Tax Benefits When Paying for Child Care Expenses

Summary

Paying for childcare is a necessary part of many families’ budgets, and it can be such a large part of the budget that any relief is welcome. You have two main ways to possibly get some tax benefit —and thus, relief—for childcare expenses: the child and dependent care tax credit and a dependent care flexible spending account.
 

Child and Dependent Care Tax Credit

This is a federal tax credit available to working parents or parents who are “full-time” students or looking for work. The credit is intended to help offset the costs of childcare or dependent care during those working or school time periods.

It is a nonrefundable credit, meaning it reduces the amount of taxes you owe and can increase your refund (but not above the amount of taxes you had withheld). You receive this benefit when filing your taxes for the prior tax year.

The credit amount is determined based on a formula that uses the total of expenses paid and a percentage based on your overall income. For 2022, the maximum credit is $1,050 for one qualifying individual and $2,100 for two or more qualifying individuals.

Example 1:

• Earned AGI of $15,000
• Dependents: 1
• Dependent care expenses: $3,000 (qualifying limit)
• $3,000 x 35% = 1,050 credit

Example 2:

• Earned AGI of $60,000
• Dependents: 2
• Dependent care expenses: $6,000 (qualifying limit)
• $6,000 x 20% = 1,200 credit

You will need to keep records of the expenses you have paid. Most care facilities can provide you with a summary or receipt of what you have paid upon request.

 

Dependent Care Flexible Spending Account (DCFSA)

Another option for tax savings is through a payroll benefit called the dependent care flexible spending account. Not all employers offer this benefit, but many do, so make sure you ask your benefits coordinator at your place of employment.

To use this benefit, you must make the election during open enrollment for your company benefits. You select the dollar amount you want to set aside for expenses throughout the year, and the DCFSA is funded by equal payroll deductions each pay period. Once you pay dependent care expenses, you submit them to the DCFSA and receive reimbursement.

You can contribute a maximum of $5,000 per household per year (or $2,500 if married, filing separately).

The tax advantage for this type of account is that contributions are made pre-tax from your paycheck—thus, they reduce your taxable income that is reported for tax purposes. In addition to saving you the normal income tax, they also save you payroll tax (FICA tax).

Example:

• Federal tax bracket: 12%
• State tax bracket: 5%
• FICA taxes: 7.65%
• Contribution to DCFSA: $5,000
  • $5,000 x (12%+5%+7.65%) = $1,232.50 total tax savings

The taxes are saved by reducing your taxable income (rather than receiving a credit on your taxes). That means the benefit is spread throughout the year through less tax withholding rather than by getting it all at the end when you file your taxes.

You cannot use the same expenses to get both tax benefits. However, it may be possible to take advantage of both benefits if your overall expenses exceed the threshold of just one of them. You should work with your tax preparer or financial advisor to determine your eligibility for benefits and which would be best for your situation.