For many Americans, the costs of child care and other dependent care are burdensome expenses that can quickly add up. The high expense may keep caregivers from working and potentially force them to stay home and save.
Fortunately, there are ways to offset these costs by reducing your tax obligations. The dependent care flexible spending account (DCFSA) is one way to do that. Read on to find out how it works and whether you qualify for one.
- A dependent care flexible spending account (DCFSA) lets you contribute pre-tax earnings toward qualifying caregiving expenses.
- You pay out-of-pocket for caregiving expenses and get reimbursed through the DCFSA plan.
- Only certain expenses can be reimbursed, and they must be directly related to professional caregiving services that allow you to work, look for work, or attend school full-time.
- There is an annual cap on how much you can contribute toward a DCFSA.
- DCFSA funds are use-it-or-lose-it, meaning funds that haven’t been spent at the end of the year don’t roll over for you to use the following year.
What Is a Dependent Care FSA?
A dependent care flexible spending account (DCFSA) is an employer-provided, tax-advantaged account for certain dependent care expenses. Its goal is to help cover the costs of providing professional care so that the caregiver can work, look for work, or attend school full-time.
“The benefit of these accounts is twofold: They can provide significant cost savings for employees as well as employers,” Pauline Roteta told The Balance in an email. Roteta is the founder and CEO of Pasito, a family care financial management software company.
During a company’s open enrollment period or another qualifying event, an employee can elect to contribute a portion of their salary into the account pre-tax. Employers save money because the DCFSAs are funded through pre-tax payroll dollars; they also don’t pay Social Security or Medicare taxes on employees’ contributions to those accounts.
A dependent care flexible spending account is also known as a Dependent Care Assistance Program (DCAP). It shouldn’t be confused with a health care flexible spending account, which is used to cover an individual’s qualifying medical expenses.
There are a number of employees who can benefit from opening a DCFSA. “A parent with a child, someone with an older parent who is a dependent and lives in their home, or an individual caring for a disabled dependent would all likely qualify,” Roteta said. “But it is important to walk through eligibility with a certified professional.”
How a Dependent Care FSA Works
Dependent care FSAs are set up through your employer. You decide on the amount of money you want to contribute to the account each pay period. Those funds are then automatically withheld from your paycheck and deposited before taxes are deducted. Your employer may also contribute to your DCFSA. (Contact your human resources department to find out if this benefit is offered.)
When it comes to using the money in your DCFSA, you first have to pay for qualifying expenses out-of-pocket and then get reimbursed. This involves submitting a claim form provided by your employer along with the necessary documentation, including a receipt for the expense and proof that you already paid it. A few key pieces of information need to be included for your reimbursement to be granted:
- Your name, address, and signature
- Start and end dates for the service you want reimbursed
- Your dependent’s name and relationship to you
- Description of the service
- Amount you want reimbursed
Credit card receipts, non-itemized cash register receipts, and canceled checks won’t be accepted as proof of purchase for DCFSA claims.
Not everyone is eligible for a dependent care FSA. A few factors that can impact eligibility include the age of the dependent, your relationship to that person, and the types of expenses incurred.
The first step in determining whether you’re eligible for a dependent care FSA is figuring out whether the dependent in question is considered a qualifying person by the IRS. The answer is yes if they meet any of these definitions:
- Qualifying child: your legal tax dependent who was under age 13 when the care was provided.
- Spouse: a spouse physically or mentally unable to care for themself who lived with you for more than half the year.
- Another dependent: a dependent who wasn't physically or mentally able to care for themself, lived with you for more than half the year, and either was your dependent or would have been your legal dependent except that:
- They earned a gross income of $4,300 or more
- They filed a joint return
- You or your spouse (if filing jointly) could be claimed as a dependent on someone else's annual tax return
If you are divorced or separated, the IRS has special rules for who gets to use a dependent care FSA to pay for care-related expenses.
