As working parents know: childcare is expensive! Whether the kids are in daycare, before or after school care, day camps, or other care, it can put a big dent in your wallet. Costs can range from $199 – $596 per week, depending on who cares for your child.
While most people think about getting healthcare benefits from their employer, such as insurance, a Flexible Spending Account (FSA) or Health Savings Account (HSA), there is another tax-advantaged account that can help people save money on childcare. The account is known as a Dependent Care Assistance Plan (DCAP), or Dependent Care FSA.
What is a Dependent Care FSA or DCAP?
Like a healthcare FSA, which allow you to put aside money before taxes to cover approved healthcare expenses, a DCAP allows employees to set aside money each pay period for approved childcare expenses. The main benefit of a DCAP is that the account funds, which would already be allocated to the care, are not taxed. This helps reduce out-of-pocket costs by allowing people to pay for dependent care expenses using tax-free money.
The primary benefits of a Dependent Care FSA include:
- Increases take-home pay
- Reduces your total tax amount
- Lowers out-of-pocket dependent care expenses by an average of 30% (your exact amount depends on your income tax bracket)
- Easy to set up and manage the account
Use this online FSA savings calculator to see how much you can save each year.
Who Should Sign Up for a DCAP?
While a DCAP can be very beneficial for people with young children, most likely Gen X or Millennial parents, a Dependent Care Assistance Plan can also be useful for people who are taking care of dependent adults. This can include older parents, spouses, or other dependents over age 13 who would not be able to care for themselves without help.
Dependent Care FSA Eligible Expenses
As with HSAs, FSAs, and other tax-advantaged accounts, the IRS places restrictions on how the funds can be used. With a DCAP, the tax-free money must be used on eligible dependent care expenses for children under the age of 13 and dependent adults while you and/or your spouse are at work or going to school. Otherwise, the money will be considered taxable and will have to be included as earned income on your annual tax returns. See the lists below for eligible and non-eligible dependent care expenses.
DCAP Eligible Expenses*
- Nursery school and preschool
- Before or after-school programs
- Daycare for eligible children
- Summer day camp
- Babysitting and nanny expenses
- Sick child care
- Registration fees for eligible dependent care
- Au pair
- Work-related babysitting in yours or someone else’s home by a non-tax dependent relative
- Transportation to and from eligible care
- Work-related custodial elder care
- Adult day care center
- Care for a spouse or relative who is physically or mentally incapable of self-care
Non-qualified Dependent Care Expenses*
Some dependent care expenses that cannot be reimbursed by a DCAP include:
- Babysitting for non-work purposes
- Custodial elder care for non work-related purposes
- Educational, learning, or study skills services
- Field trips
- Housekeeping services
- Medical care
- Meals or snacks
- School tuition
- Overnight camps
*These lists for eligible and non-eligible expenses are not all-inclusive.
Other Dependent Care FSA Considerations
In addition to having a basic understanding of eligible expenses, the following information can be useful when considering a DCAP:
Signing up for a Dependent Care FSA
You can enroll in a DCAP during two specific windows. The first is during your company’s annual enrollment period (generally sometime between October and December). The other is if you experience an approved “life event,” that allows for mid-year enrollment. This can include marriage, divorce, a legal separation, birth of a child, adoption of a child, or other changes that could impact your need for dependent care.
Annual contribution limits
In 2021, the maximum amount you can contribute to a Dependent Care FSA is $10,500 per household, per year; for those married and filing separately, the limit is $5,250. Remember, this money is contributed tax-free, so it gets taken out of your paycheck before taxes.
Use the money or lose it
Unused DCAP funds do not roll over to the coming year, unlike healthcare FSAs and HSAs. Therefore, any unspent funds left in your DCAP at the end of the year will be forfeited to your employer. You can use these tips to help you estimate how much to set aside.
All submitted Dependent Care FSA claims should include supporting documentation. Talk to your benefits administrator for their requirements. Generally, you will need an expense form signed by the care provider. The form should include the dependent’s name, the type of service provided, dates of service, the amount billed, and the provider’s name and address. Any claims submitted for ineligible expenses will be rejected by your benefits administrator.
Remember to save all receipts because the IRS may request them to verify the eligibility of your expenses. Make sure the receipts are legible and contain all the necessary information. Documentation that does not meet IRS requirements include credit card receipts, canceled checks, and balance forward statements.
DCAP or dependent care tax credit?
If you have two or more dependents, the IRS allows for a $6,000 federal tax credit for dependent care expenses. Since you can’t have both, you must choose either the DCAP or the tax credit. The option that provides the most savings depends on your household adjusted gross income. If it is less than $43,000, the federal tax credit may be the better option. If it exceeds $43,000, the DCAP will likely provide more tax savings.
DataPath, Inc. is a leading technology solutions provider for employer-sponsored benefits administration.