There are two popular household employer tax breaks for families to make care more affordable. A family may only use up to $6,000 paid to a nanny or senior caregiver (qualified expenses) in any particular year. These tax breaks are not income-restricted. They do require, however, that both spouses must pass the “work-related expense test.” You (and your spouse if filing jointly) need to be employed or be a full-time student and the care must be for a qualified dependent. Additionally, the family must report and pay taxes on the nanny’s or caregiver’s wages to be eligible for either tax break.
And starting in 2018 there is a third tax break – the Child Tax Credit. This is not related to the two credits mentioned above.
To be eligible for the IRS child care tax credit, there are a number of ‘tests’ that must be met. The main factors are: 1) the nanny or caregiver must be employed to care for a qualifying person (your dependent child under 17, disabled spouse, or other qualified disabled dependent); 2) you (and your spouse if married) must have earned income; and 3) the nanny’s care must be required so you can work.
» More Details: IRS Topic No. 602 Child and Dependent Care Credit
The Dependent Care Account is a pre-tax expense account that may be used to help pay for dependent care expenses that are necessary for the parents to work. To participate, the accounts must be offered by the parent’s employer as part of flexible benefit plans. The family must elect to participate during the annual ‘open season’ benefit enrollment period and specify the amount to be deducted from the payroll on a pre-tax basis. The family maximum contribution is $5,000. These amounts are sheltered from Federal income taxes and most state income taxes (New Jersey and Pennsylvania tax these amounts). A family with adjusted gross income of $200,000 per year could save ~$1200 in Federal Taxes, and perhaps another $250 – $700 in state income taxes.
» More Details: IRS Publication 929
New for the 2023 tax year–Per the IRS website, the temporary special rules for dependent care flexible spending arrangements (FSAs) have expired. Families should pay attention to the fact that the temporary special rules under Section 214 of the Taxpayer Certainty and Disaster Relief Act of 2020 that allowed employers to amend their dependent care plan to carry forward unused amounts from 2020 and/or 2021 to be used in a subsequent year have expired. For 2023, you may only enter on Form 2441, line 13, amounts you carried over from 2022 and used in 2023 during the grace period. See the line 13 instructions for Form 2441. (Source: IRS 2024)
» More Details: IRS Publication 503
Because the Internal Revenue Code allows families with 2 or more dependents to itemize up to $6,000 of dependent care expenses, if you use $5,000 for your Dependent Care Flexible Spending Account, you may have an additional $1,000 in excess expenses that can be claimed on Form 2441. This will save most families an additional $200 per year off their tax bill.
A nanny or senior caregiver provides childcare and is a contributing member of a household, not a business. Business owners may directly deduct wages, payroll taxes, and certain benefits provided for the businesses’ employees from their business income. Families do not have the ability to do the same on their personal income tax return. A family may only use the two techniques above to use in-home care expenses to reduce their income taxes.
Beginning in 2108 there is a third tax break – the Child Tax Credit. The Child Tax Credit is given to taxpayers for each qualifying dependent child who is under the age of 17 at the end of the tax year. Legislation passed in December 2017 doubled the credit to $2,000 per child and made $1400 of it refundable. This tax credit is phased out over adjusted gross income of $400,000 for married couples and $200,000 for single, head of household and qualifying widow(er) filers.
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