Executive summary
Becoming a parent can feel like an explosion of responsibilities...and expenses. And, if your income is increasing, you're likely phasing out of the child tax credit. Here's a silver lining that could save you on taxes: The Dependent Care Flexible Savings Account (DC-FSA) tax planning strategy. The DC-FSA is a government tax break for working parents that can save you up to $1850 per year on child and dependent care expenses.
We break down below:
(a) what a Dependent Care FSA is
(b) what makes it a valuable tax planning strategy
(c) how to check if you qualify for the higher tax break and optimize your taxes with this strategy
Table of contents
What's a Dependent Care Flexible Spending Account (DC-FSA)?
A Tax Planning Strategy:
Alphabet-soup name hiding a multi-thousand dollar tax break for working parents.
That's Dependent-Care Focused:
Chunk of tax-free care spending for kids under 13, disabled spouses, or older parents in eldercare.
And Offered Through Employers:
Around 40% of workers have access to a DC-FSA through their employers according to the Bureau of Labor Statistics.
How much could it save me on taxes?
Childcare is expensive! The national average cost of childcare is roughly double the price of a year's tuition to an in-state public university. According to this 50-state survey by the Economic Policy institute, annual infant childcare costs can go as high as $17,00 in California and $24,000 in Washington D.C. (my hometown)... so every dollar you can save counts!
The DC FSA can save you up to $1,850 in 2022. The DC FSA offers you an upfront tax deduction (i.e., savings of ~20-40% - depending on your tax bracket) on dependent care expenses up to $5K in 2022. Not bad for the max ~2 hours of effort to get this set-up and going. In 2021, President Biden enacted a one time change to the contribution limit, allowing families to essentially double their contribution to their DC FSA, but it has reverted back to its normal contribution limits for 2022.
Does this strategy make sense for me?
Two items to check to see if this strategy would work for your family to save on taxes.
1) Check if your employer offers a DC-FSA. ~ 40% of workers have access to a DC-FSA through their employers according to the Bureau of Labor Statistics. DC-FSAs can be combined with a standard health care FSA or an Health Savings account (HSA). DC-FSAs do not impact HSA eligibility.
2) Check if you have eligible expenses.
What’s included:
Expenses involved in caring for a child under 13, or eligible loved ones who aren't physically or mentally able to take care of themselves (e.g., a disabled spouse, an elderly parent who is your dependent).
That includes: pre-school, nursery school, summer day camps, before/after school programs, a nanny, au pairs, or daycare.
What’s excluded:
Tutors, music lessons, language classes, kindergarten, non-work related babysitting, or sleep-away camp. See the federal government’s official list for the full details (which hasn’t been updated for 2022 by the IRS yet).
The Fine print:
- Receipts required. It is important that you save receipts in case the IRS requests itemized receipts.
- Use it or lose it. Similar to health care FSAs, there's a "use it or lose it" rule on these accounts, so you'll lose any funds remaining in your account when the plan year ends. Your employer might offer you a 2.5 month grace period, or up to $500 to be rolled over to next year's plan.
- Requires a contribution to use. You can only use money from a Dependent Care FSA account after you make contributions from your paycheck.
How do I take advantage and sign up?
1) Determine how much to contribute.
You should choose the maximum of either
(a) the $5K limit for married couples filing jointly OR the $2,500 limit if filing separately OR your company's limit, in case it's lower.
(b) your estimate of how much you spend on your qualifying dependent care each year. (see list of what’s included / excluded above).
2) Proactively reach out to HR.
Many companies have left employees in the dark on this perk. At Steward, we've found multiple employers (e.g., Visa, Carlyle, etc.) of our clients (working professionals in their late twenties - forties) haven't communicated to employees that they're eligible.
So it’s definitely worth proactively asking your employer about if (a) they offer a dependent care flexible savings account (FSA), (b) what's the latest upper limit you can contribute, and (c) when you can enroll. You'll typically need to enroll during your employer's open enrollment period (typically November through mid-December) and elect a contribution amount on your employee benefits site during that time To make life easier, we’ve shared below...
An email template to send to HR
Hi {HR Benefits Contact},
I was wondering if I'm eligible for a Dependent Care FSA, and how much our organization will allow me to contribute. I would love to take advantage of this given that child care is one of my most significant expenses.
Asks for your help:
1. Could you let me know what the upper contribution limit for the Dependent Care FSA is and help me up our contribution to that limit? I'd like to up our annual contribution to the maximum our organization is allowing.
2. Could you let me know if there are any deadlines for me to keep in mind?
3. Also would love your guidance on how best to file our expenses so that we can use the Dependent Care FSA.
What happens after you sign up?
1. You will receive an FSA debit card that you can use to pay for eligible expenses. The same card will apply to a Health Care FSA, if you have that account too.
2. If you don't use the card, then after you have received and paid for services, you'll need to submit a claim form for reimbursement. Remember to save all receipts, which are required for reimbursement and validation of expenses.
3. Each plan year, you can incur eligible expenses until March 15 of the following year, and you have 90 days to file your claims.
FAQs:
Can I still do this if I already have a Health Savings Account?
You can have a Dependent Care FSA at the same time as a Health Savings account. You're not running afoul of any double-dipping rules. We personally use both!
How does the Dependent Care FSA differ from a healthcare FSA and can I have both?
Yes, you can have both. These are similarly named (confusing!) but they deal with different expenses: Childcare and eldercare related expenses vs. medical and health related expenses.
Curious to learn more?
- DC FSA tax strategy covered in Kiplinger (Tax-Focused Newsletter)
- The federal government’s official list of what expenses are eligible vs. not
- Steward ‘s mission is opening up the 1%’s wealth strategies to America’s up-and-coming families with a combination of 21st century tech and trusted advisors. We help families determine how, where, and when to invest and save on taxes in plain-English, with minimal time and effort. Steward can personalize your recommendation on next steps for a Dependent Care FSA. Steward can also integrate this tax strategy with your broader financial picture. Give it a try here.
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