by active duty military pay to determine the percentage of federal credit on the above chart

The California credit is determined on Form FTB 3506 (below) and attached to the taxpayer’s Form 540.

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Student note: Students should review the instructions for Form FTB 3506 at this time.

Qualifying Person

A qualifying person is:

1. A child under age 13 who meets the requirements to be a dependent as a Qualifying Child.  A child who turned 13 during the year qualifies only for the part of the year when he or she was 12 years old
2. A spouse/RDP who was physically or mentally incapable of self-care.
3. Any person who was physically or mentally incapable of self-care and either:

1. Was a dependent
2. Would have been a dependent except that:

1. He or she received gross income of $4,050 or more

ii. He or she filed a joint return

iii. The taxpayer, or his spouse/RDP if filing a joint return, could be claimed as a dependent on someone else’s 2016 return. [9]

Qualifying Child

A Qualifying Child is a child who meets all of the following tests:[10]

• Relationship Test – The child must be a son, daughter, stepchild, adopted child, eligible foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of one of these.  An adopted child includes a child who has been lawfully placed with the taxpayer for legal adoption even if the adoption is not yet final.  An eligible foster child must be placed with the taxpayer by an authorized placement agency or by a court.
• Age Test – For the purposes of qualifying for the Child and Dependent Care Expenses Credit, the child must be under 13.
• Residency Test – The child must live with the taxpayer for more than half the year.
• Support Test – The child must not have provided more than half of his or her own support.
• Joint Return Test – The child must not have filed a joint federal or state income tax return with his or her spouse/RDP.
• Citizenship Test – The child must be a citizen or national of the U.S. or a resident of the U.S., Canada, or Mexico.

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Divorced, RDP Terminated, Separated, or Never-Married Parents

Special rules are needed in determining if the taxpayer’s child meets the requirements to be his qualifying person.  Only one parent qualifies to claim a child as a qualifying person when separate returns are filed by the parents.

In cases where both parents pay for child care for the same child, only one parent can qualify for the credit.  Some custody agreements include a provision detailing which parent is entitled to the credit.  However, that parent must meet all eight of the qualifications listed on Page 1 of the instructions for Form FTB 3506, Section C, Qualifications, to claim the credit.  To determine whether the taxpayer’s child meets the requirements to be his qualifying person, the following table should be used for verification purposes.

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Custodial Parent and Noncustodial Parent

The custodial parent is the parent with whom the child lived for the greater number of nights during the year.  The other parent is the noncustodial parent.  If the child lived with each parent for an equal number of nights during the year, the custodial parent is the parent with the higher adjusted gross income.[13]

Parent Works at Night

If a parent works a night-time schedule, and the child lives with that parent for a greater number of days, but not nights, then that parent is treated as the custodial parent.  On a school day, the child is treated as living at the primary residence registered with the school, even though the child may have been absent from the home most of that day.  For this reason, the child’s registered address with the school he or she attends may be an important factor in figuring out who is the custodial parent.

Married Persons or RDPs Filing Separate Returns

Generally, a taxpayer who is married or an RDP must file a joint return to claim the credit.  However, the taxpayer can take the credit on his separate tax return.[14]  In addition the taxpayer must meet all of the other qualifications listed in Section C on Page 1 of the FTB 3506 Instructions.

• The taxpayer lived apart from their spouse/RDP at all times during the last 6 months of the tax year
• The qualifying individual lived with the taxpayer more than half the tax year
• The taxpayer provided more than half the cost of maintaining the home in which both taxpayer and qualifying individual lived

Nonresidents and Part-Year Residents

Nonresidents and part-year residents are eligible to claim the credit depending on whether there was California source earned income.  Nonresidents must have earned income from California sources.  For nonresident servicemembers, military wages are considered California source earned income for the purpose of qualifying for the credit.  To qualify for the credit, part-year residents must have earned income while a California resident or earned income from California sources while a nonresident.

Once it is established that the taxpayer qualifies to claim the credit, he must complete and attach Schedule CA (540NR), California Adjustments—Nonresidents or Part-Year Residents, to his tax return.  Form 540NR Long Form must be used.  It is imperative that Part I of Schedule CA (540NR) is fully completed or the credit may be disallowed.

Qualifying Expenses

Qualified expenses include amounts paid for the care of the taxpayer’s qualifying person while he worked or was looking for work.  No more than $3,000 for one qualifying person or $6,000 for two or more qualifying persons may be used to figure the credit.  See the following chart illustrating what types of expenses can be included in the computation of the credit on Form FTB 3506.

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