What You Need to Know About Childcare Tax Incentives

Childcare costs are often a sizable financial burden for working families, especially for those with more than one child. Fortunately, there are tax credits and incentives which can help to offset this burden, making it easier to balance the costs of child care. Even though many parents are aware that some incentives exist, many do not take full advantage of them due to a lack of understanding.

There are two primary tax breaks for working parents: flexible spending accounts and a federal income tax credit. Knowing the difference between the two is the key to determining which is best suited to your family, and for which you may be eligible.

Flexible Spending Accounts as Childcare Tax Incentives

Some employers offer flexible spending account plans to their employees, which effectively reimburse them for expenses incurred as a result of childcare for dependents under the age of thirteen. As long as the expenses are necessary in facilitating your ability to work, you can receive these tax-free reimbursements. For couples who are married and filing jointly, expenses must be necessary for either both of you to work, or for one to work while the other pursues an education full-time for a minimum of five months.

Funding for a flexible spending account is taken out of your paychecks, and is not subject to federal income, Medicare or Social Security taxes when it’s used solely to pay for eligible, childcare- related expenses. However, there is a maximum annual contribution of $5,000, whether you’re married and filing jointly or filing separately. At the end of the year, any remaining balance in the flexible spending account will revert to your employer, so it’s important not to contribute more than you think you’ll be able to spend.

Childcare Credit Information

For working parents whose employers do not provide access to a flexible spending account, there is another option. The 2013 childcare tax credit allows for $3,000 of childcare expenses for a single child under the age of thirteen, or $6,000 for two or more children. Be aware that any expenses incurred during a tax year when one child turns thirteen are only considered eligible if they originated before the child’s thirteenth birthday.

Working parents whose adjusted gross income for 2013 is $15,000 or less for the year are allowed the maximum rate of 35%, while higher earners may only be eligible for a 25% credit.

Determining Eligible Expenses

These tax incentives are only available in relation to eligible childcare expenses, which can be fairly complicated territory for families to navigate. For instance, payment for childcare is not eligible for these credits and incentives if a spouse or the other parent of your qualifying dependent was paid for childcare services. Also, an adult child under the age of nineteen can’t be paid for childcare services rendered to allow you to take advantage of these incentives, even if the adult child was no longer listed as a dependent. Childcare providers must be listed and identified on your tax return.

Full-time nannies’ salaries, au pairs’ pocket money and daycare providers’ fees are all considered eligible expenses, as are before-school and after-school care for children of school age. Private school tuition for children in kindergarten and up are not eligible expenses, though private preschool tuition is an eligible expense. You can deduct fees for summer day camps, but not overnight camps.

Which Option Should I Choose?

Ultimately, the best option for your family will depend upon your individual situation. Families with an income of $43,000 and above will usually benefit more from a flexible spending account. Families with lower earnings, or those who do not have access to a flexible spending account, will obviously benefit more from the childcare tax credit.

In order to utilize tax-free FSA contributions for childcare or claim the childcare tax credit, you must include Child and Dependent Care Expenses Form 2441 with your Form 1040, and claim the credit on line 84 of the 1040. A tax professional can help you maximize your childcare tax incentives, effectively reducing your childcare costs throughout the year.

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