Child and dependent care is a critical issue and a large expense for many American families. Millions of people rely on child care to be able to work, while others are responsible for older parents or disabled family members. If you care for a child or adult who is incapable of self-care, who lives in your home for at least eight hours each, and whom you can claim as a dependent on your income taxes, you may be able to take advantage of dependent care flexible spending accounts (FSAs). These accounts allow individuals to pay for qualified child and dependent care expenses while lowering their taxable income. (For related reading, see Give Your Taxes Some Credit.)

Dependent Care FSA Overview
Dependent care FSAs are set up through your workplace. Participants authorize their employers to withhold a specified amount from their paychecks each pay period and deposit the money in an account. Instead of using the FSA money to pay for expenses directly, you pay those costs out-of-pocket and then apply for reimbursement.

Once you have paid for expenses that qualify for reimbursement from the FSA you will need to complete a claim form provided by your employer and attach receipts or proof of payment with the form. The receipts must include specific information to prove that the payment was for qualified expenses. Specifically, the receipt must note:

  • the date of the expense incurred
  • the expense amount
  • the full name, address and social security number (SSN) or tax identification of the person who provided the care

The main benefit of an FSA is that the money set aside in the account is pretax, thus reducing the amount of our income subject to taxes. For someone in the 28% federal tax bracket, this income reduction means saving $280 in federal taxes for every $1,000 spent on dependent care with an FSA.

The IRS limits the total amount of money you can contribute to a dependent care to $5,000 each year for married couples filing jointly, unmarried couples, and single individuals, and $2,500 if you are married and filing separately.

If you and your spouse are divorced, only the parent who has custody of the child(ren) can use FSA funds for child care. If you are married both you and your spouse must work and earn income to qualify for reimbursement (unless one spouse is disabled and unable to work). If not, the money you contribute to the account will be forfeited and you will be billed for the taxes due because you did not pay taxes on the amount in the first place.

The money in your FSA can only be used for expenses for:

  • A dependent who is 13 or younger
  • A spouse who is unable to work and care for him or herself
  • Another adult dependent who is unable to care for him or herself and for whom you claim the dependent exemption on your taxes

Expenses That Qualify for FSA Reimbursement
Once you deposit money into an FSA, you can begin using those funds toward reimbursement for qualified expenses. You can only use the money for bills that meet the IRS definition of eligible dependent care service. That means that the services must be necessary in order for you and/or your spouse to work and earn an income. Qualified expenses include:

  • Physical care
  • In-home care, such as a nanny or au pair, or institutional-setting care, such as child or adult daycare services, by qualified caregivers
  • Summer day camps
  • Before- and after-school care
  • Transportation provided by a caregiver
  • Application fees, deposits, etc. required for obtaining care, but only if care is subsequently provided

The IRS' Publication 503: Child and Dependent Care Expenses outlines expenses that qualify for FSA reimbursement.

Expenses That Do Not Qualify for FSA Spending
Remember that you can only use FSA money for expenses that are necessary for you and/or your spouse to work and earn an income. Expenses that do not qualify as FSA-approved and therefore are ineligible in an FSA include:

  • Education (i.e. kindergarten, preschool, summer school, tutoring, school tuition)
  • Babysitting by minor-age (under 19) sibling/child or individual claimed as a dependent
  • Overnight camps
  • Enrichment programs and lessons (i.e. music, sports lessons)
  • Meals
  • Custodial nursing care or long-term care for parents not living with you
  • Housekeeping

What to Consider
Before creating a dependent care FSA, you should consider the following:

  • FSAs are not "prefunded." With some healthcare FSAs, the employer "fronts" the money and is repaid through paycheck withholding. With dependent care FSAs, you pay expenses out-of-pocket, then receive reimbursement based on how much you have withheld from your paycheck for dependent care expenses.
  • Before setting up a dependent care FSA, compare its potential tax benefits with the child and dependent care tax credit.
  • FSAs operate with a "use it or lose it" policy, meaning that you must use all of the money you deposited into the account for qualified expenses by the end of the plan year or you will lose your money.
  • You will need to report your FSA contributions on your federal tax return.
  • Participation in a dependent care FSA is not automatic - you must re-enroll every year by the enrollment deadline.
  • You can only change the amount of money you choose to have withheld from your paycheck for the FSA within a 31-day window following a "qualifying event", such as a marriage, the birth or adoption of a child, the death of a dependent, divorce or a change in your (or your spouse's) employment.

