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How to use a Dependent Care FSA

Over the last few years, I have utilized a Dependent Care Flexible Spending Account (FSA) for our child care expenses.  2018 was not much different, except we struggled with our administrator and our daycare claims.  Based on those experiences I wanted to write about how these accounts work and some potential pitfalls.

What is a Dependent Care FSA?

So what is a Dependent Care FSA?  Essentially this is a Flexible Spending Account for child care expenses.    Like a Health Care FSA essentially you determine an amount of money each year during your employer annual enrollment to contribute to this account.   The amounts are then deducted from your paycheck tax-free across the year.   

Contribution Limits for a Dependent Care HSA

You can contribute up to $5000 dollars a year as a married couple or $2500 if single.  Note you can only claim up to the income of the lower-earning spouse, not a concern for myself but something to be aware.  Your spouse can’t make $100 with a  side hustle and then claim the credit for $5K.

Dependent Care FSA is Only for Working Adults

Throughout the year you utilize the money against dependent care expenses tax-free.   A pretty good deal even if it is a bit shy of the typical costs for dependent care.    Note both parents must work to get any type of dependent care tax credit from the government.  Any expenses must be for the purpose of allowing you and your spouse to work.

Child Care Tax Credit versus Dependent Care FSA

For those in the know you are probably asking but what about the child care tax credit?  Essentially you can also claim a credit somewhere between 20-35% of  $3K per kid or $6K per household as a credit for dependent care expenses.   The usage of the Dependent Care FSA decreases the amount you can utilize for the credit by the contribution amount.    So if you contribute $5K to the dependent care FSA then only 1K can be considered against the credit.  So on the surface, this seems like they cover similar areas.  Which one to choose?

Dependent Care FSA, the better solution for Middle Class and Above

Well the dependent care tax credit is a tax credit based on a percentage of the $3K or $6K amounts.    Those with an AGI below $43K collect 35% of the amount.  Those earning more than $43K get 20%. Meanwhile, the dependent care FSA is a tax deduction, so essentially it returns your marginal tax rate on the contribution amount in tax reduction.  This means the dependent care FSA is a better deal for those with an AGI over $77K at current tax rates as their marginal tax rate is above 20%.   This is also true for those with even lower brackets with a single kid, where the dependent care FSA allows the full 5K amount as tax-free, as opposed to the credit limiting the consideration to $3K per child.  

Our Experience with the Dependent Care FSA

 Historically we claimed the full $5K plus the $1K dependent care credit.  However, things changed when my wife became self-employed.  She now only works approximately ten hours a week.  Also, one of our children is now in kindergarten.  As such our expenses are limited.  We can only count daycare expenses needed for my wife to work (I work full time so my wife is the delimiter).    So the number is considerably less than $5K.

Estimating the Years Expenses

To calculate this for the year we determined she would work 2 days a week while our son was in preschool from 9-12.    We determined the cost to support her workload and that was our contribution in 2018.    Note you can calculate the amount in this manner regardless of whether the person works 2 days every week so long as such a setup would be required to support the weeks that they will do so.  IE if my wife works 2 days a week for 45 weeks of the year, the account can still cover the other 7 weeks if the facility requires you to book for the entire year.    So this rough approximation worked.

A Change in Our Contribution Amounts

Until it didn’t.  When we got to the summer of 2018 we determined she needed 3 days a week and 9-3 to get her work done.   This constituted a significant cost increase in preschool expenses.  Not to fear.  While you set your dependent care during open enrollment, the law allows you to adjust it for a life event.  Most but not all companies honor this provision for increasing amounts as well as decreasing.  What is a life event?  It could be the loss or gain of a job for either spouse.  It could be the birth of another child.   Or, in our case, it could be the increase in the cost of care to support work.  So in June, we increased our dependent care amount from $1700 to $3000.

Ambiguity and Hurdles Due to Increasing Contributions

And this is where we got into trouble without realizing it.  You see, increasing or decreasing the amount due to a life event does not just change the total amount for the year.  It essentially subdivides your funds.   So the expenses you incur before life event must go against money contributed pre-life event.  The amount after the life event must go for expenses after that event.  What this means seems to be rather vague based on the IRS’ web page. 

