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Child care flexible spending account also offers tax savings

What with the continuing debate over the Affordable Care Act, aka Obamacare, and the recent easing of the medical flexible spending account (FSA) use-or-lose rule, most of the attention during this fall's workplace benefits enrollment season has been on the health-care options.

If you have kids, however, you also should check out your company's child care FSA.

Child care wooden blocks

In most cases, businesses that offer workers the medical FSA option also provide a similar plan to help them cover child care costs.

And like its medical companion, a child care FSA saves you tax money because you put money into the account before your income or payroll taxes are calculated.

Eligibility issues: The major eligibility requirement to establish a child care FSA is that both you and your spouse work.

Basically, both the husband and wife need child care services so that they can each earn income. You also qualify if you or your spouse is looking for work or going to school full-time.

The work rule doesn't necessarily mean that a parent who works from home is out of luck. But it must be an income producing enterprise, not a thinly disguised hobby.

But if your spouse is a non-income earning stay-at-home mom or dad, you cannot have a child care FSA. The Internal Revenue Service isn't going to help cover the costs of a child care break for a frazzled parent.

Account contribution limits: The maximum allowed to be put into a child care FSA is $5,000.

If both you and your spouse have the FSA option, that means your combined contributions can't exceed five grand. Run the payroll numbers to see which parent's paycheck would get the most out of the FSA.

If, however you're divorced, only the parent who has custody of the child/children can use FSA funds for child care.

About the kids: Generally, you claim dependent care expenses only for expenses related to children age 12 and younger.

However, costs connected to care of a dependent of any age who is (1) mentally or physically incapable of caring for themselves and (2) whom you claim as a dependent on your federal income tax return can count for FSA reimbursement.

Qualifying expenses: For most parents, the FSA money will go to a day care center.

But other types of child care typically qualify for coverage. They include:

  • In-home care, such as a nanny or au pair,
  • Summer day camps,
  • Before- and after-school care,
  • Transportation provided by a caregiver and
  • Application fees, deposits, etc. required for obtaining care, but only if care is subsequently provided.

IRS Publication 503, Child and Dependent Care Expenses, has a full list of eligible expenses and qualifying care givers.

FSA limits: Unlike medical FSAs, child care FSAs aren't prefunded.

That is, you don't get an advance on money you're planning to put into the child care FSA. You can only get reimbursed from what's in the account.

But like the medical FSA, there is a use or lose component.

Treasury just announced a new $500 rollover option for medical FSA money. There's no similar rollover for child care FSAs, but that's not really a problem. Most parents will tell you that with the cost of child care today, they have no problem using up every last cent of the $5,000 account maximum.

FSA vs. credit: While a child care FSA is definitely worth considering, don't forget about the child and dependent care credit.

You might be able to benefit from both. You just have to make sure that you account for the child care FSA money when figuring the child care credit.

The credit, which is a dollar-for-dollar reduction of any tax you owe, ranges from 35 percent of $3,000 in care expenses for one child or $6,000 for two or more kids for parents with income of $15,000 or less to 20 percent on those amounts for parents earning $43,000 or more. In between those earnings levels, the credit is phased down.

The bottom line is that credit maximums for multikid care costs go from $2,100 for lower-paid working parents to $1,200 for similar but higher income parents.

Just how do the credit and FSA work together?

In figuring eligible credit, you must subtract the FSA reimbursement amount from the amount of credit you can claim. For example, you have three kids and spent $15,000 on their child care (I am not a parent so I'm making up a number for illustration purposes only; please don't blast me if it's way off the mark.). You used up your $5,000 FSA money. Your income level allows you to claim the child care credit at the 20 percent limit of your care expenses.

So what amount of expenses do you use?

The maximum you can count to figure the credit is $6,000. But since you used $5,000 in untaxed FSA money to pay for some child care costs, you must subtract that account money from the credit cost amount, meaning your credit is $200, or 20 percent of $6,000 - $5,000 = $1,000.

Yes, parents, I hear you. $200 isn't much. But at least it's a credit, meaning that your $8,200 tax bill is cut to $8,000.

To get an idea of savings from a child care FSA and/or the child care tax credit, check out HealthHub's calculator.

And while it has no direct connection to child care or taxes, I had to include this charmingly hilarious video of twin toddlers who communicate via their own private language.

Talking twin babies

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