Having dependent children is rewarding, but often costly. Among the many expenses new parents incur is child care. The federal government has enacted a tax credit designed to help child care more affordable for families.
Child and dependent care credit. You are eligible for a nonrefundable child and dependent care tax credit if you currently pay someone to watch your under-age-13 dependent child or children so that you can be gainfully employed. In order to claim the credit, the child must live with you for more than half the year.
The credit amount is equal to the amount of qualified child care expenses multiplied by an applicable percentage determined by your adjusted gross income (AGI). The amounts appear below:
Maximum qualifying child care expenses for one child: $3,000
Maximum qualifying child care expenses for more than one child: $6,000
Applicable percentage for taxpayers with AGI of $15,000 or less: 35 percent*
Applicable percentage for taxpayers with AGI over $43,000: 20 percent
*For taxpayers with incomes of between $15,000 and $43,000, the applicable percentage is reduced by 1 percent for each $2,000 of income over $15,000 until the percentage reaches the minimum 20 percent level for income or more than $43,000. The 1 percentage point decrease applies even if the taxpayer's income is just a fraction over the previous level. For example, if a taxpayer has an income of $15,002, the applicable percentage will be reduced to 34 percent.
Qualifying child care expenses. Qualifying expenses can include the in-home related expenses of a housekeeper, babysitter or cook. Services performed by a dependent care center are allowed only if the center is certified and in compliance with all local laws. A portion of boarding-school expenses may qualify for the credit, but overnight camp fees are specifically not allowed. The credit is allowed to enable part-time employment, too, but qualifying expenses must be directly related to the time needed for dependent care.
Child tax credit. Parents eligible for the child-care credit are usually also eligible for the child tax credit. (Do not confuse the child and dependent care credit, which is related to child care costs, with the child tax credit that is available to all parents with qualifying children.) For tax years through the end of 2017, the maximum credit amount that may be claimed is $1,000, and is refundable for up to 15 percent of earnings over $3,000.
Employer-provided assistance. If you work for an employer that provides for tax-advantaged dependent care assistance, that may result in taxable income. However, there is an exclusion available, and some taxpayers may be able to take advantage of flexible spending account (FSA) programs enabling them to make tax-free contributions that can be used to pay child care expenses later on. Here are a few of the details:
Up to $5,000 of dependent-care assistance that you receive from an employer-paid nondiscriminatory child care program for employees is completely tax free (the figure is $2,500 for married filing separate income tax returns). The excludable assistance must be for the care of children for whom the child-care credit is available.
If your employer maintains a so-called cafeteria plan that lets employees choose between receiving fixed amounts of cash or qualified tax-free benefits, the amount you elect to receive for child-care assistance under the plan is tax-free if the benefit provided doesn't exceed $5,000 ($2,500 for married filing separately).
Your employer may maintain a flexible spending account that essentially allows you to choose to reduce your salary by an amount that's set aside in an account set up to pay for child-care expenses (up to $5,000 or $2,500). In effect, such a plan enables you to pay for part or all of your child-care expenses with pre-tax dollars.
If you are provided with some form of employer provided assistance other than an outright cash payment of eligible expenses, you may need to consider whether to use the cafeteria plan or flexible spending account or pay for the care expenses with your own cash and claim a tax credit. If you are in this position, a decision must be made well before the beginning of each year. We can tell you which choice will save you the most from a financial and a tax perspective in your circumstances. We can also fully explain any other tax issues related to your choice of child care, including your payroll tax responsibilities if you decide to have someone help with a child in your home. Please give us a call.
IRS Circular 230 Disclosure
Pursuant to U.S. Treasury Department Regulations, information contained in this article is not intended by TOPC Potentia P.C. to constitute a covered opinion pursuant to regulation section 10.35 or to be used for the purpose of (i) avoiding tax-related penalties under Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.