For single parents or dual-income families, child care is on the list of major expenses. A Child Care Aware of American study in 2012 detailed average child care costs across the nation. The results are astounding.
According to the study, the average annual cost of full-time, center-based care for an infant ranged from $4,600 to $15,000, varying across the country. In Mississippi, which had the lowest child care costs, full-time, center-based care for a 4-year-old averaged $3,900 a year, or more than $300 a month.
The range is huge, but the message is this: Child care costs are high compared with household expenses and family incomes. The same report showed that in 40 states and the District of Columbia, the average annual care was more than 10 percent of the state’s median income for a two-parent family. And in 22 states, child care cost more than the state’s median rent.
Whether you’re struggling to pay for full-time or part-time child care, or even an after-school program, there may be steps you can take to get back at least some of that child care money on your taxes. Here’s what you need to know:
Table of Contents:
Child Care Tax Credits
This tax option allows you to claim a credit for child care that is provided to allow a child’s parents – or legal guardians – to work or go to school during the year. Although these tax credits were on the fiscal cliff chopping block, they were extended indefinitely early this year.
The current tax break allows parents to claim up to 35 percent of child-care related expenses for up to $3,000 per child or $6,000 per family. The percentage of expenses you can claim depends on your adjusted gross income.
We’ve written about the qualifications for the tax credit, which are, of course, a bit complex. But here are a couple of things to be especially aware of:
- You may be able to claim the child care tax credit if you were unemployed for some or all of 2012. If you paid for child care so that you could look for work, you’ll probably be able to claim this credit.
- You can probably also claim this tax credit if you paid for child care so that you could attend school full time.
- This tax credit doesn’t just cover payments made to a day care. Other qualifying expenses include payments made to a nanny, a private preschool or kindergarten, day camp programs (overnight camps don’t count), and before- and/or after-school care. Also, if you paid a much-older sibling to watch your child while you worked, those expenses may qualify as long as the sibling you paid was 19 by the end of 2012.
That’s the dependent care tax credit. If you paid for child care in 2012 and the next option was available to you, you should talk to your tax professional about claiming it.
Dependent Care Account
If you work for a company that offers you the option of a dependent care account, you want to check out this option. It’s similar to the medical Flexible Spending Account. (In fact, in some companies, it’s referred to as a Dependent FSA.)
Basically, you have your employer fund this account with pretax dollars and then you pay for child care out of it. You can put up to $5,000 in the account, but you have to use it all before the end of the calendar year. If you put in more money than you need, you’ll lose what’s left, so calculate your expenses carefully.
The benefit is that the money in the dependent care account isn’t taxed – not even Social Security and Medicare taxes. Plus, it lowers your tax liability, which may mean a smaller bill or a larger refund at the end of the year.
Some Potential Caveats
I can tell you from experience that there are some potential issues with a Dependent Care Account. It sounds great, and it can be a good way to save on taxes. But it can also make paying for child care a pain.
With some companies’ Dependent FSA option, you can get a debit card that you can use to pay for care on-site. But this only works if your child care provider accepts the card.
With many of these accounts, you have to pay for dependent care out of pocket and then file for reimbursement. It can take a few days to a few weeks for a claim to be processed and you are reimbursed.
If you have a budget with lots of monthly wiggle room, the reimbursement process is nothing more than annoying paperwork.
However, if you’re on a tight budget as my family is, it can pose problems.
You see, when you’re funding the Dependent Care Account, you’re automatically taking at least part of your child care expenses out of every paycheck. For a fully funded account at $5,000 a year, your company will take about $416 a month out of your checks.
The problem comes when you have $416 less and you have to pay your day care provider $300-$1,000 out of pocket. Let’s just say that made my January and February a little financially uncomfortable this year.
That doesn’t mean that you should give up on this option. Check with your human resources department to figure out how your account works. Then look at your financial situation to figure out if you could use a Dependent FSA for your child care needs.
But Which is Better?
In a few cases, you may be able to benefit from both the Dependent FSA and the child care tax credit. But you can’t claim the same expenses twice. For most parents, this means choosing one benefit or the other.
I can’t tell you which option is going to save you more money in the long run. It depends on your income, your tax bracket, the size of your family, and how much you pay for child care.
This worksheet from FSA Feds will help you figure out which option will save you more money.
Here’s one example from the worksheet:
Let’s say you and your spouse make a combined income of $50,000. You pay $10,000 a year for full-time day care for your infant and your toddler.
If you fully fund a $5,000 dependent care account, your taxable income will drop to $45,000. Your total federal tax liability will be $12,442.50. Your take-home pay after taxes will be $32,557.50, and $27,557 of expendable income after paying for child care.
If you don’t use an FSA and pay for dependent care out of pocket, your total federal tax liability will be $13,825. You’ll wind up with $26,175 in expendable income after taxes.
Keep in mind, this is a pretty loose scenario. It doesn’t take into account other tax credits you might receive and state taxes aren’t included here. But you can see that using a Dependent FSA can help you get more money back in your pocket for the year.
And for most families with average income, using a Dependent FSA is the best money-saving option. But you’ll want to talk to your tax professional (before the year starts and you have to decide whether to use your company’s dependent care benefits).
You May Be Able to Take Both
Here’s a secret to help you get the most out of your dependent care benefits: you may be able to use both the Dependent Care FSA and the dependent care tax credit.
You can’t double dip, so you can’t claim the money that you used from your FSA for the child care tax credit. But if you have expenses greater than $5,000, you can claim some of the remaining money on your taxes for the dependent care tax credit.
If you take a look at Form 2441, the form used to claim the dependent care tax credit, you’ll see how complex this credit is. In fact, it’s a little crazy.
So if you think you might qualify to use your Dependent FSA and claim a dependent care tax credit, you should talk to a tax professional. If you don’t have the FSA option, make sure you claim this tax credit if you have any qualifying dependent care expenses.
And even if you do have the option, talk with a tax professional to figure out whether the dependent care account or the tax credit will give your family the best benefits.