Conclusion
Opening and funding a dependent care FSA can help you plan and pay for the care you need to help you be able to work and earn a living. Consider looking into a plan offered by your or your spouse's employer and learn about how much you could save on taxes by taking advantage of this option.

For more, read Healthcare FSAs Increase Your Personal Savings.

Related Articles
  1. Retirement

    Payroll Deductions Pay Off

    Find out how you can bypass or defer taxes on thousands of dollars each year.
  2. Retirement

    Healthcare FSAs Increase Your Personal Savings

    This benefit could give you a return this year that puts many other investments to shame.
  3. Taxes

    10 Money-Saving Year-End Tax Tips

    Getting organized well before the deadline will curb your frustration and your tax liability.
  4. Options & Futures

    20 Ways To Save On Medical Bills

    Handy tips to cut the cost of hospital bills, co-pays, prescription drugs and more.
  5. Insurance

    What Does It Cost To Raise a Child in America?

    Having a family can be an expensive proposition, but couples who know the numbers can strategize to lower the costs.
  6. Economics

    Calculating the Consumption Function

    The consumption function shows the level of consumer spending as it relates to disposable income.
  7. Economics

    Is a Recession Coming?

    In the space of a week, the VIX Index, a measure of market volatility, spiked from 13, suggesting extreme complacency, to over 50, evidencing total panic.
  8. Mutual Funds & ETFs

    4 Mutual Funds to Consider If Interest Rates Rise

    Learn what mutual funds will perform best if interest rates rise. Interest rates can rise due to inflation or to an improving economy.
  9. Economics

    Understanding Switching Costs

    Consumers incur switching costs when they receive a monetary or other type of penalty for changing a supplier, brand or product.
  10. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
RELATED TERMS
  1. Duty Free

    Goods that international travelers can purchase without paying ...
  2. Negative Option Deals

    A dubious business practice that involves supplying a typically ...
  3. G.19 Report

    A monthly statistical report from the U.S. Federal Reserve that ...
  4. Drip Pricing

    A pricing technique in which only part of a product or service’s ...
  5. Behavioral Modeling

    Using available and relevant consumer and business spending data ...
  6. Mobile Health

    Mobile health is the practice of medicine using new mobile technologies.
RELATED FAQS
  1. How does the grace period work on my Flexible Spending Account (FSA)?

    Some employers offer the grace period option for their employee's flexible spending account, or FSA. The grace period is ... Read Full Answer >>
  2. Can my IRA be garnished for child support?

    Though some states protect IRA savings from garnishment of any kind, most states lift this exemption in cases where the account ... Read Full Answer >>
  3. Is Japan an emerging market economy?

    Japan is not an emerging market economy. Emerging market economies are characterized by low per capita incomes, poor infrastructure ... Read Full Answer >>
  4. Are Social Security payments included in the US GDP calculation?

    Social Security payments are not included in the U.S. definition of the gross domestic product (GDP). Transfer Payments For ... Read Full Answer >>
  5. What economic indicators are important to consider when investing in the retail sector?

    The unemployment rate and Consumer Confidence Index (CCI) rank as two of the most important economic indicators to consider ... Read Full Answer >>
  6. How do alimony and child support factor into my taxable income?

    The Internal Revenue Service, or IRS, applies a different tax treatment to alimony than child support. Most forms of alimony ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!