Congratulations! While you’re planning for the arrival of your child, evaluate how the Dependent Care Flexible Spending Account and the Child and Dependent Care Tax Credit fit into your financial plan. If you’re already a parent, give yourself a double check. Feel more confident that you have a plan that fits your family’s needs today.
Learning Points
Dependent Care Flexible Spending Account (DCFSA)
If you and your spouse/partner want to evolve your joint to-do list into an actionable plan, evaluating a dependent care flexible spending account (DCFSA) is an essential step.
IF YOU PLAN TO SEND YOUR CHILD TO NURSEY SCHOOL OR DAYCARE WHILE YOU AND YOUR SPOUSE WORK, consider participating in your employer’s dependent care flexible spending account program.
WHEN YOU CONTRIBUTE TO YOUR DCFSA, you do not incur payroll taxes on the contributed portion of your income. This pre-tax benefit account can help reduce your taxes depending on your specific situation.
For example, if you’re a married couple filing a joint return, and you’re firmly in the 24% federal tax bracket, this income reduction could mean saving up to $240 in federal taxes for every $1,000 spent on dependent care with an FSA, subject to taxpayer contribution maximums.
If you’re having a new baby, or experience another Qualifying Life Event, you should be able to enroll in your employer’s DCFSA program.
DCFSA Contributions
If you elect the DCFSA benefit, you fund it using pretax income that your employer sets aside in a separate account. Because you make your contributions to your DCFSA before that income is taxed, your contributions can potentially lower the amount of your taxable income.
CONTRIBUTION LIMITS: In 2024, the maximum amount your household can defer from your compensation to your DCFSA is:
- $5,000 for single taxpayers and married couples filing jointly.
- $2,500 for married couples filing separately.
These limits are household maximums, not individual tax-payer limits.
You and your spouse/partner want to coordinate your contributions so that you do not exceed your respective household limit.
Further, if you receive any employer contributions or subsidies to your DCFSA, these amounts further reduce your household limit.
DCFSA Compensation Limits
If you are categorized as a highly compensated employee (HCE) by your employer, then your maximum dependent care benefit could be reduced.
In the context of your DCFSA in 2024, you are generally considered a highly compensated employee (HCE) if you are:
- A more-than-5% owner of the employer at any time in the current or preceding plan year; or
- An employee who earned more than $150,000 in the prior plan year.
Further, your employer can choose to ignore the second bullet if you, the employee, weren’t also in the top 20% of employees when ranked by pay for the preceding year.
Source: IRS Publication 15-B (2024)
Earned Income Considerations
IF YOU OR YOUR SPOUSE/PARTNER DO NOT PLAN TO HAVE EARNED INCOME in the tax year you want to contribute to a DCFSA plan, the DCFSA is not a benefit you should pursue.
The amount of work-related expenses you use to figure your credit can’t be more than:
- Your earned income for the year if you are single at the end of the year, or
- The smaller of your or your spouse’s earned income for the year if you are married at the end of the year.
Meaning, if you or your spouse/partner plan to have $0 of earned income, you won’t be able to offset any qualified expenses and should not plan to fund a DCFSA.
Qualified Expenses
IF YOUR EMPLOYER PROVIDES DEPENDENT CARE BENEFITS UNDER A QUALIFIED PLAN, you may be able to exclude these benefits from your income. Your employee benefits handbook should provide you with this determination. If not, contact your human resources or benefits resource department about whether the benefit plan qualifies.
You can also ask your benefits team for a definitive answer on your highly compensated employee status based on your employer’s non-discrimination testing results.
If you elect this benefit, then you’ll need qualifying dependent care expenses, like daycare costs, during your plan year.
CONSIDER THESE ADDITIONAL SITUATIONS, where a dependent care flexible spending account is a useful option for your family:
- Daycare, nursery school, or preschool
- Before- and after-school care
- Babysitting and nanny expenses
If you pay these expenses for a dependent under age 13, so that you and your spouse/partner can work, explore how you can be reimbursed under your DCFSA plan.
Experiences and services like tutoring, overnight camps, or non-work-related babysitting are not eligible for reimbursement.
Reimbursement and Related Documentation
ONCE YOU HAVE PAID FOR EXPENSES THAT QUALIFY FOR DCFSA REIMBURSEMENT, you will need to complete a claim through your employer’s chosen provider and process. Providing the correct documentation is critical.
Specifically, you’ll want to verify your dependent care provider shares the following documentation:
- Name of dependent receiving care
- Amount you paid for service
- Type of service (e.g. day care, day camp, after-school, elder care, etc.)
- Provider name and address
- Date(s) of service
If you’re looking to learn more about the details of this topic or to explore how it applies to your family’s situation, consider reviewing the IRS’s Publication 503, Child and Dependent Care Expenses.
Child and Dependent Care Tax Credit (CDCTC)
You can use your dependent care FSA (DCFSA) in conjunction with the child and dependent care tax credit (CDCTC).
The qualified expenses you pay with your DCFSA need to be different from the qualified expenses covered by your child and dependent care tax credit.
The CDCTC is a nonrefundable tax credit. When used correctly, you can reduce your federal income tax liability based on your qualified child and dependent care expenses if you are working or are looking for work.
The maximum CDCTC amount you can claim depends on the number of qualifying individuals:
- A maximum of up to $3,000 if the taxpayer has one qualifying individual.
- A maximum of up to $6,000 if the taxpayer has two or more qualifying individuals.
Your CDCTC is calculated by multiplying the amount of qualifying expenses by a predetermined credit rate. The credit rate varies by the taxpayer’s adjusted gross income (AGI). The maximum 35% credit rate reduces to 20% for taxpayers with AGI above $43,000.
Perhaps most importantly, for every dollar of DCFSA excluded from income, the taxpayer must reduce the maximum amount of qualifying expenses claimed for the CDCTC.
BECAUSE TOPICS LIKE THE DCFSA AND THE CHILD AND DEPENDENT CARE TAX CREDIT, like so many others in financial planning, intersect with the world of tax, make sure you coordinate with a qualified tax professional.
The Next Step
When you know who and what are truly important, you can create incredible clarity about your spending and saving.
Clarity to confidently spend on things that matter. Clarity to avoid spending your hard-earned resources on things that aren’t aligned with what you want in life.
As your financial planner in Saint Louis, we can help you plan for the future and enjoy the present moment.
Start feeling more confident that you are making progress toward your savings priorities and planning for your child. Once you know which pre-arrival planning items you want to tackle, set aside time on your calendars to start making progress on what you want to achieve.
Proactive and open collaboration with your financial, tax, and estate planning professionals can help you work towards your financial goals. Working with your financial planner in Saint Louis can provide you with the right mix of accountability, collaboration, and long-term thinking.
If you’re unsure about your next step, let’s talk.
Disclosure
This commentary is provided for educational and informational purposes only and should not be construed as investment, tax, or legal advice. The information contained herein has been obtained from sources deemed reliable but is not guaranteed and may become outdated or otherwise superseded without notice. Investors are advised to consult with their investment professional about their specific financial needs and goals before making any investment decision.