How to Get a Tax Break for Summer Child Care

“Summer time, and the living is easy,” goes the song. Even though the tax day is still on its way, it is never too early to begin planning out your summer vacation! Easy if you are a kid, that is. For working parents, the additional burden of summer child care is far from easy. Summer child care can get expensive. Fortunately, Uncle Sam is there to help through flexible spending accounts and dependent care credits.

Dependent Care Flexible Spending Accounts

If you have a dependent care flexible spending account (DCFSA) through your employer, you can set aside as much as $5,000 per household from your salary to pay for dependent care ($2,500 if you are married filing separately). That’s a big benefit because the funds you contribute to your FSA aren’t subject to income taxes or payroll taxes such as social security and medicare taxes. These plans are also sometimes referred to as dependent care assistance plans (DCAPs) or dependent care reimbursement accounts (DCRAs).

There are a few caveats:

1. The person receiving the care must be your dependent, and if a child, must be under the age of 13 or incapacitated.
2. If you are married, both spouses must earn income of $5,000 or more unless your spouse is disabled, a full-time student, or looking for work.
3. The funds you set aside must be used by the end of the year, or else they may be lost.
4. And here’s the kicker: You must sign up for the payroll deduction during your employer’s enrollment period at the beginning of the year.

Now, assuming that you have your Dependent Care FSA in place, what kind of expenses qualify?

Child care providers. In order to be reimbursed for your child care through your FSA, your child care provider must provide you with a taxpayer identification number (employer ID number or social security number). That means they must report the income on their tax return.

Summer camps. Summer day camps qualify for reimbursement, but overnight camps do not. That’s good news for parents who enroll their kids in a variety of day camps, such as soccer camp, tennis camp, computer camp, and the like. But if your child needs remedial schooling during the summer, forget it: tutoring and summer school are not eligible.

Payments to Grandma. If you hire grandma or another relative to take care of the kids this summer, you can be reimbursed from your dependent care FSA plan as long as grandma has a social security number and reports the income on her tax return. Other relatives may qualify as well unless they are your dependents. So you can’t pay your 16-year-old to take care of the younger kids and claim her as a dependent.

Child and Dependent Care Credit

If you don’t participate in a dependent care assistance program, you are still entitled to claim the child care expenses we have been discussing with the Child and Dependent Care credit. If your income is $15,000 or less you can claim a federal tax credit of as much as 35% of the costs you pay, up to $3,000 per child ($6,000 total). As your income increases, the credit goes down, settling at 20% if your income is $43,000 or more.

That’s still a goodly amount: if you have two children and pay $3,000 of qualifying child care expenses for each child, you’ll get a federal tax credit for $600 for each child. That will reduce the taxes you owe.

Since you can’t claim a tax credit for expenses that are reimbursed to you through your Dependent Care FSA, which would benefit you the most, the DCFSA or the tax credit?

Let’s say that you are in a 22% federal tax bracket and contribute $5,000 to your DCFSA. That will save you $1,100 in federal income tax, and may save you in state taxes as well. In addition, you’ll save 1.45% in Medicare tax and up to 6.2% in social security tax.

Now let’s say that you claim the expenses as the child and dependent care credit instead of contributing to a dependent care assistance program. Assuming your credit is 20%, that $5,000 in child care expenses will save you $1,000 in federal income taxes. If your income is low, you’ll qualify for the higher 35% tax credit, but most people at that income level wouldn’t pay federal tax anyway, and the credit is not refundable.

So for most parents, the DCFSA income exclusion is best. But whichever you choose, be sure to reap the tax-savings benefits of child care and day camp expenses this summer.