Dependent Care FSA Basics: Tax-Free Money for Day Care

Flexible Spending Accounts (FSAs) allow you to contribute a percentage of your paycheck to a special account before taxes are applied to your pay. Then, you use this un-taxed money to reimburse yourself for eligible expenses. There are two types: a Health Care FSA for health-related expenses, and a Dependent Care FSA for day care expenses that you incur while you’re at work. Here we will discuss a Dependent Care FSA.

The Dependent Care FSA can knock 30% off the cost of day care by reimbursing you with money that isn’t taxed. Do you have children who go to day care, or need care before or after school? Do you have an aging parent who lives with you and needs care while you’re at work? Are you tired of writing checks to your day care provider? If so, consider this account. You can use it to pay day care expenses for a “qualifying person”—someone you can claim as a tax dependent on your federal income tax return. Generally, this means children under age 13, or a spouse or other dependent who is mentally or physically incapable of self-care and lives with you for at least half the year. The care must be necessary to allow you (and your spouse, if married) to work or look for work full time, or attend school full time. For an up-to-date list, go to www.irs.gov and search for Publication 503.

Note: The Dependent Care FSA is NOT for your dependent’s health care expenses. It is for dependent day care needs. You can use this account to help pay for day care that lets you go to work. If you’re married, your spouse must work, be looking for work, or go to school full time.

How Does It Work?

  • When you enroll in the Dependent Care FSA, you decide how much money to contribute for the year.
  • The money is taken out of your paychecks in equal amounts before taxes are applied to your pay. The money goes into your Flexible Spending Account.
  • You don’t pay federal income tax, Social Security tax, and in most cases, state income tax on the money you contribute. The amount you would have paid in these taxes is how much you save. Average savings are about 30%.
  • After you pay your day care provider, you file a claim to be reimbursed with money from your FSA.
  • You should save your receipts in case there is a question about whether an expense was eligible.

How Much Can I Contribute?

The IRS sets a maximum amount each year and employers can set limits within that. For 2016, the maximum amount you can contribute to your Dependent Care FSA is $5,000 if you’re single or married and filing jointly; $2,500 if you’re married and filing a separate return.

Important Deadlines: Use It or Lose It

You must use all the money you contribute to an FSA during the plan year for which you made the contribution. Money left in your account after the claim deadline will be forfeited—you don’t get it back, and it doesn’t roll over. This is an IRS rule, often called the “use it or lose it” feature. This simply means you should carefully consider how much you contribute. Be sure you contribute enough to get the benefit, but do not contribute so much that you have a significant amount of money left over. An easy way to estimate the right amount is to review your family’s current day care expenses and consider whether you’ll need the same amount (and kind) of care next year.

Reimbursement

You must have the full amount of money you are claiming in your account before it can be reimbursed. Keep this in mind when you are budgeting—you may not be able to be reimbursed for your January day care expenses until mid-February, for example.

Did You Know?

DCFSA vs. tax credit: Should you use the DCFSA or the federal tax credit to save money on your employment-related dependent care expenses? It depends. As a general rule, the more you earn, the more likely you are to get the best tax savings from the DCFSA. But, if your day care expenses are unpredictable, you may find the tax credit works more to your advantage, because it does not carry the risk of forfeiture. To determine which is best for you, check with a tax advisor or see IRS Publication 503, Child and Dependent Care Expenses.

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