Childcare takes a significant bite out of working Americans’ incomes: about 10% on average, and 20% of the population spends 25% or more their income on childcare according to Care.com. Given this virtually unavoidable aspect of having a family, tax relief for childcare was written into the tax code.
Unfortunately, the tax benefits for childcare come nowhere near the actual expense that you pay on a regular basis. But you can still get some tax savings if you plan ahead and are mindful of which expenses do and don’t qualify for benefits.
Using a Flexible Spending Account (FSA) For Childcare Expenses
If you and/or your spouse has access to an FSA at work, you should definitely take advantage of it for childcare. Money can be contributed to FSAs pre-tax similarly to a 401(k), or health savings account so you aren’t spending all of your after-tax money on childcare.
A variety of childcare-related expenses aside from daycare centers can be run through an FSA including preschool and even day camps so long as the chief purpose of sending your child there is so that you can go to work.
FSAs can provide a decent tax shelter but have some drawbacks. Regardless of whether it’s just you or your spouse who contributes to an FSA, the annual family contribution can’t exceed $5,000. You’ll need diligent records concerning payments for childcare since you have to submit reimbursement requests to retain your tax benefits.
Since FSAs also forfeit your contributions at the end of the year if you don’t use them, you need to figure out your childcare costs well in advance and try to contribute an amount that’s as close to the actual sum as possible.
Child and Dependent Care Credit
This non-refundable tax credit is worth between 20-35% of your qualifying childcare expenses based on your income. While there is no income cap on who is allowed to claim 20% of their childcare expenses, to figure the credit you can use up to $3,000 every year for two eligible children for a $6,000 maximum. Eligible children are under 13 years of age when the care was provided. Qualifying individuals other than your dependent children include your spouse who is mentally or physically unable to care for themselves and lived with you more than half the year, as well as adult dependents similarly incapable of self-care.
Daycare centers, private nannies and babysitters, and certain after-school programs are eligible for this tax credit provided that you are using them to go to work. This means you can’t count the costs of getting a babysitter for date night or running errands, only costs incurred for work and job interviews.
To qualify for the credit, care providers can’t be your spouse or the parent of the qualifying individual. They also can’t be your child who is under the age of 19 or anyone else you claim as a dependent. You will need to provide identifying information for the childcare provider, including a Social Security Number or ITIN if you are using a private nanny or sitter.
Since this credit non-refundable, it can only reduce what you owe in taxes rather than result in a refund such as the Earned Income Tax Credit or the refundable portion of the Child Tax Credit.
Can I Use an FSA and Still Get the Childcare Tax Credit?
Yes. You can use an FSA and still claim the childcare tax credit. However, if you do this, then FSA funds are applied first to your eligible childcare costs. If you spent $3,000 on daycare and used up $3,000 from your FSA, then you don’t qualify for the tax credit, but that $3,000 will still be tax-free. If you have two children and paid the maximum of $6,000 but only had $4,000 in the FSA, you can then use that remaining $2,000 for your two children to claim the tax credit while the $4,000 in the FSA is tax-free.
While the tax credit for childcare is limited to just two children with a cap of $3,000 per child, the benefit is still available to you no matter much you earn. You can also stack it with an FSA if you have access to one. If you pay sitters on an ongoing basis in order to work, you also need to collect tax ID information to get the credit.