School is nearly out for summer, a realization that’ll make young students throw their hands in the air as their parents scramble to find affordable ways to keep them busy. Although it may seem impossible at times, these next few months don’t need to drain your bank account. If you have one, a dependent care flexible savings account, or FSA, can help you avoid that scenario.
These accounts are great tools with which working parents can pay for certain child-care related expenses. If your child is 12 or younger, you’ll be able to use pretax dollars to pay for things like day care and summer day camps.
Dependent care FSAs can get fairly complex. Carrie Houchins-Witt, a financial advisor in Coralville, Iowa, and Anita Delventhal, an accountant and tax advisor in Lake Orion, Michigan, provide the inside scoop on how they work and why you might want to sign up for one if you haven’t already.
To qualify, parents must have jobs or be actively looking for work
If you and your spouse work, you can qualify for a dependent care FSA. These accounts are doubly beneficial, as they reduce your taxable income while assisting with the costs of child care, Delventhal says.
You can sign up for a dependent care FSA if your employer offers one as part of its benefits package. You select your annual contribution amount during the enrollment period.
“When a dependent care FSA is offered, it requires employees to project how much they think they’ll spend in dependent care over the course of the year,” Houchins-Witt says. “This is an amount which any parent knows is often difficult to estimate. Be conservative. Most FSA plans are use it or lose it.”
At the end of the year, you may forfeit any amount left in the account, unless your employer lets you roll those funds into the next year.
Contribution limits and eligible expenses
Single parents and married couples filing joint tax returns can put up to $5,000 into a dependent care FSA each year. For married couples who file separately, the limit is $2,500 per person, Delventhal says.
Summer days camps, but not overnight camps, can be paid for using funds from a dependent care FSA. The same holds true for au pair and babysitting costs, as long as these services occur during hours when you’re working. The care provider can’t be your spouse or child.
“You can’t get a tax deduction for paying your 15-year old son to watch your 12-year-old daughter,” Houchins-Witt says.
You also won’t be able to use FSA funds to pay for costs associated with kindergarten or any grade level above that. Nursery and preschool programs typically do qualify. Parents pay these expenses out-of-pocket, but can get reimbursed by submitting a claim to the company that runs their FSA. Be sure to get receipts for eligible expenses.
Relationship between dependent care FSAs and dependent care tax credit
You may have heard of the dependent care tax credit, which works differently from an FSA. Parents can’t double dip, meaning they either have to opt for FSA funds or the credit on any given expense.
So if you used money from your FSA to pay for your child’s day care, you won’t be able to claim a tax credit for that expense. However, you can get a tax credit for whatever child-care expenses aren’t covered by funds from the FSA, Delventhal says.
“The maximum for the deduction is $5,000, while the maximum for the credit is $6,000, so many of my clients use $5,000 for the FSA deduction and the extra $1,000 towards the credit,” Houchins-Witt says.
The $5,000 maximum FSA deduction is for one or more dependents, but the dependent care credit is $3,000 for one dependent or $6,000 if you have two or more children. Therefore, the FSA makes more sense if you have only one dependent child, Houchins-Witt adds.
As helpful as a dependent care FSA can be, using one isn’t always so straightforward. Therefore, it would be a smart move to check in with a tax professional to determine how you can maximize an FSA’s benefits while also taking advantage of the dependent care tax credit.
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