Fewer than half of parents take advantage of this money-saving tax break
Parents could save more than $2,000 a year on child care costs, but more than half leave the money on the table.
While most parents (67%) know they could save on child-care costs with a tax break called the dependent care flexible spending account, only 44% actually use one, according to a survey of 1,100 parents by Care.com, an online referral service that matches families with caregivers. “It’s a big missed opportunity that we want to shed some light on,” said Kerri Swope, vice president of Care.com HomePay, which provides household payroll services.
Flexible spending accounts (FSAs) are offered as part of an employee benefits package at many companies. Parents can put up to $5,000 of pre-tax earnings into the account per year and use it to pay for day care, nannies, and care for other dependents, like aging parents. Depending on your marginal tax rate, you can save up to $2,300 a year.
If your employer doesn’t offer a dependent care FSA, there’s still a way to get a tax break on care costs. When you file your taxes, you can save up to $600 if you have one child and $1,200 if you have two or more kids by using the child or dependent care tax credit. This requires itemizing care-related expenses on a special IRS form.
And parents should also be aware of the plain old child tax credit, which goes to anyone with a kid, regardless of whether parents pay for their care or not. This credit was doubled under the recently passed Tax Cut and Jobs Act to $2,000 per child.
Parents need all the help they can get with child care costs. Sending two children to day care costs more than rent in many states, and parents spend far more than the recommended 7% of their income on child care in all 50 states, according to a recent report by Child Care Aware of America, a Virginia-based nonprofit that advocates for affordable child care.
Here are tips for parents who want to use these tax breaks:
Parents must meet the ‘work-related expense test’
These tax breaks are only for child care that’s necessary because mom and dad are too busy working — or looking for work — to care for their kids themselves. Also: They only apply to children 13 or younger.
Sometimes you can use more than one tax break — good news for the ‘sandwich generation’
Some families mistakenly assume they have to choose between the dependent care FSA and the child-care tax credit, but you can use both if you have more than one dependent, like a child and an aging parent. More families than ever are in this position, as Generation X-ers juggle caring for both kids and parents. Care.com saw significant growth in 2016 in the number of families who have two caregivers in their homes — one for a child and one for the child’s grandparent.
Placement agency fees are covered, and so are some other unexpected expenses
Both the FSA and the child-care tax credit cover a wide range of expenses , including nursery school, after-school programs, and babysitting by a relative (as long as that relative isn’t a dependent and the babysitting was so the parent could go to work). Many parents are surprised to learn that the FSA and tax credit also cover fees that parents pay to a placement agency to find a nanny, which can be several thousand dollars, Swope said.
You have to pay your nanny on the books to get the tax breaks
Though some families are tempted to pay their nannies off the books, that’s a no-no for several reasons. It’s illegal, for one, and people who do it are cheating their nannies out of unemployment insurance and worker’s compensation. Another reason to pay a nanny above board: You can’t use the dependent care FSA or dependent care tax credit unless you paid your nanny legally. And remember: You don’t pay so-called “nanny taxes” at tax time. The term refers to taxes that families who employ nannies start paying as soon as their nanny starts working for them.