When you hear ‘tax law change’ you probably freak out and start imagining the IRS taxing your food, or possibly your water, or maybe your 1967 Chevelle you just purchased (oh wait, the IRS already taxes all of those!). Well, don’t fret, because the IRS has good news this time. Read on for a very simple way to lessen the financial blow of childcare (no, it’s not putting your kids up for adoption).
The American Rescue Plan
I think most people are familiar with this due to the national news coverage of the 3rd round of stimulus checks. It also extended the federal unemployment benefits and made some other key changes that provided some relief to the lower class. But what most people don’t realize, is that this plan allowed a huge deferral of taxes for money used to pay qualifying child care expenses. Heck, a good portion of society still doesn’t know that Dependent Care Flexible Savings Accounts, or DCFSAs, even exist. Well, now you do! This rescue plan also increased the amount of the child and dependent care tax credit, which tons of people haven’t heard of either. Remember, an educated taxpayer is less of a taxpayer.
These are amazing savings vehicles. Realistically, you avoid paying taxes on money that you would be spending no matter what. That’s right, you can pay less taxes on the money you give to your child care provider. Granted, the provider has to be legitimate and have a taxpayer identification number, but would you expect anything less from the IRS? The American Rescue Plan increased the annual contribution limit from $5,000 to $10,500 per year. That is more than DOUBLE! For the average American, the original tax savings on the $5,000 limit would have been approximately $1,100. With the new limit, the average parent can expect to save $2,300 in 2021. That’s right, $2,300 for doing the exact same thing you would be doing anyways. Note that this change only applies to the 2021 tax year as of the time of this writing.
You’re probably wondering if it’s really as easy as I claim. For the most part it is, but as with anything else the IRS is involved in, there are some extra steps. First off, you can only utilize a DCFSA if your employer offers it. BUMMER. If they do offer a plan, you’ll choose your annual contribution amount which will be drafted from your paycheck in equal installments. Once the money arrives at the vendor, you’ll need to retrieve it in order to pay for qualified expenses. Most providers allow for a “pay me back” claim, or a “pay my provider” claim. In my case, I always choose the “pay me back” option, and the money is back in my bank account about 3-4 days after my normal payday. Not too bad for $2,300 in annual savings.
The child and dependent care tax credit
This was one of the trickier tax credits to begin with, as it has a complicated phaseout and individuals should calculate the difference between it and the previously mentioned DCFSA. This credit allowed individuals a 20%-35% credit of child care expenses on up to two children. The maximum credit was 35% of $3k of expenses for one child, and 35% of $6k of expenses for two children. This tax year, the maximum credit is raised from 35% to 50%, and the maximum qualifying expenses to be claimed are raised to $8k and $16k, for one and two kids, respectively. This puts the top credit for 2021 at $4k and $8k. Keep in mind you’ll only get the full credit if your household income is less than $125k. Once you exceed this, you’ll experience a phaseout up to $440k. Couples earning over $440k will experience a further phaseout before losing the credit altogether.
Where to get started
First thing’s first, contact your HR department to see if a DCFSA is offered by your employer. If it’s not, perhaps you should ask if they can add it. Either way, you should crunch the numbers to see if the DCFSA or child and dependent care credit is better for you. If you have really high child care expenses that exceed the amounts of both of these tax advantages, you could actually be eligible for both. So be sure to read up before tax season.
If a DCFSA is offered, you should crunch the numbers to see what your annual child care expense is. For us, we spend about $20,000 per year, which is clearly over both the $5,000 and $10,500 contribution limits. Once you have this figured out, you’ll want to ensure your provider has a taxpayer ID number. If you ask them, they should be able to provide this pretty easily. Now all you need to do is wait until your account funds, submit a claim for reimbursement which includes a receipt or letter from the provider, and enjoy your new found tax savings!
Note: employers are not required to honor the increase as authorized by the American Rescue Plan. You’ll want to check with your HR Department to see if this applies to your plan.
Here at the Wealthy Idiots, we’ll continue to bring you tax savings that you have never heard of. After all, why should we pay more than our fair share?