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How Dependent Care FSAs Work

Posted By Jim On 06/14/2011 @ 7:02 am In Personal Finance | 19 Comments

We have some friends that have been looking at day care centers in the area and it’s mind boggling how expensive child care can be, at first glance. It’s no surprise when people say that it’s often not even worth it to be working if you have to put two or more kids into daycare. One particular school charges about $1500 a month, which is more than what I paid in rent the first few years I lived in Maryland!

Fortunately, there are a few tax credits and employer benefits that can mitigate some of those costs. One of those employer benefits is a dependent care FSA. Dependent care FSAs are designed to allow you or your spouse to continue working while supporting a dependent, which is typically going to be a child (but doesn’t have to be). To that end, a dependent care FSA lets you contribute part of your pre-tax salary into a special account to help pay for those costs.

Qualifying Dependents

A qualifying dependent has to qualify one of these three conditions:

  • Be a tax dependent under the age of 13,
  • Any other tax dependent who is physically or mentally incapable of self-care and resides in the same principle residence,
  • A spouse who is physically or mentally incapable of self-care and has the same principle residence.

Contribution Limits

The federal limit is $5,000 per year per household, lowered to $2,500 for those married filing separately. If both spouses work and both of their employers offer this, their total combined FSA balances cannot exceed the $5,000 federal limit. If one spouse does not work, he or she must be disabled or a full-time student or the household loses access to the dependent care FSA (remember, the purpose of this is to allow someone to continue working while supporting their dependents). If either spouse earns less than $2,500 a year, then the limit is lowered to the level of that spouse’s salary.

Don’t forget about the Child and Dependent Care Credit [3] when you are deciding how much to contribute. That credit is worth $3,000 of expenses paid in a year for one qualifying individual and $6,000 for two or more. That credit’s amount is lwoered by any benefit provided by your employer.

Which Expenses are Eligible?

Your employer should provide a list of expenses that are and are not eligible but in general expenses related to providing care are eligible, with the exception of “food, lodging, clothing, education and entertainment.” The IRS does allow you to include “small amounts paid for these items if they are incident to and cannot be separated from the cost of caring for the qualifying person.” The IRS also states that, at least for education, expenses for nursery school, pre-school and similar programs for children below the level of kindergarten are considered expenses for care. Kindergarten or higher are not (though before and after school programs may be). Things start to get really complicated after a while so I recommend reading Publication 503: Child and Dependent Care Expenses [4] and contacting your HR for more information.

How They Differ from Medical FSAs

There are a few quirks that make Dependent Care FSAs slightly different than medical FSAs (other than the contribution limit). The biggest difference is that you can’t spend funds unless they’ve already been contributed. For example, if you elect $100 a month ($1200 a year), then you won’t be able to spend the first $100 until after you’ve made the contribution through payroll. Medical FSAs are prefunded, meaning you would have access to the entire $1200 before having the payroll deductions.

I’ll be honest, I thought it was going to be a pretty easy post when I started writing it but it really got complicated pretty quickly (especially after I read about the $3,000/$6,000 tax credit), since the Medical FSA is fairly cut and dry. I hope my explanation of Dependent Care FSAs was clear!


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[2] Email: mailto:?subject=http://www.bargaineering.com/articles/dependent-care-fsas-work.html

[3] Child and Dependent Care Credit: http://www.irs.gov/newsroom/article/0,,id=106189,00.html

[4] Publication 503: Child and Dependent Care Expenses: http://www.irs.gov/pub/irs-pdf/p503.pdf

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