Summer break is a carefree time for children, but for working parents, it can be stressful to find childcare. The good news is that the federal government offers tax breaks for child tax credit that help to ease the financial burden of summer childcare. Let’s explore two options that can help you save money: Dependent Care Credit and Flexible Spending Accounts (FSAs).
Saving on Childcare Costs with a Dependent Care FSA
Your employer might offer a program to help you save on childcare expenses. It’s called a Dependent Care Flexible Spending Account (DCFSA), and it lets you set aside money from your paycheck before taxes are taken out.
Here’s how it works.
Each year, you choose an amount of money to contribute to your DCFSA, up to $5,000 per household (or $2,500 if you’re married and filing separately). This money comes out of your paycheck before taxes are applied, so you pay less in taxes overall.
Think of it like a special savings account for childcare. The money you contribute can then be used to pay for qualified dependent care expenses, like daycare, preschool, summer camps, or even before and after-school programs.
By using pre-tax dollars to cover these costs, you can save a significant amount of money compared to paying for childcare with your regular income.
Dependent Care FSA: Eligibility and Spending Rules
Before you dive into the world of tax-advantaged childcare savings with a Dependent Care FSA, there are a few key things to consider:
1. Who qualifies for care?
The person you’re paying for care for must be your dependent, either a child under 13 years old or someone who is incapacitated and unable to care for themselves.
2. Living arrangements
The qualifying child must have lived with you for more than half of the year. They also cannot have provided more than half of their own financial support during that time.
3. Age matters
The qualifying child must be younger than you, the taxpayer claiming them on your return.
4. Married filing jointly
If you’re married and filing jointly, both spouses need to have earned income of at least $5,000 per year. There are exceptions though, if your spouse is disabled, a full-time student, or actively looking for work.
5. Use it or lose it
The funds you contribute to your Dependent Care FSA typically have a “use it or lose it” rule by the end of the year. Check with your plan administrator to confirm deadlines.
6. Enrollment window
This is important. You can only sign up for a Dependent Care FSA during your employer’s designated enrollment period, which usually happens at the beginning of the year.
So, if you miss the window, you’ll have to wait until next year to participate. Once you have enrolled and your Dependent Care FSA is up and running, let’s explore what kind of expenses qualify for reimbursement!
Using Your FSA for Childcare and Summer Activities
This section explains what types of childcare and summer programs qualify for reimbursement through your Flexible Spending Account (FSA).
a. Childcare Providers:
To use your FSA for childcare expenses, your provider needs to be a registered business. This means they must have a Taxpayer Identification number, which can be either an Employer ID number (EIN) or a Social Security number. This requirement ensures the childcare provider reports the income they receive from you on their tax return.
b. Summer Camps:
There’s good news for parents who utilize summer day camps! The costs associated with these programs are eligible for FSA reimbursement. This applies to various day camps, including those focused on activities like soccer, tennis, or computers. However, overnight camps don’t qualify under FSA guidelines.
c. Educational Programs:
It’s important to note that some summer programs aren’t covered by FSAs. Unfortunately, tutoring and summer school expenses cannot be reimbursed through this account.
d. Payments to Relatives:
Thinking about having Grandma or another relative watch the kids this summer? You can use your FSA funds to pay them, as long as they have a Social Security number and report the income they receive on their tax return. This extends to other relatives as well, with one exception: you cannot pay a dependent, such as your 16-year-old child, to care for your younger children and still claim them as a dependent on your taxes.
Child and Dependent Care Credit: An Alternative to Dependent Care Assistance Programs
Even if you don’t participate in a Dependent Care Assistance Program (DCAP), you can still claim a tax credit for your child care expenses through the Child and Dependent Care Credit. This credit offers a significant tax break, especially for families with lower incomes.
Tax Credit Based on Income
The Child and Dependent Care Credit is a tiered credit, meaning the percentage of credit you receive depends on your Adjusted Gross Income (AGI). Families with an AGI of $15,000 or below can claim a credit of up to 35% of their childcare expenses, capped at $3,000 per child (with a total maximum of $6,000). This percentage decreases as your AGI increases, reaching a minimum of 20% for families with an AGI of $43,000 or more.
Example for Lower Income Families: Let’s say you have two children and pay $3,000 in qualifying childcare expenses for each child. If your AGI falls under $15,000, you’d be eligible for a credit of 35% on each child’s expenses, resulting in a tax credit of $1,050 per child (35% of $3,000). This credit directly reduces the amount of federal income tax you owe.
Key Point: While the DCFSA offers tax advantages, the Child and Dependent Care Credit can be a better option for some families, particularly those with lower incomes.
Frequently Asked Questions
Ques. Who qualifies for the Child Tax Credit?
Ans. This depends on your income, filing status, and the number of qualifying children you have.
Ques. How much is the Child Tax Credit worth?
Ans. The credit amount can vary depending on your income and the age of your child. However, for 2023, the maximum credit is $2,000 per qualifying child.
Ques. What are the changes to the Child Tax Credit for 2023?
Ans. The Child Tax Credit was expanded for tax year 2021 but has since reverted to pre-expansion rules.
Ques. Do I need to repay any Child Tax Credit I received?
Ans. No, the Child Tax Credit is not a loan and does not need to be repaid.
Ques. How can I claim the Child Tax Credit?
Ans. You will claim the credit when you file your tax return for 2023.
Also Read-
The Financial Compass for Expansion: Why You Need a Top-Notch Financial Controllers