As the cost of childcare continues to increase, more and more parents and guardians are looking for ways to reduce this cost. So, the IRS has a credit that can help offset some of the costs, and it’s called the Child and Dependent Care Credit.

So how much can someone actually save by taking this credit?

It’s really going to vary, because the credit is somewhere between 20 percent to 35 percent of qualified expenses paid, and those expenses can be up to $3,000 for one child or $6,000 for two [or more].

So let’s say that you have two children and you have the maximum 35 percent credit; it could be a $2,100 credit for those two children.

Now, if the person uses their employer’s cafeteria plan, then up to $5,000 of expenses can be used, even with one child (where if you just used the credit you can only have up to $3,000 of expenses).

So who is actually eligible to take this credit?

So anyone with a qualified individual. And when you think of a “qualified individual,” it’s going to be:

  • A dependent under age 13
  • A spouse who can’t take care of themselves
  • Some other kind of disabled individual

One of the things with this credit is that the parent or the guardian must have earned income, and if somebody’s married, they must both have earned income, because this is called the “dependent care credit,” which means that you need someone else to watch your child while you’re working or doing other things; so that’s the reason why both must have earned income.

Right. But what expenses can they actually use this credit for?

It’s kind of all over the place:

  • Daycare, nursery school and babysitters count
  • Preschool before kindergarten (like 4K) counts
  • But kindergarten, first grade, second grade, all the way up … those costs of schooling do not count
  • But if you have to take your child before or after school for those programs, those count (so school doesn’t count, but the before and after care counts)
  • Summer school does not count
  • Private tutoring doesn’t count
  • Overnight camps do not count, but if it’s a day camp, that does

I don’t understand how or why one does and one doesn’t; that seems very complicated.

It’s one of those things where you really have to kind of look at all your expenses and talk to somebody who’s truly a professional and knows this area to say “yes” and “no.”

So how can a family actually take advantage of this? What do they have to do?

You can do one of two things:

  1. You can either take the credit on your tax return.
  2. Or you can use your employer’s cafeteria plan.

And sometimes you can use a combination of both!

So do you have any tips for people if they decide which option is better for them?

Sure:

Tip #1

So if you have access to a cafeteria plan at work, this is most likely the best option, especially if you have just one child. Because like we talked about before, if you’re going to take the credit, the credit is only available on the first $3,000 worth of expenses, where if you take your cafeteria plan you can use up to $5,000 of expenses for one child. And, you know, with the cafeteria plan, you actually not only save income tax, but you also save on Social Security tax and Medicare tax.

Tip #2

If both spouses are working and both have access to a cafeteria plan, then I would use the cafeteria plan of the lower-paid employee. And the reason for this is—because like I said earlier—you can save income taxes, Social Security and Medicare taxes. Let’s say that the higher-income spouse is already above the Social Security limit. Well if you use it with that particular employer, you’re only going to save income tax and Medicare, you’re not going to save the Social Security, because they’re already over the limit. So it makes sense to—in general—use the lower of the two income (W-2 wage) persons.

Tip #3

If you have two children in daycare, then I would say families should use the cafeteria plan and take the credit for the rest.

Once, again, a lot of different ways … and you really need a professional!

 

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Jeff Dvorachek
I joined Hawkins Ash CPAs in 1998. I am the partner-in-charge of the Manitowoc, WI, office and tax director for the firm. I have thorough experience providing tax services to individuals, commercial businesses, nonprofit entities and estates and trusts. I also provide compilation and review services. I lead the Tax Committee and am a member of the Information Technology Advisory Committee.

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