Not all expenses can be covered using a dependent care FSA. The key is that the account funds are used to cover care-related costs that allow you to work, look for work, or attend school. Examples of qualifying services include:
- Before- and after-school care (but not tuition)
- Babysitters, nannies, and au pairs
- Day care for adults
- Late pick-up fees
- Licensed day care centers
- Nursery schools or preschools
- Placement fees for a dependent care provider
- Day camps
Some examples of expenses that would not be eligible for reimbursement from your DCFSA include:
- Advance payment of services that have not been provided yet
- Educational expenses, such as tuition fees, summer school, or tutoring
- Food, lodging, clothing, education, or entertainment (unless amounts paid for these items are incidental to and can't be separated from the cost of care)
- Late payment fees
- Medical care
- Overnight camp
- Registration fees
- Transportation expenses unrelated to getting to and/or from the site of care
The IRS does limit the amount of money you can contribute to a DCFSA each year. The annual contribution maximum was $5,000 for single filers and married couples filing jointly until the pandemic hit, Roteta noted.
“However, the government gave employers the option to increase that amount…this past year due to the spotlight on care-related needs and expenses during the pandemic,” she said.
Thanks to the American Rescue Plan Act, single and joint filers could contribute up to $10,500 into a dependent care FSA in 2021, and married couples filing separately could contribute $5,250 (up from $2,500). Employers can choose whether to adopt the increase or not. For 2022 and beyond, the limit will revert to $5,000.
Your Money Doesn’t Roll Over
Unlike a health savings account, unused money in a DCFSA generally doesn’t roll over to the next year. Your employer may offer a grace period of two-and-a-half months into the new year to use up your funds before they expire.
The exception is for plan years ending in 2021 and 2022, as COVID-19 relief measures allow employers to permit account holders to carry over their unused funds into the next year.
Dependent Care FSA vs. Child Care Tax Credit
You have another option for saving money on dependent care expenses via lowering your taxable income: the child and dependent care tax credit. Similar to a DCFSA, the credit only applies to expenses that are necessary for you to work (unless you’re disabled or a full-time student).
The credit is awarded based on your income and a percentage of the expenses you incur while caring for a qualified person for the year. For 2021, the American Rescue Plan Act raised the maximum taxpayers can receive: up to $4,000 for one qualifying person and $8,000 for two or more qualifying people. It’s also potentially refundable, meaning you might not have to owe taxes to claim it.
The child and dependent care tax credit may be a good option for families who don’t have access to a dependent care FSA or those with lower adjusted gross incomes. There is no danger of losing money. For high-earning families, a DCFSA may provide more substantial savings.
Using a Dependent Care FSA for Elderly Parents
Though many DCFSA holders use their funds to pay for child care costs, it can also help cover expenses related to caring for an elderly parent.
You need to meet a few qualifications. First, your parent must have lived at home with you for more than half of the year. You can also claim them as a dependent (or would be able to if it weren’t for the exceptions outlined above). Your parent must be incapable of caring for themself. Finally, the expenses you incurred must be directly related to helping you go to work, look for work, or go to school full-time.
How To Enroll in a Dependent Care FSA
“Timing is also a factor in determining whether or not an employee can contribute to a Dependent Care FSA,” Roteta said.
Typically, employees are only allowed to set up or make changes to their DCFSA plans during open enrollment or if they experience a qualifying event (such as getting married or giving birth) outside of the company-wide enrollment period.
Frequently Asked Questions (FAQs)
How much should I put in a dependent care FSA?
If you participate in a DCFSA, budget carefully so you don’t over-contribute and end up losing money at the end of the year. You should look back at your bank account and credit card statements from the past couple of years and add up how much you’ve spent on dependent care. Use that number to come up with an estimate. Keep in mind that you can’t contribute more than the annual maximum.
Who can have a dependent care FSA?
Only certain people are eligible for a dependent care FSA. To enroll, you need to meet the following qualifications:
- You and your spouse work or are looking for work (unless your spouse has a disability that prevents them from working).
- Your employer offers this plan.
- Your dependent is a qualifying person according to IRS criteria.
- You incurred qualifying expenses.
Should I use an FSA or the child care tax credit?
Whether you should use an FSA or the child care tax credit depends on your care needs and financial circumstances. But it’s not necessarily an either-or decision. You can often use both if you don’t double-dip. For instance, if you contribute the maximum allowed to a DCFSA and you incur more expenses beyond that maximum, you may be able to claim the difference on your taxes to receive the credit.