Child care is often one of a household’s biggest expenses, costing families across the U.S. an average of $8,355 annually per child. And the pandemic has only made it even more challenging for parents to find affordable care. In about half of families, one or both parents left the workforce, reduced their hours, or took a leave of absence during the pandemic, according to Cleo’s Working Parents survey.
Thankfully, there are several tax benefit programs designed to help working parents and caretakers offset the high cost of care. For example, dependent care flexible savings accounts (FSAs) and the child and dependent care tax credit both offer substantial savings. Below, we break down both of these benefits programs so you can decide which one is best for you or your employees.
Dependent care FSA
A dependent care FSA is a tax-advantaged plan that many employers offer which allows employees to allocate pre-tax dollars toward eligible dependent and child care expenses. As explained in our blog post about how to budget your FSA, this benefit program enables you to allocate a certain amount of money at the beginning of each year, which will then be deducted pre-tax from your paycheck each month. The contribution limit for a dependent care FSA is $5,000 per year if you are filing by yourself or jointly with your spouse. If you are married and filing separately, it’s reduced to $2,500 for each party.
The following claimants can be considered dependents:
- A child (or children) under 13 years of age
- A spouse who requires care
- A parent or other tax dependent (including a child over 13) who is incapable of caring for themselves
This program helps employees afford the dependent care costs that allow them to work full-time, so most eligible expenses are those that support your ability to work.
Here are some examples:
Child and dependent care tax credit
The child and dependent care tax credit covers similar expenses as the dependent care FSA. Unlike the dependent care FSA, however, you don’t need to apply for it through an employer. This means that those who don’t qualify for an FSA, such as part-time employees, can still take advantage of this tax credit.
But there are major differences between the two programs. While an FSA allows you to allocate money from your taxable income, the child and dependent care tax credit is simply a credit for a percentage of your expenses and only applies to those who fall below the income threshold.
The child and dependent care tax credit was significantly expanded for 2021 only as part of the American Rescue Plan, making the credit fully refundable and increasing the maximum credit to $4,000 for one qualifying dependent and up to $8,000 for two or more. For the 2022 tax year, the credit will revert to its previous maximum of up to 35 percent of the first $3,000 of expenses for one dependent ($1,050 credit) and the first $6,000 of expenses for two or more dependents ($2,100 credit). The credit will also no longer be refundable, meaning that if a family does not make enough money to owe taxes, they are not eligible to receive the credit.
The American Rescue Plan also made the full credit available to families with an adjusted gross income (AGI) of $125,000 or less. In 2022, households must have a combined income of less than $15,000 to get the maximum credit of $1,050 for one child or $2,100 for two or more children. As income increases, families will receive smaller reimbursements. Families with an annual income between $45,000 and $438,000 can claim 20% of their expenses, up to $600 for one child or $1,200 for two or more children.
To claim the credit, you must submit Form 2441 with their Form 1040. You’ll need to provide a valid taxpayer identification number (usually a Social Security number) for each qualifying person and must also provide the information of each dependent’s caretakers. You can find a detailed FAQ on the IRS site.
Which option is best for you?
Your choice will likely depend on your overall child or dependent care costs and annual salary. If you’re wondering whether it’s possible to take advantage of both programs, the answer is yes — but you can’t double up. For example, you can’t claim the same eligible expense through a dependent care FSA and the tax credit.
The child and dependent care tax credit can potentially put a lot of money directly into parents’ pockets. However, not all caretakers will qualify for this credit, or their expenses may exceed the tax credit thresholds. That’s why the dependent care FSA is an excellent option for lowering the burden of child care costs.
If you’re an employer looking for more information on how to establish a dependent care FSA, drop us a line at sales@getbenepass.com.
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