With the cost of child care through the roof the last few years, a Dependent Care FSA is a great option to get a slight tax break on your money.
One of the biggest expenses that young families will incur is the cost of childcare should both parents return to work. In major cities around the countries, it’s nothing for a family to be paying more than $1,000 per week, per child. That equates to right around $50 per day and typically doesn’t even include a food program for your child.
Let’s be honest, there is no end in sight as most of these facilities have licensed teachers who watch infants. That’s great, and I get why parents love that, but it’s driving the costs through the roof.
Currently, the Internal Revenue Service (IRS) will allow a tax credit to help the burden. For 2021, you could reduce your federal income by $3,000 per child, or up to $6,000 with two or more children. Let’s just be honest, families that need full-time daycare are spending far more than that.
The credit is a good gesture, but families need to consider looking into other options, and a Dependent Care Flex Savings Account (FSA), may be exactly what you need. You are not permitted to claim the same expenses on both your federal income taxes (child tax credit) and Dependent Care FSA.
There are some situations where there is some overlap, but that gets a little more complicated. A quick example would be if you have two dependents. A Dependent Care FSA will allow up to $5,000 of expenses, and the IRS allows up to $6,000 of dependent care write-offs. You can use the additional $1,000 when filing, but you can’t make use of any duplicate expenses for that amount.
The bottom line is you can use both, but you can’t double-dip. Because of the Dependent Care Tax Credit being limited by the households adjusted gross income (AGI), high earning households are often better off exploring the Dependent Care FSA options.
The key here is, don’t think about it which option is necessarily better, be ahead of the curve and figure out how you can utilize both programs.
Now, the tax credit is fairly simple, and most people understand how that works. The Dependent Care FSA has slightly more to it, and here is a better breakdown of everything you need to know when making a decision.
Here are a few key items to know about a Dependent Care FSA:
- A Dependent Care FSA is somewhat new, and you can only have access if your employer offers it. If you don’t currently have access to one through your employer, it’s likely worth mentioning to your HR department that you would have a strong interest.
- If you and your spouse are separated, only the custodial parent can utilize the program.
- There are limitations to how much you can contribute, please make sure to read all the details on what your program offers.
- Dependent Care FSA’s cannot pay out cash. Any contribution that goes unused from that year will be lost.
Now that you have a basic overview of what a Dependent Care FSA is, let’s dive into the real details of the program and figure out exactly how it can help save you some money with the crazy, increased costs of daycare.
First things first: a Dependent Care FSA is not just for daycare. It is eligible to a dependent under the age of 13, or any spouse or adult dependent in the home that isn’t physically or mentally able to care for themselves. This would be anyone for who you claim the dependent exemption on your taxes. In most circumstances, this type of FSA will be utilized for daycare, but there are other options available.
A Dependent Care FSA is set up through your employer, where they take the money directly out of your paycheck each pay period. The company will then put that money into the FSA account, and you will later be reimbursed via the Dependent Care FSA.
The form to get the reimbursement is typically very simple to fill out, and you will just need some sort of receipt with proof of your payment. You will have to include information like name, provider, dates of service, type of service, and the cost to get your money.
These are all things that are easily available and put in place to keep out the fraudulent requests. So, what is the major benefit of going through all this hassle, you ask? Any money that you set aside for a Dependent Care FSA is using pretax dollars.
This means that every dollar you contribute will not be subject to taxes. For a typical person who is in the 24% federal bracket, that means every $1,000 you contribute, you save $240 on daycare a year. With the max being $5,000 in 2022 (in most cases), that means you can save up to $1,200.
One thing to keep in mind if you are new to a Dependent Care FSA is that the rules are changing drastically in 2022 (for now). The American Rescue Plan did allow a major increase in contributions for the 2021 year. Single and joint filers were able to contribute up to $10,500.
As of now, that was a one-year thing, and the amount will be cut back to $5,000 in 2022. This is a very fluid topic in the current administration, so make sure you stay up to date with any changes that could be occurring over the next few months.
It is important to remember that each company can have different rules on utilizing a Dependent Care FSA. I know for me, both my spouse and I must work full-time to be eligible, with full-time meaning an average of 30 hours or more per week.
Some companies may not be as strict, but when I asked questions on the auditing, they told me I would be subject to submitting pay stubs to prove her employment. My wife currently only works 20-25 hours per week right now, thus making me ineligible for the perk.
