Personal Finance

Childcare costs hit new heights. This employee benefit can help you save $5,000

Key Points
  • Working parents can use the child and dependent care credit, which is worth up to $1,050 for one child under 13 or $2,100 for two or more kids under 13.
  • You might have access to a dependent care flexible spending arrangement at work: Save up to $5,000 each year per household on a pretax basis.
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Childcare costs are approaching the level of college tuition in some parts of the country, but this fall your employer might offer you a way to save.

Say hello to the dependent care flexible spending arrangement or FSA. This account allows you to save up to $5,000 each year per household on a pretax basis.

Assuming your child is under age 13, you can use the money to cover daycare and before- or after-school care expenses, as well as care at home.

Nearly 9 out of 10 large companies offer dependent care FSAs to their workers, according to the National Business Group on Health, a trade association that represents large employers.

The dependent care FSA can take the sting out of the rising cost of childcare, which continues to climb annually.

The national average cost of care for one child is about $9,000, according to Child Care Aware of America.

See below for the least affordable states for center-based infant care in 2017.

Here's what you should know about workplace perks and tax credits that can help offset the cost of childcare, and which ones might be right for you.

"You might have to run some scenarios to see whether the FSA or the tax credit is more beneficial," said Harjit Virk, a CPA with Getzel Schiff & Pesce.

Dependent care FSA

Dependent care FSAs differ from the health FSAs you may already be familiar with in a number of ways.

For instance, you can also fund a health FSA with pretax dollars, but employees are subject to a contribution limit of $2,650 in 2018. These funds can be used for out-of-pocket medical costs.

Leftover balances in both the health and dependent care FSA are subject to "use it or lose it" provisions at the end of the year.

Employers may allow workers a 10-week grace period at the end of the year to spend down leftover health FSA funds or they may permit employees to carry over a balance of up to $500 into the next year.

This isn't the case for dependent care FSAs, however: If you don't use all of the cash by the end of the year, you forfeit the money.

These accounts are just one of the tax-friendly ways to help cover childcare expenses

Dependent and child care tax credit

If you want to claim this tax credit, you have to come clean to the IRS first
If you want to claim this tax credit, you have to come clean to the IRS first

You should also know that there is a dependent and childcare tax credit for working families.

Depending on your adjusted gross income, you can claim a maximum of $1,050 for one child under age 13 or $2,100 for two or more kids under 13.

In order to nab this break, you need to have the taxpayer identification number of the person or center providing your childcare.

The arrangement you have with your caregiver must be considered above board by the IRS in order for you to claim the credit.

Not only are you ineligible for the credit if you're paying your nanny under the table, you're also running the risk of owing Uncle Sam back taxes and penalties.

In fact, if you pay your nanny or sitter more than $2,100 in 2018, then it's up to you to withhold Medicare and Social Security taxes. This equates to 15.3 percent of wages and is split between the worker and the employer.

Decide what's best

Mike Kemp | Blend Images | Getty Images

Given the option, you can take the FSA or the tax credit, but you should know that you can't use both of these breaks to cover the same expenses.

In general, the FSA is a better deal for families in higher income tax brackets because savers are reducing their taxable income by making the contribution.

That means they subject less of what they earn to taxes.

"The FSA plan is a deduction against your income, so it depends on your tax rate," said Julie Welch, CPA and member of the American Institute of CPAs personal financial planning executive committee.

"The dependent care credit on the other hand reduces your taxes," she said.

Here are the rates for single filers:

Rate Taxable Income Bracket
10%0 to $9,525
12%$9,525 to $38,700
22%$38,700 to $82,500
24%$82,500 to $157,500
32%$157,500 to $200,000
35%$200,000 to $500,000
37%$500,000 and up

These are the rates for married joint filers:

Rate Taxable Income Bracket
10%0 to $19,050
12%$19,050 to $77,400
22%$77,400 to $165,000
24%$165,000 to $315,000
32%$315,000 to $400,000
35%$400,000 to $600,000
37%$600,000 and up

A family in the 12 percent income tax bracket that contributes the maximum $5,000 to an FSA reaps $600 in federal income tax savings.

On the other hand, that family could be in line for a credit of up to $1,050 for one child or $2,100 for two or more kids.

Consider your total childcare expenses and your household income before you commit to funding a dependent care FSA.

"It's worthwhile to look at your tax situation and what works better, especially now that all of the rates have changed," said Welch.

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