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Save Big With Dependent Care Benefits

If you're like me, you know a little about a lot of things. That and a dollar will get you a Slurpee at 7-Eleven (and not the biggest size, either). So I shouldn't have been surprised to learn a thing or two about dependent care benefits when going over the IRS' guidelines in Publication 503.

It turns out that having a child in preschool, a move that allows me to significantly increase my writing time and earn more money for the family, qualifies me for dependent care benefits. Why am I surprised? Because what I thought I knew about dependent care benefits was that they had to be used for babysitting or day care. The last time I looked at the IRS guidelines was when my first child was a baby. In other words, preschool wasn't yet on my radar.

That baby is now a rising first-grader, and my second child graduated from pre-K just a few weeks ago. Between the two of them, they logged in five years of preschool at a price tag of approximately $9,000. Had my husband and I used the benefits available to us -- either child care tax credits or dependent care flexible spending -- we could have saved upwards of $2,700. Ouch.

But all is not lost. Our youngest begins preschool this fall, just in time for Mom to do more work from home. You can bet that my husband and I will be using dependent care benefits or the child care tax credit this time around, as well as looking for other tax breaks that may benefit our growing family.

Here's an introduction to Dependent Care Flexible Spending and the Child Care Tax Credit designed to get you asking the right questions before it's too late.

Dependent Care Flexible Spending
A Dependent Care Flexible Spending Account (sometimes referred to as a reimbursement account) allows you to have money set aside from your salary, pre-tax, each pay period in order to get reimbursed for eligible expenses related to the care of your dependents. Eligible expenses include those that allow you or your spouse to work, look for work, or attend school full-time. The cap is $5,000 for single heads of household or folks who are married and filing jointly. Here are some other aspects of flex spending accounts to consider:

  • You must open a Dependent Care Flexible Spending Account during the annual enrollment period. To make any changes to the amount you're having deducted, or to enroll outside of that window, you'll have to meet the criteria for a "qualifying event." Check with your HR representative to find out if you qualify.
  • Unlike a health-care flexible spending plan, you cannot get reimbursed for an expense that is greater than the amount you currently have set aside in your account.
  • Flex spending plans work under the use it or lose it principle, which means that if you haven't spent the total amount by the deadline and requested reimbursement, you can say goodbye to the money. Therefore, your calculations to determine how much to set aside need to be as accurate as possible.

Child Care Tax Credit
The Child Care Tax Credit allows you to apply up to $3,000 of expenses paid in a year for one qualifying individual, or $6,000 for two or more qualifying individuals, to your taxes through the Dependent Care Tax Credit. In order to claim the credit, you must fill out Form 2441: Child and Dependent Care Expenses when you file your federal return.

  • To take the Child Care Tax Credit, you don't have to fill out any enrollment forms or have money taken out of your paycheck. You do have to file your federal tax return by the IRS deadline, however.
  • The use it or lose it rule doesn't apply because none of your money has been taken from your paycheck outright.
  • Since the amount of the credit is based on your adjusted gross income, folks in higher tax brackets may be able to save more under the flex spending program.

Which one should I choose?
The answer to this question depends entirely on your family's adjusted gross income, your tax bracket, and how many dependents you have. Take a look at this worksheet designed to help figure out which benefit will save you the most money, then check with your tax advisor to see what works best for your particular situation.

Next steps

  • Contact your HR representative for details regarding your eligibility for flex spending plan options.
  • Talk to your tax advisor about which option -- Child Care Tax Credit or Dependent Care Flex Spending -- can save you the most.
  • Read the IRS' publications to determine the myriad dependent care expenses that are eligible for reimbursement. You, like me, may be surprised.

This article is adapted from theMotley Fool Green Light "Money Answers" archive, which features more than 100 articles on personal finance topics such as taxes, credit, and beginning investing, organized by subject and life stage. For access to this content -- plus the current newsletter, back issues, members-only discussion boards, and advisor blogs -- take a free 30-day trial today!  

Fool contributor Elizabeth Brokamp is a licensed professional counselor who regularly talks money with her honey, Robert Brokamp, editor of The Motley Fool'sRule Your Retirement newsletter. The Fool has a disclosure policy.


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