Finances 101: How To Maximize Tax-Benefits to Cut Child Care Costs

As you may have seen from our previous articles on Finance 101 and Big Ticket Items this month, we are focusing on finance and costs in July. 

While the US has a ways to go in terms of paid maternity leave (this is only mandated by three states currently) and universal childcare services, there are ways to navigate taxes that can help offset some of the costs of childcare.  

Some employers will offer Flexible Savings Accounts to their employees as part of a benefits package. Flexible Savings Accounts are accounts in which employees can set aside pre-tax dollars to help pay for either medical expenses or dependent care expenses. Both types have thresholds of how much you can contribute per year, as well as other limitations on the types of things you can spend money on. 

Dependent Care Flexible Savings Account (DCFSA)

A DCFSA is a great way to use pre-tax dollars towards child care expenses. Per the IRS, a married couple filing a joint tax return can contribute up to $5,000 per year of pre-tax money to a DCFSA to use for eligible expenses, such as day care, preschool, or adult care as well. (If you file separately, you can each contribute $2,500). 

These are employer sponsored, and money is deducted directly from your paycheck pre-tax and deposited into the account. 

Eligible expenses include (for children under 13):

• nanny, babysitter, or daycare expenses

• Summer camp

• Preschool

• nursery

This account can also be used to help care for adult family members who are unable to care for themselves. 

According to Haven Life insurance, “An example of your tax savings would be: If you contribute the maximum $5,000 in a given year, and fall into the 24% tax bracket, you’d be saving about $1,583 a year in taxes including both federal income tax and the 7.65% Social Security and Medicare tax.”

As with all FSAs, if you do not use the money in this account, you are unable to roll it over. So it’s important to know that you’ll use all your contributions. Considering that the average amount spent on child care in the US in 2018 was $21,696, we have a feeling you might be using all $5000 of these contributions. 

Child and Dependent Care Tax Credit (CDCTC)

If you pay for someone to care for your child or another family member so that you can work, you may qualify for the Child and Dependent Care Tax Credit. 

This credit allows you to claim up to $3,000 of expenses for one child or $6,000 for two or more children (or qualifying adult family members). You then apply a credit rate between 20%-35% (based on income) to receive a credit. For example, if you make over $43,000 a year, your credit rate would be 20%. 20% of $3,000 is $600, so you would receive a credit of $600 for one child, or $1200 for two or more children. 

Similarly to a DCFSA, to qualify for this, the child must be under the age of 13, or the adult dependent must be physically and/or mentally unable to care for themself. 

Also, the care in question must be necessary for the parent to be able to go to work or school. Meaning, babysitters for Friday night date night sadly do not qualify. 

There are a couple other restrictions for this tax credit; you have to have earned income that year, you need a social security number, and the care provider must have a taxpayer identification number.

Can you use both of these together?

Yes, although it’s a bit complicated. The CDCTC excludes any employer benefits - such as a DCFSA. However, if you contributed $5000 to your DCFSA but your child care expenses were over that amount, you can use the difference to apply for the CDCTC. 

For example, a family of two or more children can use the $6,000 threshold, subtract $5,000, and then apply the $1,000 for a tax credit. If you make more than $43,000/year, you would get 20% back or $200. 

In most cases, for higher income families the DCFSA will provide more benefit (20% of $6,000 is $1,200, which is less than the exclusion of $5,000 in a DCFSA). According to the Tax Policy Center, lower-income families are less likely to have access to DCFSAs so will benefit more from CDCTCs.