Don’t just assume that is the rule for your company though. I spoke to many of my friends after learning this, and it appears companies’ qualifications for the program can vastly differ. I would defer you to your HR group to make sure you completely understand any program offered.
As with anything nowadays, there is an app to help. If you have questions on a Dependent Care FSA or need help tracking receipts and bills, utilize The Federal Flexible Spending Account Program (FSAFEDS) app.
Qualifying Dependent Care FSA Reimbursements:
Remember, there are some guidelines on what you can and can’t use this FSA money for. There are some items of leniency, but if you are truly looking to capitalize on all the benefits, childcare makes that extremely easy. Below is a quick list of qualified expenses.
- Physical care – this would typically be if you are utilizing the program for a spouse or dependent who is unable to care for themselves. These bills can add up quickly and it’s an easy way to at least pay with tax free dollars.
- In home childcare, including a nanny, babysitter, or au pair. Please keep in mind anyone you utilize this program with must be properly filing taxes themselves. At times, there can be under the table daycare deals that wouldn’t qualify for a Dependent Care FSA reimbursement.
- Before and after school care. This could be in your home or at a care facility.
- Any money given to a caregiver for transportation.
- Fees incurred from enrollment to care programs. Keep in mind the care program must abide by all bullets above to qualify.
There is nothing too tricky about what is acceptable for reimbursements, but there are a couple of things to keep in mind about what won’t pay.
Non-Qualifying Dependent Care FSA Reimbursements:
These FSA accounts are to be utilized for expenses incurred by a family that is necessary for you and/or your spouse to work and earn an income for your family. The expenses below would not qualify for reimbursement.
- Education – While you can pay for childcare, once they hit school age, you can’t account any cost incurred for them to attend school. There is a fine line when younger aged kids start attending pre-school, in most scenarios these costs are eligible.
- Overnight summer camps. This is a strange one, but if the camp goes overnight it turns from eligible to ineligible for reimbursement.
- Extracurricular activities like sports or any other items that require lessons. These are considered option activities, and not necessities.
- Meals – should food not be provided at a care facility or qualifying program, that will have to be left out of the reimbursement submission.
Most of these aren’t shocking and at the end of the day, remember, any type of care for a dependent under age 13 or a dependent/spouse who is unable to care for themselves is covered. If you are married with a working spouse or have full custody of children under the age of 13, there aren’t many reasons that you shouldn’t at least inquire about utilizing this type of FSA program.
Things to Consider Before Enrolling in Dependent Care FSA:
Before making any big financial decision, I highly recommend doing a thorough look at all your options. I have laid out a lot of reasons why a Dependent Care FSA makes sense for a lot of folks, but there are certainly reasons it may not make sense for you. Here are a few quick items to think about when making a decision.
- This type of FSA account is not pre-funded. What that means is all expenses you pay utilizing this account must be paid by the contributor, and then they will be reimbursed via check or payroll from the company. This isn’t just a card that you swipe when paying, there are a few extra steps that take up some additional time. If you are someone that despises that extra work and don’t always value the savings, this may not work for you.
- This is typically a use it or lose it. It can depend on the company program, but please make sure you have the full understanding. If there is any chance that your qualifications may change throughout the year, just think about how much you want to contribute. While you want to utilize the full tax advantage, please make sure you don’t leave any money on the table.
- A Dependent Care FSA is an account that will have to be re-enrolled each year. Please make sure when you go through open enrollment each year, you don’t forget to re-submit your enrollment. When you are going through this process, there are so many things to remember and it’s easy to forget something like this.
- This FSA account is eligible to be changed for “life changing events”. That means if you and your spouse get divorced, have another child, or someone loses their job, you do have up to one month to adjust the contributions to the account.
Before my wife started to stay home with our children (a huge reason being the cost of daycare), I did utilize the Dependent Care FSA. I maxed it out because I got to a point where I was spending $10,000 per year on daycare.
Once my wife quit her job (which was luckily later in the year), I became ineligible for the company program. Had I not spent all the money before she left her job, I would have been subject to surrendering that money back to my company.
I get it, no one has the ability to see the future. My point is to just really think about it before you pick your contribution. It’s easy to think that you will just max it out, but if you are new to the program, I would recommend starting out smaller for year one just to see how it goes.
As with anything that is put out by our federal government, the rules can get confusing when trying to utilize the tax credit and Dependent Care FSA. While it is possible, and there is value to both, please make sure to speak to your accountant as well, before pulling the trigger.