Child care is a significant expense for parents. For working moms and dads, it is also an unavoidable cost especially when family members aren’t an option as a full-time babysitter. According to Care.com, one in every three families in America spent about 20% of their annual household income on childcare in 2018. That’s almost like a second mortgage. But there is a way to prepare for child care costs without dividing up your monthly paychecks and having nothing left.
Setting up a dependent care savings account through a Flexible Spending Account (FSA) that is deducted from your paycheck pre-tax or taking advantage of the Child and Dependent Care Tax Credit can help you save money on eligible dependent care expenses.
Here’s how to decide between the two.
Dependent Care Flexible Spending Account (FSA)
Your employer may sponsor FSA accounts. They are a place to set aside money out of each paycheck in order to pay for health care expenses. An employer can decide whether to give their employees options for an FSA account or health care FSA (HSA) account which have different eligibilities and contribution limits. A Dependent Care FSA is an account that is meant to keep money specifically to pay to care for your dependents, your children.
Eligible expenses outlined in IRS publication 503 include daycare expenses or nursery school care, a nanny or au pair, and summer day camp or overnight camp. The maximum amount of pre-taxed dollars you can put in the dependent care savings account for 2018 is $5,000 for married couples per household. The money you contribute to your FSA is protected from federal, state, Social Security, and Medicare taxes (7.65%). This brings down your total taxable income, saving you money on your taxes as a result.
An FSA is essentially an untaxed savings account that you can draw from to pay for child care, but know that you must use the funds by the end of the plan year or else you may lose any excess money. Your employer has the choice to set up the account as they wish, and unused funds essentially belong to them. Rolling over additional funds in an FSA at the end of the year is often not an option.
Child Dependent Care Tax Credit
The federal government also offers credit for working taxpayers who pay someone to look after their child or children under 13. According to the IRS, the credit is worth between 20 and 35 percent of allowable expenses depending on income. Expenses are limited to $3,000 for paid care of one qualifying dependent while the limit is $6,000 if you are paying to care for two or more children. The IRS offers a tool to see if you are eligible to claim the credit.
Claiming the tax credit will also lower the amount of taxes you owe at the end of the year.
Combining Credit with an FSA
You cannot claim the child care tax credit while contributing to a Dependent Care FSA unless you are spending more than $5,000 a year on expenses for two or more children. You could use the $5,000 in your FSA and still claim the tax credit on your remaining balance which is only $1,000 since the tax credit limit is $6,000.
Dependent Care Savings Account vs. Tax Credit | C&D
Oftentimes, claiming the government’s tax credit is the only option available if the taxpayer doesn’t have access to a dependent care savings account from their employer. Other times, it comes down to a choice between what the parent prefers (a potential credit on their tax return or the pre-tax deduction with each paycheck).
Our CPAs and advisors at C&D can help you decide which savings route is best for you. At the end of the day, we all want the best care for our children, but a nanny shouldn’t have to cost your entire hard-earned paycheck. Schedule a consultation to see how and where to set up accounts to help save on child care costs.