Written by Timalyn Bowens, EA Published on April 5, 2022
Key takeaways:
- A dependent care FSA (DCFSA) allows qualified individuals to pay for child and dependent care expenses completely tax-free, up to a certain limit.
- The money that you contribute to the account lowers your taxable income for the year, but you must use DCFSA funds within a certain period of time.
- You can contribute to a health savings account (HSA) and dependent care FSA at the same time.
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Millions of employees have access to health and dependent care benefit programs sponsored by employers. Dependent care flexible spending accounts (DCFSAs) are one of these programs. They help ease the burden of child care costs.
A dependent care FSA allows individuals to use pretax dollars to pay for qualified dependent care expenses. The money you contribute to your DCFSA can reduce your taxable income, but you must use the funds within a certain period of time. This account follows the popular “use-it-or-lose-it” rules like other FSAs.
Below, we’ll explain how a dependent care FSA works and how you can make the most of this type of account.
What is a dependent care FSA?
A dependent care FSA is a tax-advantaged account used to reimburse out-of-pocket dependent care expenses. You will not have to pay taxes on the money you put into the account. It is also a cafeteria plan, which means the employer writes and maintains it for the employee. The IRS excludes the benefit of this type of plan from taxable income.
This account is not pre-funded by employers, like other FSAs. This means that participants don’t have access to the full amount of funds they plan to contribute at the beginning of the year. They cannot use the benefits until they have that amount in their account.
Individuals who participate in this dependent care benefit authorize their employers to withhold a certain amount of money from their paycheck each pay period for the account, similar to having a health FSA.
Who gets a dependent care FSA?
Working adults whose employers offer cafeteria plans may get a dependent care FSA. This account is only available if you pay the expenses of a dependent under the age of 13, a spouse, or an adult dependent who is unable to care for themselves.
Married couples are generally only allowed to use a dependent care FSA if both spouses are working or actively looking for work. Therefore, benefits are not available for a stay-at-home mom or dad. There is an exception if the parent is not working due to a disability or educational training as a full-time student. Only the parent with custody of the child can use FSA funds for child care if the couple is divorced.
Self-employed individuals cannot open a dependent care FSA. However, they can take advantage of the benefits if their spouse participates in an employer’s plan. They may also qualify for a similar account: dependent care assistance program (DCAP).
How is a dependent care FSA deducted?
Dependent care FSA contributions are pretax money set aside from the participant’s paycheck each pay period. This amount, plus any employer contributions, are excluded from income under Section 125 of the Internal Revenue Code. This reduces the amount of income that is subject to income tax.
The deduction is limited to the smallest of:
- Total amount of dependent benefits received during the year
- Total amount of qualified expenses incurred that year
- Earned income
- The maximum amount allowed under your dependent care plan
For example: Juli’s employer offered her a dependent care FSA to pay for her son’s child care expenses in 2019. The maximum amount she was allowed to contribute under her plan was $5,000. But Juli can only deduct $2,350, because that is the amount she contributed to the account. She has to take the lesser of her contribution and the maximum amount allowed for her deduction.
The American Rescue Plan Act increased the maximum amount of dependent care benefits to $10,500 for 2021. This means an eligible family can deduct up to $10,500 in dependent care benefits on their 2021 tax return. The maximum deduction went back to $5,000 per household ($2,500 for a married filing separately return) in 2022.
If the DCFSA funds are not properly spent, your account administrator may deny your claim for reimbursement. This means the funds are forfeited, and taxes will have to be paid on the amount spent.
Below is a table that shows a list of qualified and nonqualified dependent care expenses.
| Qualified dependent care expenses | Nonqualified dependent care expenses |
|---|---|
| Before- and after-school care | Private school |
| Day camp | Overnight summer camp |
| Nanny/babysitter so you can work | Nanny/babysitter for date night |
| Adult day care services by qualified caregiver | Companion care |
| Application fees and deposits for care | Tutoring application fee |
| Physical care | Enrichment lessons for recreational activities such as music and sports |
Is a dependent care FSA use-it-or-lose-it?
