Any working mom or dad with young children understands the impact of child care on the family budget. The good news is that you may qualify for a tax deduction or be able to pay for your child care with pretax earned income – taking some of the sting out of this very necessary expense.
Generally speaking, if you pay someone to care for your child while you (and your spouse, if married) work, you have two options to recoup these expenses. If your employer offers a dependent care account, you may pay for child care with pretax earned income throughout the year. Otherwise, you could claim the Child and Dependent Care Credit on your federal income tax return if you are eligible.
To qualify for either benefit:
- The care must have been provided for one or more qualifying persons. A qualifying person is a dependent child who is age 12 or younger when the care is provided. Your spouse and other dependents who are physically or mentally incapable of self-care may also qualify.
- The child care provider must be a licensed day care provider, preschool provider or legal nanny. Costs to attend kindergarten or a higher grade do not qualify, but before or after school care would qualify. You must identify the care providers on your tax return by including their name, address, and Social Security number or employer identification number. If you pay someone to come to your home to provide the care, you may be considered a household employer that would need to withhold and pay Social Security and Medicare taxes.
Employer Provided Dependent Care Accounts
If your employer offers a dependent care account, you can elect to fund the account based on the maximum amount you are allowed to deduct, which is the lower of $5,000 or your earnings in any given year. So if you set aside $5,000 and are in the 25 percent tax bracket, you will save $1,250 in federal taxes throughout the year.
You need to budget carefully when setting these accounts up. Any funds that are not spent on child care will be taxable to you when you file your return.
The dependent care contributions are reported on Form W-2, Box 10. If you have an amount shown in this box, you will need to file Form 2441 to show that you spent that amount for qualifying dependent care.
Child and Dependent Care Tax Credit
The child care tax credit allows you to deduct 20 to 35 percent (depending on your adjusted gross income) of the first $3,000 you spend per dependent child, per year for qualified child care. If you have two or more qualifying children, you may use up to $6,000 of expenses to figure the credit. There is no limitation on your adjusted gross income.
The credit is available for individuals to take if they work full or part-time. They may also take the credit if they are looking for work or if they are going to school full-time. If the taxpayers are married, both taxpayers must be employed, looking for work or going to school full-time. If one parent stays at home, the credit is not available.
If you exclude any income under a dependent care benefit plan, you cannot count that as an expense when figuring out the child and dependent care credit.
If either option is used, Form 2441 must be filed with your tax return. You need to report the qualifying individual’s name, Social Security number and the amount of expenses incurred. You also need to report the care provider’s name, address, identification number and the amount paid.
Be sure to explore these tax-saving options with your employer and tax advisor. RKL’s team of tax professionals can help you maximize your tax strategy to recoup these unavoidable costs of raising a family. Contact us today!
Contributed by Ruthann J. Woll, CPA, a manager in RKL’s Tax Services Group and member of the firm’s Not-for-Profit Industry Group. Ruthann has significant experience in tax planning and compliance and specializes in serving individual and not-for-profit clients.