Dependent Care Flexible Spending Accounts Offer Tax Savings
With the costs of child and eldercare rising, managing quality care for loved ones can be a daunting task. If your employer offers a dependent care flexible spending account (FSA), you should consider the tax savings it offers.
A dependent care FSA allows you to direct part of your pre-tax earnings into a special reimbursement account. Because the money goes into your dependent care account before federal income or Social Security taxes are withheld, you pay less in taxes. During the year, you use these funds to reimburse yourself for dependent care expenses.
Eligible dependents include dependent children under age 13 who are claimed as dependents on your tax return, and your spouse or other adult dependent, such as a parent, who is physically or mentally incapable of self-care and for which you maintain a household.
Types of reimbursable expenses
Payments to nursery schools and day care centers qualify for reimbursement, as do payments for before- and after-school care and summer day camp (but not overnight camp) for children up to age 13. If the dependent is not your child, the expense of care outside your home qualifies only if the dependent regularly spends at least eight hours per day in your home.
Payments made to an individual or to a relative who cares for your dependents are also eligible, provided that this relative is not a person who you claim as a dependent.
Careful estimates required
It is important to carefully estimate the amount to deposit in your account because, under IRS regulations, there are limits on the amount of money in the account at the end of the year that can be carried over to the next year. FSA plans are generally subject to the “use-it-or-leave-it” rule - meaning unused FSA funds are forfeited - but new rules allow an employer to provide that employees can carry over up to $500 of unused FSA funds into the next plan year.
Employers could also offer a grace period option that gives 2 and ˝ months after the end of the plan year to incur eligible expenses. Either the grace period option or the $500 carryover option may be offered by an employer, but not both options. Employers are not required to offer either option, so be sure and see what is available where you work. If your yearly expenses exceed the amount in your FSA, the remainder must be paid with after-tax dollars.
Changing the amount specified
Once you have designated a contribution amount for a given year, you may not discontinue contributions to your account. The only way the amount can be changed is if you have a change in family status, such as marriage, divorce or legal separation, birth or adoption of a child, or the death of a spouse or dependent. You can also change your contribution amount if there has been a significant change in your spouse’s coverage due to a change in his or her employment.
Dependent care tax credit
You cannot use the Dependent Care FSA and the federal dependent care tax credit for the same expenses. You will need to determine which approach would be more advantageous. Lower income families may be better off claiming the child-care credit than using a FSA, but it’s best to check with a CPA.