Yes. Your DCFSA funds will expire if they are not used by the end of the year. That’s typically the case with money that you contribute to an FSA. Some plans, like a healthcare or limited purpose FSA, will allow an extension or carryover.
Dependent care FSAs typically do not allow carryovers, but they do have a grace period. This gives individuals 2.5 months — 90 days past the end of the year — to submit receipts for reimbursement.
An exception was made for dependent care FSAs to have carryovers under the Taxpayer Certainty and Disaster Tax Relief Act. It allowed individuals to carryover unused funds from 2020 and use them in 2021 if their employer allowed it.
Can I pay a babysitter with a dependent care FSA?
Yes. You can pay a babysitter with a dependent care FSA if their service meets certain criteria.
The IRS defines eligible dependent care services as those that are necessary for the person to work or actively look for work. This can be working for someone else or in your own business. It also includes working from home. Eligible babysitting costs do not include:
- Date night
- Family vacation
- Other recreational activities (working out, lunch, personal appointments)
How can I use up my dependent care FSA?
You can use your dependent care FSA to pay for child care for your child younger than age 13 who you claim on your taxes. If your spouse is unable to work or care for themself, you can also use your dependent FSA to reimburse those expenses. The dependent care FSA can also be used to care for other adult dependents unable to care for themself. These individuals must also meet the criteria for you to claim them as a dependent on your tax return.
The table below shows a list of qualifying dependents and type of expenses that are eligible for reimbursement through a dependent care FSA:
| Qualifying dependent | Type of care |
|---|---|
| Child 13 or younger | Babysitting, day camp, before- and after-school care, au pair, nanny |
| Disabled qualifying relative | Day care, day camp, home care services, and au pair |
| Spouse unable to work or care for themself | Adult day care and home care services |
| Adult child unable to work or care for themself | Adult day care, group home, and home care services |
How do I report dependent care FSA on my taxes?
You report dependent care FSA benefits on Part III of Form 2441, Child and Dependent Care Expenses. This form is also used to figure out the amount of the child and dependent care tax credit. The tax benefits received from your dependent care FSA will reduce the amount of the tax credit that you are eligible to receive. This is why Part III is completed first. It is important to talk with your tax professional to see if the tax credit or FSA will be more beneficial.
Do I need a receipt for dependent care FSA?
Yes. You need a receipt from your dependent care provider. This receipt serves as a statement that you turn in to your FSA provider for reimbursement. This statement must have specific information about the care they provided. The statement must note the following:
- Dependent’s name
- Provider’s name
- Date of service
- Type of service
- Amount paid for service
It’s important to contact your FSA administrator to determine how dependent care FSA reimbursements are handled.
Can you contribute to an HSA and dependent care FSA?
Yes. You can contribute to a health savings account (HSA) and dependent care FSA at the same time. Both healthcare plans use pretax dollars to pay for expenses.
Every dollar that you contribute to a health savings account allows you to pay for qualified medical costs tax-free. A dependent care FSA reimburses individuals for qualified dependent care expenses. Contributing to both accounts allows plan participants to lower their taxable income.
For example: Larry, a 37-year-old employee, contributes the maximum amount ($3,650) to his individual HSA in 2022. Larry has a 10-year-old daughter from his previous marriage who he is the custodian for. Larry’s job offers him a dependent care FSA to help reduce the cost of child care. Larry decides to contribute the most that he can in 2022, which is $5,000. This will reduce the amount of money that he pays taxes on by $8,650 ($3,650 + $5,000).
The bottom line
You can reduce your taxable income by using a dependent care FSA to pay for qualified dependent care expenses. If your funds are not spent properly, you will have to pay taxes on them. You must use all your dependent care FSA funds within a certain period of time, or you will lose them.
Dependent care FSA comes with many benefits, but it’s best to review your needs and tax situation to determine if this account is best for you.
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