I found some companies administrators consider this to mean only your total planned annual contribution amount as set during annual planning is available for expenses before life event.   In that case, I could spend $1700 on expenses before June. My company meanwhile interpreted the law to mean the amount actually deposited before the event is all that is available for those expenses.  I didn’t find this out until I attempted to claim the January to May expenses of $900.  The amount in the account as of June 1 was only $600 so they declined part of my claim.  No big deal except I’d exactly calculated my needs for the year in resetting the amount to $3000.  I was going to be short.

Vague Rules, I’m Still Not Sure on Company Policy

I will pause before I continue to recount just how vague this ruling is.  I’m still not sure my administrators’ official policy is to only pay out the deposit amount.  I fought with them for months to get an explanation.  There were other issues with the claim and honestly the resolution did not make much sense in other ways.  So I guess what I’m saying is I might recommend against increasing dependent care FSA amounts mid-year using a life event.  I suspect many administrators (mine is one of the largest in the country) don’t know how to handle it.  It caused me hours on the phone with my plan provider to get things fixed.

How Did I Resolve My Under Expenses?

So there we are with $300 in missing expenses for our dependent care FSA.  This is a use it or lose it account, so if I didn’t spend $300 of the money my company would reclaim the amount.  There was no way I would allow that to happen, so I dug in and explored ways to claim the credit.

You can utilize a dependent care FSA to pay:

  • Care for a dependent under 13
  • Care for a disabled person over 13 who cannot care for themselves
  • Camps- so long as they are day camps for work related expenses.
  • Fees and deposits for said care

You Cannot Pull Forward Expenses for a FSA

You can also not claim the credit ahead.  IE. you cannot prepay January 2019’s expenses and claim against 2018.  Nor can you count reimbursed expenses, say if your employer pays part of your child’s daycare. So what did we do about the missing expenses?

Searching for Unclaimed Expenses

Well, we got lucky.  We had some expenses that we had not claimed for a day time summer camp during which time my wife worked.  First, we added these reducing us to $200 in missing expenses.  

Expense Tracking Requirements

In order to claim expenses, you need to make a verifiable effort to validate the identity by obtaining the provider’s tax information, name, and address.  In the absence of said information, you must prove you tried.  That provider must not be your dependent, if a relative must be over the age of 19, and must not be the parent of the child for which care is rendered.   We considered using amounts paid to a mothers helper employed earlier in the year to increase our reported expenses. That being said we could not find anything directly talking about the legality of utilizing a minor for the expense. We did find some random websites claiming it was not allowed. We ruled this avenue out rather than take the chance.

Note: We paid our helper only a few hundred for the few times she visited.  As such, she was under 18 and under income limits so the nanny tax was not applicable.  If you have an over 18 nanny that works in the home whom you pay over $2100 a year you must withhold taxes and contribute the employer half of social security and Medicare.  If they make more than $1000 a calendar quarter you must also withhold.  Over $600 and you owe them a W2.  Finally, in most states, you must pay unemployment insurance once this point is reached.    Needless to say, spending $200 on a mothers helper does not apply but these are all things to keep in mind.

Backup Plan for Dependent Care FSA Expenses

Thankfully we had a backup plan.  We essentially paid my mother to watch our kids for the period of the holiday break at the end of the year. This was time we would otherwise have needed her to watch the children anyway as my wife had deliverables due.  Given the amount was under the nanny tax amount this had limited additional tax ramifications.  My mother has to report the income on her taxes and pay the taxes plus self-employment amounts.  She’s in a lower bracket then we are so it’s not far off a wash to me paying the taxes in the first place and just gifting her the funds. Paying taxes on the missing $200 and providing the amount to my mother is better than losing the entire amount to my employer.  Thankfully it did not come to that.

Anyway, hopefully my experience here can help others as they navigate the world of dependent care FSA’s.

Do you have a dependent care FSA option t work?  Do you utilize it?

Full Time Finance is for Entertainment Purposes Only. Any tax moves you make are yours and yours alone. Remember to check all local state tax and federal laws before taking action. Consider talking to a Tax Accountant as necessary.

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