DEFINITION of Dependent Care Flexible Spending Account (FSA)

Dependent-care flexible spending accounts let employees use tax-exempt funds to pay for childcare expenses they incur while at work. Employees can also use FSAs to cover adult daycare expenses for elderly family members who live in the home. Parents and guardians can save a significant amount of money when they use an FSA, rather than after-tax dollars, to pay for dependent-care expenses.

BREAKING DOWN Dependent Care Flexible Spending Account (FSA)

Employers take dependent-care FSA contributions out of employee paychecks before taking out most taxes, making those contributions exempt from federal income taxes, payroll taxes and some state income taxes. Some states charge income taxes on FSA contributions. The maximum dependent-care FSA contribution is $5,000 a year per household or the amount of the earned income reported by the employee or spouse, whichever is less.

Expenses and Eligibility of a Dependent-Care FSA

You can use a dependent-care FSA to cover daycare expenses for a child who’s age 12 or younger. The FSA can cover preschool tuition and summer camps, although you can’t use the account to pay for kindergarten or school tuition for a child age 5 and older. In addition, you cannot use the account to reimburse an older child who watches a younger sibling.

While many taxpayers use the accounts to pay for child-related daycare expenses, you also can use the account to cover adult daycare expenses for other qualifying dependents, including elderly family members who live with you. The coverage also applies to a spouse who is mentally or physically incapable of staying home alone.

A dependent-care FSA is designed to cover daycare expenses that employees incur because they are working, so a taxpayer must have an earned income to take part in the FSA. If the taxpayer is married, the spouse must have an earned income, be actively looking for work or a full-time student.

Special Considerations for Dependent-Care FSAs

As an example, assume your combined federal, state and payroll taxes are 30 percent. If you contribute the maximum of $5,000 to the FSA, that saves you $1,500 in taxes. Most employers require you pay dependent-care expenses out-of-pocket and then file for reimbursement.

Carefully examine your expected daycare expenses before deciding how much to contribute to your FSA. If you fail to use the entire account by the end of the year, you forfeit the remainder. It’s also important to note that the $5,000 maximum contribution applies to single filers and married couples filing jointly. If both spouses work, couples can run all expenses through a single account or divide their FSA contributions between two accounts that total no more than $5,000. If you plan to file for the childcare tax credit, you must subtract any expenses you paid through an FSA.