Every family would rather invest in a college fund than overpay the IRS. Looking at how child care is paid is one way to accomplish this.
The Child and Dependent Care Credit considers several life attributes, but the most influential items are the gross income of the parent(s), dollar amount of child-care expenses, age and other basic information about the child, and the working status of the parent(s).

This is a lot to consider, and it is likely why most people choose to use a Flexible Spending Account (FSA) when available through their place of employment. If the tax credit is used instead of an FSA plan, the credit is equal to 20% to 35% of dependent care expenses, depending on the taxpayer’s income. Sometimes it is tax advantageous to use an employer’s FSA plan, and sometimes it is advantageous to spend money out of pocket to get the tax credit.

 

Here’s a quick overview of the guidelines and limitations of using the tax credit:

• Eligible child-care expenses are limited to $3,000 annually for one child or $6,000 for two or more.
• Eligible child-care expenses must be incurred in order to give the child’s parents the opportunity to work or look for work.
• The daycare must be in compliance with state daycare laws and cannot be administrated by a relative.
• The taxpayer (or married couple, if filing jointly) must furnish over half the cost of maintaining the household, meaning, for example, that if a taxpayer lives with his or her parents and therefore does not provide for over half of the household, the credit cannot be used.
• The dependent must be under the age of 13 or disabled at the end of the year. This means that if a child turns 13 in December, he or she is not eligible to have his or her daycare expenses used for the tax credit for that year.
• If married, the parents must file jointly. There is an exception for parents who live apart for more than half the year. Individuals who are legally separated or under a decree of divorce are not considered married.

 

Let’s examine a couple of quick examples, one where it would be advantageous to use an employer’s FSA plan to pay for dependent care expenses, and one where it would be better to forego the FSA and take advantage of the Child and Dependent Care Credit.

Advantageous:
Kim is a single mother of two who works most evenings and some days. In this case, if she used the Child and Dependent Care Credit, she would save $1,560 on her taxes. If she had an FSA available through her employer, she would only save $750.

Here are the details: During the evenings, Kim’s mother looks after her two children. However, Kim works during the daytime four days a week, and in order to do so, she pays a daycare $25 per day of care for each of her children (amounting to $10,000 a year). If Kim makes $33,000 a year, placing her in the 15% bracket, she may claim $6,000 (the maximum amount) of child-care expenses. According to the credit percentage associated with Kim’s income from the credit table the Treasury publishes, she will get a tax credit for 26% of her qualifying dependent care expenses, so she may reduce her tax bill by $1,560. If she had an FSA through her employer, she could have saved $750 ($5,000 x 15%) a year on her tax bill because the most she could have used tax free from an FSA account is $5,000.

 

Not Advantageous:
Tina is married to Hank. Hank works full-time and makes $150,000 a year. Tina works two days a week to maintain the consulting business she started before having children. She spends $5,000 a year for daycare expenses. Hank has a dependent care plan through his work which allows him to not pay tax on $5,000 of income used in the plan per year. In this case, they are in the 28% tax bracket. They would only receive a credit percentage of 20% of $5,000, according to the Treasury publications, so if the couple use the work plan, they will save $1,400 on their tax bill, but if they use the credit, they will only save $1,000.

 

As you may see, even a fairly simple example of a family’s interaction with using an FSA versus the tax credit is a bit difficult to understand. Unfortunately for many people, most families exist outside the standard examples of how this tax credit applies to a particular situation. This is why it’s helpful to have a professional examine your situation and suggest ways your family may save money.

 

Waiting until the end of the year or until tax time is often too late to take optimal advantage of your tax situation. Contact us today so we can tell you how the tax code may be used to your advantage for the rest of the year!