Childcare and Taxes: Five Things You Should Know

Kids are expensive. Here’s how to save money on childcare.

It’s no secret that having kids can be costly. But when tax time rolls around, there are actually some financial perks to having those little ones in the house, since they can afford their parents some pretty significant tax benefits.

On the flip side, there are also some things to keep in mind when paying for your little ones’ care — like how to properly handle taxes if you have a nanny.

Here are five things you should know when it comes to childcare and your taxes.

 

You May Qualify for the Child and Dependent Care Credit

One of the major benefits afforded to you as a parent come tax season is the child and dependent care credit. This credit, not to be confused with a tax deduction, is available to qualifying parents who pay childcare expenses for one or more qualifying children so that they can work, go to school, or look for work.

“The credit [ranges from 20 to] 35 percent of your qualifying expenses, depending on your adjusted gross income,” says Brian Ashcraft, director of tax compliance at Liberty Tax Service. “It can be claimed for qualified yearly expenses up to $3,000 for one qualifying child or $6,000 for two or more children.”

Any child who was under age 13 at the time of care qualifies. “If your child turned 13 during the year, you can claim a portion of this credit for the time during the year in which they were still under 13,” says Josh Zimmelman, owner of Westwood Tax & Consulting in New York. “You can also receive the credit for children or other dependents over age 13 if they are unable to care for themselves.”

Not All Care Counts Toward the Credit

It’s important to keep in mind which childcare costs are eligible for the credit — and which are not.

“[I]f your child is not school age and you pay for your child to attend nursery school or pre-school, that is considered care and can qualify for the credit,” Ashcraft says. “Before- or after-school care can qualify for the credit as well because they are necessary for your child’s care while you work.”

Although overnight camp does not count toward the credit, since it isn’t considered a work-related expense, the cost of summer day camp qualifies if the camp provides care while the parent or parents are at work.

Care that’s covered by the tax credit can range from a daycare facility to a nanny in your home. Even hiring a relative to watch the kids qualifies, though there are stipulations.

“The care provider can’t be your spouse, the child’s parent, another one of your children under age 19, or any other dependent of you or your spouse,” Zimmelman explains. “That is, a babysitter or nanny qualifies you for the credit — having your 16 year old watch your toddler doesn’t.”

In order to be eligible for the child and dependent care credit, your child (or children) must have lived with you for at least half the year, Zimmelman says.

The Dependent Care Flexible Spending Account is Another Choice

But the child and dependent care credit isn’t your only option.

Some employers offer a dependent care FSA, a pre-tax benefit account you contribute to that reimburses you for qualifying childcare expenses. Generally, funds from these accounts can pay for the same services that the child and dependent care credit covers, from day camp to a nanny to conventional day care.

Not sure which option is right for you? Generally speaking, the child and dependent care credit will be more beneficial to those who fall into less than the 15 percent tax bracket. If you are a moderate to high earner, using the dependent care FSA will be your best bet — especially if you are married and filing jointly.

To put it simply, the tax credit is better for those earning less, while the FSA is better for those earning more.

So You Don't Lose Money — Or Break The Law

If you opt to use an FSA, be careful not to put too much money aside. That’s because the money won’t roll over from year to year. Whatever you don’t spend toward childcare during the year, you’ll lose. For example, if you put $5,000 into your FSA but only spend $3,500 on childcare that year, you’ll say goodbye to $1,500!

In addition, there’s a limit to how much you can set aside each year — currently, that’s $5,000. Keep in mind that this limit is for both parents, combined.

Also note that if you’re divorced or unmarried and sharing custody, only one parent can claim the child and dependent care credit.

Finally, you can’t “double dip.” Any expenses you paid for with your FSA cannot also be claimed as part of the child and dependent care credit. There are some very precise rules and limits if you want to take advantage of both the FSA and the tax credit, so be sure to check with your tax advisor.

You May Need to Pay the Nanny Tax

It’s also worth remembering that if you pay your in-home care provider $2,000 or more in a calendar year, you’ll need to pay the “nanny tax,” depending on what state you live in. This means that you have tax and payroll obligations as the employer of your care provider.

“Though not required to claim the childcare credit, parents that employ a nanny should make sure that they comply with all employment tax filing and payment obligations,” says Travis Greaves, tax partner at the law firm Greaves Wu LLP in Washington, D.C. In short, paying “under the table” and claiming the credit will not sit well with the IRS if you get audited.

Editor’s note: It’s tax season, which means we’ve increased our tax coverage to help make filing your taxes easier for you whether you’re a single entrepreneur, filing jointly for the first time, or trying to get the most bank for your buck when it comes to taxes and childcare. As always, let us know what you think.

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