Weekly Tax Advice: Is my child care deductible?

Posted on February 10 2014

Anyone with children knows they can be expensive, but the government helps you out a bit during tax time. In addition to the child tax credit that many parents claim, you also may be able to get tax benefits if you spent money on child care during the year. The question-and-answer format at OnePriceTaxes will walk you through the process of determining what tax benefits you can claim, but if you'd like to understand how it all works, read on for an overview of the potential tax benefits for child care.

Guidelines for what constitutes money spent on dependent care

First, the care must be for a child who is 12 years old or younger at the time when the care is received. Alternately, the care can be for a dependent who is not capable of caring for himself, like a mentally challenged child or spouse, or an elderly parent.

Second, the person who you are paying to provide the care cannot be your spouse, the parent of the child, one of your children who is 18 years old or younger, or another person you claim as a dependent on your tax return. You must identify each child care provider on your tax return with the provider's name, address, and tax identification number, which is generally the Social Security number if the provider is an individual.

Finally, the child care must be during a time when you are either at work or actively searching for work. Also, you and your spouse must both have earned income unless one of you is a full-time student. The amount you claim for child care expenses must be less than you earn, or if you are married, less than either you or your spouse earns. For the purposes of this rule, a full-time student is considered to have earned $250 per month, or $500 with two children, for each month of school.

Flexible spending account for dependent care

Although there is a tax credit for child care, we will start by discussing the tax deduction available. There is no way to claim a tax deduction for child care directly on your tax return, but if your employer offers a flexible spending account (FSA) for dependent care, this is even better than a tax deduction. The FSA not only shields the money from income taxes, but also from Social Security and Medicare taxes.

You're allowed to set aside up to $5,000 per year out of your paycheck tax-free. Your employer keeps the money in an account for you and reimburses you for your dependent care expenses during the year. You must use all the money during the calendar year when it is deducted from your paycheck.

The amount you'll save by using a flexible spending account depends on what tax bracket you're in, which could be anywhere from 10% to 39.6%. In addition to reducing your taxable income on your tax return, this money also gets shielded from the 7.65% of Social Security and Medicare taxes you're ordinarily charged out of your paychecks. Therefore, if you're in the highest tax bracket, you can save a maximum of 39.6% plus 7.65% of $5,000, which is $2362.50. However, if you're in a lower tax bracket, you will not save as much.

Child and dependent care tax credit

The way to claim your child care directly on your tax return is with the child and dependent care tax credit. This is a credit of between 20% and 35% of your allowable expenses on child care during the year. Your maximum allowable expense is $3,000 if you have one child receiving care or $6,000 if you have two or more children receiving care.

Before calculating the tax credit, you may need to reduce your maximum allowable expense even more. If you use other tax-free money to pay for child care, you must reduce your maximum by that amount, dollar for dollar. For example, if you have one child and you used $1,250 that your employer contributes for child care purposes, your maximum allowable expense for claiming the tax credit would be $1,750. If you only spent $1,500 on childcare beyond what your employer covered, then you would only be able to claim the tax credit on $1,500 of expenses.

The amount of money you get back through the tax credit depends on your adjusted gross income (AGI). For 2014, if your AGI is $15,000 or less, you get a tax credit of 35% of your allowable child care expenses. The percentage of the tax credit gets phased down to 20% with an AGI of $43,000 or higher. When you use OnePriceTaxes, the amount of the tax credit will be automatically calculated for you. It's important to note that this credit is not refundable, so the maximum credit you can claim is equal to the maximum amount of your tax for the year.

Can you use an FSA and claim the tax credit?

In most cases, you will have to choose between using an FSA and claiming the child and dependent care tax credit. Because the money you use from an FSA is excluded from your taxable income, it reduces the maximum amount you can claim with the tax credit. However, if the money you use from your FSA (plus any other money you get tax-free from your employer) is less than the $3,000 maximum for one child or the $6,000 maximum for two or more children, then yes, you can also claim the child and dependent care credit for any remaining money you spent. For example, say you spent $5,000 from your FSA but have two kids, so your maximum for the tax credit is $6,000. In this situation, you can't claim the tax credit on the $5,000 you spent from your FSA, but you can claim it on the last $1,000 of your expenses.

As you strategize for next year, consider checking to see if your employer offers an FSA if you have a high income. In general, if your AGI is at least $43,000, you will be better off using the FSA. People with lower income, especially if they pay for child care for two or more children, are generally best off taking the child and dependent care tax credit.

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