Dependent Care Flexible Spending Account (FSA) rules and eligible expenses can appear daunting at first – until you understand the basic guiding principles behind this popular employee benefits program.
A family in the 24% tax bracket can use an FSA to save $1,582 each year with the little risk of leaving unused funds on the table. It is definitely worth it!
Make the most of your tax savings opportunities. Make adult and childcare more affordable by enrolling during your employer’s annual open enrollment period.
- Rules on contribution limits, non-working spouses, and qualifying events
- Are private schools, babysitters, nannies, and summer camp expenses eligible?
Dependent Care Flexible Spending Account Eligible Expenses
Dependent Care Flexible Spending Account eligible expenses are wider than many parents realize and narrower than what others hope. Below are the basic criteria followed by our interpretation as they relate to common service providers.
- Daycare must enable you and your spouse to work
- Services must be for the physical care of the child, not for education, meals, etc.
- Spouse or dependents over the age of 13 who are incapable of self-care
Private school expenses are sometimes Dependent Care FSA eligible. Tuition is an education outlay, which often disqualifies these charges. However, the IRS guidelines provide several grade-based exceptions.
- Education expenses for private preschool, nursery school, and similar programs qualify as childcare and are eligible for reimbursement.
- Tuition expenses for private kindergarten and higher grades are ineligible for reimbursement. However, any after school care provided by these facilities do qualify.
The typical babysitter expenses rarely qualify for Dependent Care FSA reimbursement. Many parents hire babysitters to watch over a youngster at their home for non-work-related activities.
- Go out to eat at a restaurant
- Watch a movie at the theater
- Attend a party or other social function
At-home babysitter costs do qualify when the care enable one or both parents to pursue a work-related task. For example, a babysitter watches your child while one working parent sleeps and the other is at his or her job. Keep dated receipts for any of these activities.
The typical fees paid to a nanny often qualify as Dependent Care FSA expenses. Most nannies care for young children in the home so that both parents can work. They meet the basic criteria.
However, keep in mind that by claiming an at-home nanny you then become a household employer. You will need an employer identification number (EIN) and you may have to pay employment taxes.
Summer camp fees are sometimes Dependent Care FSA eligible expenses. IRS rules dictate when you can claim these charges.
- Overnight or sleepover summer camp is not work-related
- Summer day camps do qualify even if they specialize in special activities such as computers, or sports such as soccer, basketball, baseball, etc.
Dependent Care Flexible Spending Account Rules
Learning the Dependent Care Flexible Spending Account rules can help parents save money on their qualifying childcare expense. Making a pretax contribution to an FSA reduces your income subject to three types of taxes.
- Federal income
- Most state income
The Dependent Care FSA annual contribution limit for 2018 going into 2019 is still small compared to what most parents typically spend on childcare each year. Consider these average weekly costs for one child.
- Nanny: $580
- After School Sitter: $242
- Child Care Center: $211
- Family Care Center: $195
- Au Pair: $390
The Dependent Care FSA annual contribution limit for highly compensated employees may be reduced to zero if the benefits for the program favor employees in this class – as described in section 129(d) of the Internal Revenue Code.
A highly compensated employee for 2018 meets either of the following tests.
- Was a 5% owner at any time during the year or the preceding year
- Received more than $120,000 in pay for the preceding year and was in the top 20% of employees when ranked by pay for the preceding year
Married couples do not enjoy an increased Dependent Care FSA annual contribution limit compared with divorced or separated parents – unless one person provides the support by him or herself.
- $5,000 for a married couple filing jointly
- $2,500 for a married person filing separately
- $5,000 for a single parent
Divorced and unmarried parents do not gain an increased contribution limit. The primary custodial parent may contribute the full limit. The non-custodial parent is not eligible to file a claim on the childcare costs even if that parent is able to claim the child as a dependent.
A Dependent Care FSA does not have a rollover period feature similar to its counterpart for medical expenses. Under the healthcare version, you can rollover up to $500 of unused money into the next plan year.
The use-it-or-lose-it rule still applies for dependent care are costs with a 90-day grace period to file claims for the previous plan year. However, parents who follow the IRS instructions carefully have little risk of forfeiting unused funds at the end of the year.
Spouse Not Working
You may be able to claim Dependent Care FSA expenses even if your spouse is not working. Two IRS tests determine who does and does not qualify for reimbursement from the account.
- Work-related test: The childcare spending must enable you and your spouse to work or look for a new job. The IRS rules allow for two additional work-related categories.
- Full-time students
- Physically or mentally unable to care for self
- Earned income test: Your spouse must have earned income during the year that exceeds the claimed childcare spending. Below are common examples to do and not qualify.
|Wages, salaries, tips||Worker’s compensation|
|Self-employment earnings||Unemployment benefits|
|Taxable disability pay||Social security retirement|
|Non-taxable combat pay||Child support|
Apply these two tests together against several common scenarios to determine if your claim is valid even though your spouse is not working.
- Stay at home mothers do not qualify because they do not incur work-related costs
- Self-employed spouses are eligible provided their net earnings exceed childcare costs
- Spouses who lose their job qualify provided they actively look for new employment and their earned income for the year exceeds the claimed charges
Dependent Care FSA qualifying life events allow couples to make contribution changes during the middle of the plan year. You do not have to wait until the annual open enrollment to make appropriate changes.
Qualifying life events minimize the risks associated with having unused money because of the use-it-or-lose-it rule. Cafeteria plan regulations permit participants to make mid-year changes in payroll elections consistent with any of these new statuses.
- Legal marital status
- Number of dependents
- Employment status
- Change of residence
- Dependents begin or cease to meet eligibility requirements
Versus Tax Credit
A Dependent Care FSA versus the Childcare Tax Credit comparison can help you determine which alternative works best for your situation. The rules are complex, and each family situation is unique. Consult your CPA for a final recommendation.
Here is a brief summary of the pros and cons. In general, families with Adjusted Gross Income above $43,000 and/or one child in daycare do better with the FSA. Parents with lower income and/or two children in daycare find the Child Care Tax Credit works better.
|One Child Limit||$5,000||$3,000|
|Two Children Limit||$5,000||$6,000|
|Tax Savings – AGI $43K +||22% +||20%|