In fact, according to a recent report from the child-care advocate Child Care Aware of America, the average cost of child care can range from $4,600 to as much as $15,000 per year. However, a proactive approach to tax planning may help offset and reduce a portion of the expenses associated with caring for your children while you work.
If you are paying child-care or dependent-care expenses so that you and your spouse (if you are married), can work or go to school on a full-time basis, a child-care credit from 20 to 35 percent of eligible expenses may be available. Sounds good, so what’s the catch?
First, the care must be provided to one or more qualifying persons who are defined by the IRS as being a dependent child age 12 or younger when the care was provided, or other certain individuals who are physically or mentally incapable of self-care. You may use up to $3,000 in expenses for one child or up to $6,000 for two or more children per year.
The maximum credit of 35 percent is only available to taxpayers with adjusted gross income (AGI) of $15,000 or less and the credit gradually declines to 20 percent for taxpayers with AGI greater than $43,000. However, unlike many other tax credits that phase-out completely due to higher levels of income, the 20 percent child-care or dependent-care tax credit is available to even higher-income taxpayers.
Child-care expenses that you might have overlooked also may be eligible for the credit.
According to Lee Boss, certified public accountant and managing director for The Mercadien Group in Princeton, “Payments made by the taxpayer for before- or after-school care of a child in kindergarten or a higher grade-level, as well as day camps for children under the age of 13, may qualify for the child-care credit as long as such costs allow the taxpayer to work or seek employment. The credit is often overlooked but results in real tax savings.”
While there are many qualifying care expenses, there also are a few circumstances where you will not receive the deduction.
The payments for care cannot be paid to your spouse, to the parent of your qualifying person or to someone you can claim as your dependent on your return. Also keep in mind that qualifying expenses will be reduced by any dependent-care benefits provided by your employer that you deduct or exclude from income. Additional rules may apply so consider reviewing IRS Publication 503, Child and Dependent Care Expenses at www.irs.gov or by calling (800) TAX-FORM.
For some, a dependent-care flexible spending account may be a better option.
If made available by your employer, a flexible spending account allows a married couple to save up to $5,000 ($2,500 for married filing jointly) in pre-tax dollars to pay for child-care costs. Since these funds can be saved without having to pay federal, Medicare and Social Security tax, significant savings can be realized.
While an FSA can provide tax savings, parents need to be careful not to overfund their plan because any unused money will be forfeited back to your employer.
For example, if you save $5,000 in you FSA but only have $4,000 in eligible expenses during the year, $1,000 will go back to your employer — ouch! Despite forfeiture provisions, the tax savings can be significant so be sure to consult with your employee benefits department to determine if an FSA is available to you.
Determining the most advantageous option for you is generally dependent upon income — the higher the income, the more tax savings that may be realized from the FSA, if your employer makes it available.
Lower-income households generally will benefit more from the tax credit. While you can’t claim the same child-care expenses for the dependent care FSA and child-care credit, you may be able to take advantage of both options depending on your circumstances.
As with all tax matters, be careful to maintain proper documentation.
Boss adds this: “You must identify and provide a Social Security number or (federal) employer identification number for all persons or organizations that provide care for your child or dependent on your tax return and keep records of payments made to care providers to substantiate such payments.”
Proper tax planning may help to reduce some of the costs associated with providing care for your children. Since everyone’s situation is unique, consider speaking to your tax adviser to determine the best approach for you.
Kurt J. Rossi, MBA, is a certified financial planner practitioner and wealth adviser. He can be reached for questions at (732) 280-7550 and kurt.rossi@Independentwm.com. LPL Financial Member FINRA/SIPC.